Health Policy$ense

Is Pharma Getting Greedier?

Mark Pauly on rising drug prices

[cross-posted from the Health Cents blog on]

There has been considerable consumer and policymaker concern about the rising prices of some prescription drugs, from the thousands-percent increases in the price of generics like Turing Pharmaceuticals’ Daraprim to the average 8.8% increase by Pfizer for a large sample of its brand name drugs. Putting aside appeals by brand name firms for the need for funding for research and development (which does not apply to generics), the most attractive explanation for why brand name drug makers can increase prices is because they can. (For generics, where overall prices are lower, price increases seem more related to targets of opportunity where competition has evaporated, rather than a systemic problem.)

What makes brand name price increases possible are the government enforced protections of exclusivity conferred by the patent system and the need for FDA approval, which protects many drugs (especially new and expensive biologicals) from generic competition even after their patents have expired.

However, attributing price increases to a toxic mix of corporate welfare in the form of government-enforced protection for products and unmitigated greed by the stockholders of brand name drug firms (including many of us) misses an important question whose answer has been little studied. What is the cause of each price increase?

Part of the question comes from a simple application of basic economics. As every freshman economics student learns (if they didn’t know already), the level of the market price that will prevail in a market where there is a profit maximizing monopolist will be higher, sometimes many times higher, than the price that will prevail in a market where firms are as eager for profits but have to compete with each other.  Here is the puzzle: monopoly leads to high prices, but it does not, without more going on, lead to growing prices, nor to prices that grow more rapidly than competitive prices. (Think of spikes in the winter price of produce when freezes hit the growing areas.)

Put slightly differently, if drug firms were congenitally and eternally greedy for profits (as all firms are), they would have charged today’s higher price last year, or even for many years earlier, if they could have. Perhaps we consumers should be grateful for all the years we were charged prices much lower than before last year’s jump, rather than complain about our late bad luck.

So what will cause a monopolist to raise prices? One possibility is an increase in the cost of continuing to make and distribute a patented product. Sometimes this happens, especially for vaccines, when an accident at a major production facility means that more volume has to be squeezed out of all other facilities. But this phenomenon is not very common (thank goodness).

Another and probably more common reason is in the mirror: we demanders are willing (though far from eager) to pay more. The reasons might be what would otherwise be good news: our incomes rise and our insurance becomes more generous, both reasons to be willing to pay more for more health. Others are less benign: we as a population are getting older on average, which makes some illnesses more likely. A third is that some price increases may be engineered by drug firms themselves—advertising persuades us that a particular product is the only one we will accept from our doctor, or drug firms buy out potential competitors, generic and brand name.

The main conclusion is that the steps, if any, to be taken to respond to increases in drug prices depend on the reasons for the increases — which often nobody knows or takes the trouble to find out. Those attributable to rising income and insurance coverage are undesirable but unavoidable unless we stop letting incomes rise and stop extending coverage of the formerly uninsured. Changes in levels of nefarious firm practices are fair game, but you still need to understand how they resulted in higher prices. And increases in illnesses resulting from unhealthy life styles call for good old-fashioned prevention.