The Economics of the Pharmaceutical Industry

Why is it that when it comes to medical care in this country,policy makers in Washington almost always abandon sound economicprinciples that we know work to create wealth and improved servicesin every other sector of the economy?

Think about it for a moment. In every other sector of theeconomy we understand basic economic realities that have fosteredour wonderfully prosperous society. We understand that free marketmechanisms work better than government command and controlsolutions. We understand that maximizing consumer choice andcompetition creates better services and drives down costs. Weunderstand from past experience that price controls never producedesired results and create shortages.

What is especially disheartening is that we continue to devisedysfunctional legislative policies that hinder an industry thathas‐​despite government interference‐​been the greatest saver of lifein the history of civilization. Yes, of course, much of theprogress in medicine over the past fifty years has been a result ofpublic health measures and government investment in drugs andvaccines through agencies like the National Institute of Health.But we must also recognize that most of the progress in medicalbreakthroughs have been a result of private investment and thecapitalistic entrepreneurial spirit which is in the noble pursuitof progress and profits. (I hope all of this does not seem to bepatronizing or simplistic, but there are many policy makers inWashington who actually think that profit is a bad thing when itcomes to medicine and that seniors should not have to pay themarket price for the drugs they want and benefit from.)

Here’s one recent example of the supremacy of our privatebiotechnology industry. T the race to map, decode, and sequence the100,000 genes in the human body (the human genome project) was wonby a private bio‐​tech firm, Celera Genomics Group, despite the factthat the government supplied billions of dollars to the NIH forthis purpose. This would be like a private space industry companygetting a manned rocket to the moon before NASA.

It is no accident that virtually all of the breakthroughmedicines and vaccines of the past two decades have come notprimarily from government investment, but from privatebiotechnology firms that are financed through risk capital funding.This is an industry with some 1,200 companies and some 100,000workers. U.S. firms have won the race against foreign firms inalmost every one of the top 20 breakthrough new wonder drugs of thepast fifteen years.

The claim is made again and again that the U.S. drug industry isnot just one of America’s most profitable industries, but that itis too profitable. But how can this be a problem? It is profitableprecisely because it makes products that people want‐​in some caseswant desperately. Its inventions are arguably the most valuable tosociety. We would only have a serious problem if the situation werereversed: that the drug industry has no profits.

Now I should note here that I get no money from the drugindustry, and that the Cato Institute, gets some, but not a lot. Iam a huge fan of this industry simply because I benefit from itsproducts. We all do. In fact, let’s reflect for a moment on thelast century of biomedical progress: in 1900 the death rate frominfectious diseases was 700 per 100,000 Americans. Today, the deathrate from infectious diseases is 50 per 100,000. We have been sospoiled by the amazing life saving inventions of the bio‐​medicalindustry that we don’t even think about the diseases anymore thatjust a century ago killed millions upon millions of Americans. Backthen the leading cause of death were pneumonia, influenza,tuberculosis, bronchitis, and other awful diseases like small pox,whooping cough, and polio.

More recently, consider the progress that the medical industryhas made in the two leading killers today: heart disease andcancer. The survival rate from cancer is now twice as high as itwas in 1960. The age‐​adjusted death rate from heart disease is nowabout one‐​third what it was as recently as 1950.

All of this is to say that the drug industry in the UnitedStates doesn’t just build a better mousetrap. This is an industrythat lays golden eggs. It is now developing a new generation ofexciting cures and miracle treatments for dreaded killers: cancer,heart disease, Lou Gehrig’s disease, altzheimers, AIDS, multiplesclerosis, arthritis, and on and on. This industry is dedicated tounlocking the biological explanation for these and scores of otherdiseases that cause pain, suffering, debilitation and death.

New wonder drugs, when they are first introduced on the marketare almost always tremendously expensive‐​just like cellular phonesand video recorders were when they first hit the consumer market.But who would argue that the price for new drugs is not worthpaying? A recent Washington Post story relates how new arthritistreatments are literally enabling people who have been crippled bythis disease to magically rise and walk away from their wheelchairs. What price would an arthritis sufferer pay for such atreatment? Perhaps everything they have. For all the wringing ofhands about the expensive costs of drug treatments, the real wonderis not how costly these treatments are, but relative to their valueto those who are cured or at least relieved from pain by them, howcheap they are. We should never forget the great wisdom of Emersonwho said that “the first wealth is health.”

As we speak, Congress is debating a comprehensive prescriptiondrug benefit for seniors. My advice is stop and make a longreflection on the implications of what you are doing. We ought tobe very careful‐​no, Congress ought to have close to 100%certainty – that any policy changes we make that impact the drugindustry, nurture it, rather than interfere with its life savingpotential.

Herein lies the tradeoff that Congress seems to want to make.Almost everyone understands that to give seniors all the new drugsthey want at a subsidized price could well bankrupt the nation. Wecan’t afford to give every senior every new drug, because thesedrugs are expensive, anymore than Uncle Sam can build a swimmingpool in every American’s back yard. So we are confronted with adilemma. If we are to subsidize drug purchases for seniors, eitherwe let taxpayers shoulder the weighty financial burden throughmuch, much higher taxes (after all, there is no such thing as afree lunch, someone has to pay), or we pretend there is a freelunch by imposing price controls on the drug industry and take themoney out of their profits.

Those are really the only two viable options given the currentproposals for Medicare prescription drug benefits. Both are rottenoptions.

If we demand that taxpayers shoulder the cost, we are creating afiscal blackhole that future generations may never find a way outof. We should recognize a few fiscal realities about theprescription drug benefit plan:

1. The history of Medicare is that the actual costs always farexceed the predicted costs. When Medicare was launched in 1965 theprogram was expected to cost $15 billion in 1992. Instead it cost$90 billion. The program was six times more expensive thananticipated. Same with Medicaid. And the same would almostcertainly true of a Medicare prescription drug benefit.
2. The unfunded liability of Medicare is $12.9 trillion and ofSocial Security $11 trillion. The expected unfunded liability ofprescription drugs over 75 years is expected to to be $3 to $7trillion. To put this into context. The value of all the assets ofthe Fortune 500 companie s is less than $5 trillion. When you arein a hole, stop digging. The prescription drug benefit will drillus further into financial bankruptcy at a time when we should bereining in entitlements‐ especially those for seniors. According toDavid Walker, the head of the U.S. General Accounting Office,“Absent changes in the Medicare and Social Security programs,sometime during the 2040s, government would do nothing but mailchecks to the elderly and health care providers.”
3. The prescription drug benefit will almost certainly cause drugprices to rise absent price controls. Medicare and Medicaid werewhat created the stampeding inflation in health care. In the 15years prior to Medicare and Medicaid, health costs grew at 3.4% peryear. But since 1966, health care costs have run ahead at 7 percentper year and at almost twice the level of overall inflation. We canexpect drug prices to rise in a similar runaway pattern if thegovernment gets in that business too.
4. As life expectancy rises, the cost of drug benefits to seniorswill grow very rapidly as we pay to keep Americans alive in theirlast years of life. In just the next eight years the Health CareFinancing Administration predicts that spending on prescriptiondrugs will rise from $100 billion today to $250 billion in2009.

Can the next generation of Americans afford the tax burden thatwould be required to pay for these new prescription drug benefits?The National Center for Policy Analysis says that to pay forexisting promised Medicare and Social Security benefits Americanswill be forced to pay a payroll tax of not 15% but 25% by 2025. Addto that a prescription drug benefit and that payroll tax couldeasily rise to nearly 30% of the worker paycheck. We will see a taxrevolt in America that would make the Boston Tea Party seem like aday at the park before our children fork over those heftytaxes.

There is a cartoon in a recent newspaper that summarizes thestory well. A senior is pushing a baby carriage through a drugstore check out counter and the cashier says: “That will be $54 foryour prescription.” The grandfather turns to the infant in the babybuggy and says: “Pay up.” Let us not mince words. What we have hereunder consideration is simply a very cynical versio n of fiscalchild abuse.

Congress should reject it.

But this brings us to the alternative form of paying forprescription drug benefits. Take it out of the hide of theindustry. This is the most dangerous and unwise course of actionavailable‐​and yet a course that Congress is likely to travel.

When government intervenes in an industry as it would do on amassive scale with a new prescription drug benefit, it almost inall cases correspondingly enacted new regulations and controls ofthat sector of the economy. The only option that Congress wouldhave to constrain costs of pharmaceutical drugs, would be to imposecontrols on the prices that companies can charge. The governmentwould soon become the single payer for drugs, which gives theHealth care Finance Administration virtual unlimited purchasingpower.

The temptation to limit prices for profitable drug companiescould be politically irresistible. This is especially true giventhe overcharged rhetoric in Washington attacking drug companies forwhat Senator Hillary Clinton of New York has called an industrythat charges “excessive profits at the hands of our seniors.“Moreover, almost all other countries impose price controls on U.S.drugs, so that the price in Canada for prescription drugs is oftenless than half what is charged in the domestic market.

Why not impose similar controls here and save the government andconsumers money? The answer is that most of the rest of the worldhas become a free rider on the backs of the drug industry. Thatforeign countries impose price controls and limits drug companyprofits lowers drug research and development incentives. Thesecountries’ behavior would deny relief to the afflicted in the longrun by depriving them of new wonder drugs that would be brought tomarket earlier in the absence of price controls.

If the U.S. were to follow suit, the results for our health caresystem could be catastrophic. The U.S. as by far the largest marketfor new drugs, now shoulders the burden of providing fair profitsfor the industry. If the U.S. were to impose price controls asCanada does, we would see a marked reduction and delay in theintroduction of new drugs. There is no getting around thispolitical reality.

For those Americans who actually suffer from debilitatingdiseases, the harm to society of delaying even for a few years newdrug patents for heart disease, cancer, and the like issubstantially greater than the short term benefit of lower prices.Moreover, in the long term, miracle drugs are the cheapest way totreat disease, so that price controls probably lose money for thegovernment in the long term.

The bottom line is this: Congress needs to keep our drugindustry innovative, profitable, and competitive so it remainsglobally dominant. Any step that Congress takes to weaken thisindustry not only impairs one of America’s genuinely competitivecutting edge industries‐​one that reduces our balance of tradedeficit by billions of dollars and employs hundreds of thousands ofhigh paid American workers‐​but also retards the basic health ofthis and future generations of Americans.

I would end by quoting from a Washington Post new story fromJune 24th, which underscores the continuing dynamism andcontributions of the bio‐ medical industry:

“Last October a researcher named Patrick Iversen, whoworks at abio‐​tech firm in Corvalis, Oregon, pulled genetic information abouta virus off the internet and started designing a drug to attack it.He tapped into computers in Bethesda to be sure his drug wouldn’tbe likely to cause side effects. Satisfied, a week later he haddeveloped some vials of a white powder.”

“If all goes according to plan, a doctor nurse will draw some ofthat drug into a needle later this year, perhaps in a hospital inmosquito plagued Cleveland, Ohio, and inject it into a person withWest Nile Fever. The West Nile Virus drug has been developed withthe help because he relied on something called antisensetechnology, which is the specialty of his company, AVI BioPharmaInc, a money losing biotechnology firm in Portland.”

Competing drug companies say they are finally close to makingantisense drugs work. If they are right, the blistering pace ofIversen’s West Niles drug might be a harbinger of the future. Inthe rosiest scenario of this long‐​range future, antisense will belike the medical ward aboard the Starship Enterprise, the spacevessel from “Star Trek,” where the doctor isolates the dread germthat’s turning the crew into goo, whips up a perfectly tailoredantidote in minutes and sends everyone back to work.”

“It’s the magic bullet,” says Alan Gewirtz, a hematologist atthe University of Pennsylvania, who has worked on this technologyfor a decade. If the approach were to work reliably, “you couldkill bacteria, you kill viruses, you could keep joints from beinginflamed, eyesight from growing dim, blood vessels from getting toothick and closing off.”

These are the golden eggs that I mentioned earlier in mytestimony, that are laid by the bio‐​tech industry. It is theexciting future of the bio‐​technology industry that is within ourgrasp. For the sake of our children and out children’s children, weshould race to get there and we should be willing to pay almost anyprice to do so. If the U.S. pharmaceutical industry makes tens oreven hundreds of billions of dollars getting us to thisnear‐​disease free future, all the better.