The Real Cost of Lowering Drug Prices

By now you’ve probably seen the ads bragging about lowered drug prices. The American Association of Retired Persons (AARP) is promoting those ads on television, as well as on their website, AARP.org. The first page of the website boldly states, “At Long Last, Prescription Drug Price Relief.”

For those ill-informed, the AARP doesn’t represent seniors, they represent themselves – and the Democratic Party. If seniors knew the truth, they would likely be protesting against the AARP about now. I gave up my AARP membership years ago when I discovered who they really represented.

Charles L. Hooper and David R. Henderson bring clarity to this subject in an article published in The Wall Street Journal. Mr. Hooper is president of Objective Insights, a life-science consultancy, and author of “Should the FDA Reject Itself?” Mr. Henderson is a research fellow with Stanford University’ Hoover Institution and was senior health economist with President Reagan’s Council of Economic Advisers.

They say the Inflation Reduction Act of 2022, the most mis-named piece of legislation since the Affordable Care Act of 2010, has eight provisions intended to reduce future drug prices. Some observers were surely pleased that Congress gave the Centers for Medicare and Medicaid Services (CMS) new powers to negotiate with pharmaceutical companies. Hooper and Henderson say, “They shouldn’t have been. The Inflation Reduction Act won’t noticeably reduce inflation and it will do little or nothing to lower the cost of healthcare. Forcing drug companies to charge lower prices will likely lead to fewer new drugs.”

You would think the importance of new drugs would be self-evident to everyone in the wake of the new vaccines for Covid-19, which have saved thousands, perhaps millions, of lives by preventing serious illness. Of course, we’ve all heard that Americans pay higher drug prices than people in other countries. While that’s true at face value, it is only true when comparing retail prices of brand-name drugs. Very few Americans pay retail prices; most pay a fraction – a copay dictated by their insurance plan, or the greatly discounted price on popular drug apps like GoodRx or SingleCare. Most country-to-country comparisons also leave out generics. Nine of ten prescriptions in the U.S. are filled with generic drugs priced lower than in most other countries.

In many countries, the government is the sole purchaser of pharmaceuticals. For a new drug to be used, the government must buy and distribute it. This is the case where socialized medicine systems prevail. But if the government declines to purchase the drug, it is unavailable. These governments negotiate with a take-it-or-leave-it attitude. Frequently, the drug companies take it because once research and development costs are covered, it is mostly profit.

Most drugs are developed for the U.S. market. If the drug is successful in the U.S., potential sales in Europe, Japan, China, Canada and elsewhere are gravy. If a drug can’t make it in the U.S., it is usually scrubbed. Probable success in America is a necessary and sufficient condition for the development of new drugs. Hooper and Henderson give us four reasons for this:

  • The U.S. is a relatively large country
  • The U.S. is a wealthy country
  • Negotiating prices with governments takes time, resulting in one to two years of lost sales.
  • Prices in the U.S. are somewhat more influenced by market forces – until the Inflation Reduction Act

 

To be sure, “negotiations” with CMS is a euphemism for “take it or leave it.” If a drug company doesn’t accept the CMS price, it will be taxed up to 95% on its Medicare sales revenue for that drug. This penalty is so severe, Eli Lilly CEO David Ricks reports that his company treats the prospect of negotiations as a potential loss of patent protection for some products.

What is the cost of R&D for a new drug?

Drug research and development involves enormous fixed costs. As of 2013, the cost per new drug approved by the Food and Drug Administration was $2.9 billion. Historically, these fixed costs have doubled in real terms every nine years. So in 2022, the inflation-adjusted fixed cost per approved drug is close to $7 billion.

Needless to say, if the U.S. market doesn’t help defray that cost, the drug company won’t spend that money. Drug companies are not in the business of losing money. The inevitable result is fewer new drugs will be developed.

What is the cost of fewer drugs being developed?

With no exaggeration intended, people will die sooner. Research by Columbia University economist Frank Lichtenberg suggests that 73% of the increase in life expectancy that high-income countries experienced between 2006 and 2016 was due solely to the adoption of modern drugs. He also found that the pharmaceutical expenditure per life-year saved was $13,904 across 26 high-income countries and $35,817 in the U.S. Most Americans would pay $36,000 to live an extra year.

Hooper and Henderson conclude: “Even though the U.S. shoulders the lion’s share of global pharmaceutical R&D costs, Americans get a great deal. New drugs are a fantastic investment for humanity, and Americans benefit as much as everyone else. Whether to accept that deal and get a good outcome or reject the deal and get a worse outcome should be an easy decision.”

I’ll bet you won’t read this in the AARP newsletter, or on their website.

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