The Wall Street Journal takes the Trump administration to task this morning, and rightly so, over a proposed rule from Health and Human Services to impose price controls on what Medicare Part B pays for certain drugs. The rule would set the prices HHS pays at 126% of what other developed countries pay, down from 180% today.
Why do Americans pay so much more for drugs than foreigners? That’s the question that’s driving this proposal. The simple answer is that compared to foreign countries with their price controls under single-payer health systems, the U.S. still has a relatively free drug market. But the issues underlying that answer are anything but simple. In recent years they’ve swirled around proposals to end U.S. restrictions on “reimporting” cheaper drugs from Canada and Europe, which would amount to reimporting foreign price controls, critics rightly argue, and hence to reducing incentives to invest in years of expensive research and development. I’ve addressed those issues in detail in a 2004 Cato Policy Analysis and in the Wall Street Journal here and here. This new proposal is more of the same, in different garb.
In a nutshell, the miracle drugs that have so revolutionized modern medicine don’t come cheaply. On average it takes a billion dollars and 15 years of research and development to meet FDA safety and efficacy requirements, which most new drugs fail. But once a drug succeeds, the second pill costs pennies to produce, which is why patents are so crucial, failing which no one would invest in such risky ventures. When companies look at the world, however, they see socialized systems imposing price controls—except in America. So they charge market prices here (half the world market) and take what they can get abroad. What that means, of course, is that Americans pay the lion’s share of R&D costs while foreigners get drugs “on the cheap,” and therein lies the political problem here and the call for reimporting “cheaper” drugs from abroad.
It’s more complicated still, however. Given different levels of demand abroad, companies segment markets and price differentially. But that means they have to guard against not only reimportation but “parallel markets”—local vendors in low-price markets reselling to high-price markets at a discount—or all the drugs will end up in low-price markets, only to be resold to high-price markets, undercutting companies’ profit-making venues. They can try to preserve their market segmentation with no-resale contracts and supply limits. But those contracts are illegal in Europe from a mistaken belief that they’re anti-free trade, which is why there’s a thriving parallel market there. And since proposals in Congress to lift the ban on reimportation here have included bans on no-resale contracts and supply limits abroad, companies have understandably fought them.
This new HHS proposal is not as far-reaching as the earlier reimportation proposals, but the implications for future drug R&D investment are the same. As the Journal writes, “any investor who wants to bankroll the cure for Alzheimer’s is already staring at a very small chance of success—and the Trump HHS proposal adds another potential limit on return,” likely driving investment “into less difficult drug categories” or into other ventures altogether. Government funded drug R&D might not then be far behind. That would further politicize the development of drugs, much like European formulary limits do by rendering unavailable many of the modern miracle drugs we Americans enjoy.