Big Pharma and the Regulation Question
Last week President Trump announced some new measures that were aimed at bringing down prescription drug prices but which apparently left the pharmaceutical industry happy as the measures seemed to fall short of initial fears about what could possibly have included major price regulations. Stock prices in the industry climbed up.
So here is what I think are the problems, which range from the economic to the political. First, healthcare and in particular drugs are in high demand, especially with the continued demand for life saving and pain relieving medication at a time when life expectancy has increased.
The average cost however of developing a new drug according to statista.com has soared and is estimated at about $2.6 billion dollars in recent years. While there are many firms involved in the US joint pharmaceutical and biotechnology industries, 90% of the over $400 billion industry is dominated by some 15 companies, the so called Big Pharma, with the means to invest such very large sums of money in any given year toward drug development. With a variety of such drugs to produce, given various disease niches, this means very little supply, and this is perhaps the main reason for the resulting high drug prices in a market economy. Second, and related to the first, the high cost of investing in developing a drug whose composition can readily be duplicated means that patents have to be provided to encourage such investments in the first place, otherwise firms will not be willing to invest billions in expectation of reaping rewards from profits due to the immediate emergence of replicas (generics) competing on the market. The patent ensures monopoly power and unavoidably very high prices in markets with typically very inelastic demand. Before I go into the third, let me expand a bit further on the two problems above in perhaps plainer terms: The first problem is that there is a large degree of drug production specialization taking place, which means for the most part the absence of real competition in the industry. With health problems ranging from various types of cancers to various types of liver diseases, to pulmonary type diseases, to nerve pain, to psychiatric issues etc., you immediately observe, by casual inspection of the leading drugs on the market, specialization by these pharmaceutical companies in roughly one or two of these disease groups. The second problem means that there is a reinforcement of the resulting market power through policies intended to provide incentives for innovation in drug research and production. With patents typically providing for 20 years of exclusive production of a drug from the time it is developed, you have reinforced monopoly power in the treatment of a particular disease such that other firms or would be entrants are discouraged from investing in research in that area, leading to possibly few alternatives (generics) at the time of patent expiration. The third problem, perhaps enabled by the foregoing, is the generation of enormous profits by Big Pharma with which they are able to maintain their niche monopolies through acquisition of or buying out would be competition in the form of prospective smaller companies; as well as provide a formidable lobby that spends tens of millions of dollars yearly to sway policy decisions in their favor.
Further, with such spending power, they are able to manipulate, as suggested by a HBR report, the patent and generic drug production process, to stifle competition and extend their market power beyond the life of their patents. The report discusses the use of explicit cash payments, citizen petitions, authorized generics, and restriction of access to samples (through gaming the so-called REMs process), by Big Pharma to maintain their tight grip on their niche markets. So how might we address these problems?
Two-Tier Regulation At some level we may think of the pharmaceutical industry, due to the dominance of Big Pharma, as being an amalgam of natural monopolies. This is because these companies on close inspection are largely specialized across disease areas and the cost of entry into these niches is fairly high.
Every so often when smaller firms with prospective research in that niche show up, they immediately get taken over or their need to defray the costs required to carry out clinical trials and other incidentals takes them to the doorsteps of Big Pharma which invariably use their deeper pockets to ultimately buy them over or enter into some joint production arrangement that gives them a share of resulting revenues. As a result, the need to regulate this monopoly power while not stifling the incentive to invest in new drug production, price regulation in the form of a fair markup above the average cost of production might be a good regulatory policy. That fair markup might be based on expected sales volume so that the same amount gets paid across the board for “innovation” in drug production, or it could be arbitrary but it should be set at such a level that arguably would incentivize production and yet keep prices fairly low.
Will drug companies be less incentivized to invest in especially life saving drugs because of this ceiling on their drug prices? Possibly, but the smaller companies and would be entrants into the industry are not looking to make a killing in terms of the profits that Big Pharma are accustomed to, which is why to counter that possibility we need the second level of regulation discussed below. Next, the industry, across these disease niches should be regulated for competition. Acquisitions and buyouts should be prohibited, and smaller firms with prospective research in these areas could be subsidized by the government to help defray some of the huge costs that make entry difficult. Big Pharma cannot hold the economy hostage through a diminished investment in new drugs when they realize that there is competition from other firms quite satisfied with smaller profits. Finally, and still linked to the above is the need for more political will on the part of government to break the regulatory capture that apparently exists, with prohibitions on various measures Big Pharma uses to game the patent system and the generic drug production process. This will require the expansion and enforcement of existing antitrust laws to address these so that true competition is fostered in the market. Now this is obviously a huge problem - the absence of political will - perhaps because the relevant policy makers benefit from the lobbying expenses, or/ and from the revolving door that exists between the industry and said policy makers. Such problems are best addressed in representative democracies through electoral discipline. Continued information should be made available to the public about these underlying problems and policymakers running for office should be asked the tough questions that speak to their willingness to implement said solutions and how they intend to do so. The electorate should then be willing to hold them accountable and punish those that renege by voting them out of office. President Trump promised to drain the swamp - which includes the healthcare lobby - and he also promised to take on the industry and lower drug costs. The 'American Patients First' plan proposed by the President seeks to increase competition through addressing the REMs loophole that assumedly Big Pharma uses to limit access to samples for generic production. The plan also seeks to increase negotiating power for Medicare plan sponsors, lower drug list prices through consumer awareness of drug prices in ads, and to permit more information to patients on possibly the cheapest ways to pay for medications.
It matters little what regulatory provisions he has put in place if ultimately they do not lead to a marked reduction in drug prices short term, and long term in breaking up of the monopoly power present across the various disease group drug provisions. That should be the litmus test, and not only the President but lawmakers in Congress should also be held accountable for this.
The President's plan is a step in the right direction, but it does not go far enough in terms of bringing drug prices down where as explained earlier the existence of niche natural monopolies in the industry might justify explicit price regulation even if such regulation has to be modified to take into account the unique nature of the industry.