The U.S. rate of inflation through August 2015 is just 0.2%. It has been declining for the last four years. Yet generic drug prices are rising? Why? Today, and in future posts, we’ll discuss the factors contributing to the rise of generic drug prices.
Devon M. Herrick of The National Center for Policy Analysis says the average cost of a name-brand prescription was $268 in 2011, but only about $33 for a generic drug. The price of generic drugs is usually quite low due to intense competition. In 2011, the average cost of a name-brand prescription rose nearly 18% while the average cost of a generic drug fell by 7%. But recently that trend is changing.
Generic Drugs – A Healthcare Bargain
To be sure, generic drugs represent a true healthcare bargain when compared to other treatments. Generic drugs are usually 85 to 90% cheaper than their name-brand counterparts prior to patent expiration.
Americans consume nearly $3 Trillion of medical care annually, about half of which is spent on doctors and hospital care. Compared to these expenses, prescription drug therapy is a true bargain. Americans spend twice as much for physician care and three times as much on hospital care as they do for drugs. (Fig. I)
Most people prefer taking drugs to having surgery and they are convenient and generally safer than surgery or other invasive treatments. For these reasons, more than 60% of Americans take a prescription drug in any given year, including 90% of all seniors.
An estimated 4.3 billion retail prescriptions were filled in 2014 – about a dozen per person in the United States, on average. U.S. residents spent about $329 billion on prescription therapies in 2013 and $374 billion in 2014. This is a huge rise from the $40 billion we spent on drugs over two decades ago.
Nearly half of generic drugs declined in price from July 2013 to July 2014, but the remaining half increased in price. The price of more than one in four generic drugs rose by between 10 to 100% or more. Whereas only 3 % of generic drugs fell in price by 25 % or more, 18 % rose in price by 25% or more (Fig. III). Since inflation doesn’t account for these increases, what is the explanation?
Reasons for Generic Drug Price Increases
Supply and demand is Economics 101. When supply meets demand, prices usually remain stable. When demand remains steady but supply declines, prices usually go up. Suppliers are the source of the rising generic drugs prices.
Generic Drug Manufacturers
Competition always leads to lower prices, and usually higher quality, in a free marketplace. In theory, generic drugs face unlimited competition since any qualified drug maker can apply to the FDA to produce a generic version of any drug when the original drug patent expires. But reality is far different. Several factors contribute to limiting competition in this market.
- Market Consolidation and Manufacturers Leaving the Market – Drug companies, just like health insurance companies and hospitals have been acquiring smaller firms to achieve economies of scale and to increase market penetration. Fewer companies means less competition and less pressure to lower prices.
- Slow FDA Approvals – The FDA currently has a backlog of about 4,000 applications to manufacture a generic drug – up about 40 percent from two years ago. In 2005 the FDA averaged 16 months to approve a generic drug application. In 2010 the average approval time rose to 27 months. The FDA is also discouraging Indian generic drug makers from entering the market with regulatory hurdles. They have banned drugs from the U.S. market manufactured by Indian drug makers such as Ranbaxy Laboratories.
- Informal Collusion and Price-Fixing – Collusion and price-fixing are both illegal activities but there are informal ways to achieve the same results. If one manufacturer raises their price and others follow independently, there is no law broken. This is easier to do when there are only 2 or 3 makers of that drug.
This exact scenario occurred recently when the very old drug Digoxin suddenly rose in price at one company at the beginning of 2014. By mid-year, the price had doubled as the only other two makers of the drug followed the lead of the first. This informal collusion artificially raised the cost of this usually inexpensive medicine.
(Next post: More reasons for rising generic drug prices.)