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Drug Price Controls. A "Cure" Worse Than the Disease

Earlier this year, the State of Maine passed a law to try to force down drug prices. If drug manufacturers and distributors do not lower prices after "negotiations" with the state, Maine can threaten fines of up to $100,000 for "excessive" prices, and even impose price controls. Several other states reportedly are preparing similar legislation.

Maine's politicians were especially persuaded by claims that drug prices are substantially lower in Canada. In fact, although some drugs are cheaper in Canada, other drugs are more expensive. Government studies suggesting that pharmaceutical prices are much lower in developed nations like Canada, Britain and Germany have been severely criticized by Wharton School economist Patricia Danzon ("Price Comparisons for Pharmaceuticals: A Review of U.S. and Cross-National Studies", AEI, 1999).

Danzon found that the government studies surveyed only a handful of drugs. Also, these studies did not account for the quantity of drug prescriptions. Suppose, for example, that seven drugs are more expensive in the U.S. than in Canada and three are cheaper. If the three which are cheaper are prescribed more often than the seven which are more expensive, in which country are drugs truly less expensive? Finally, the government studies sometimes compared wholesale prices to retail prices.

It is true that drugs are cheaper in less-developed countries, but this is a benefit, not a cost to U.S. consumers. Because consumers in less-developed nations cover some of the R&D costs, U.S. consumers are better off than they would be if firms charged the same price everywhere.

Put simply, if firms had to charge a single low price throughout the world there would be much less money to spend on R&D and fewer new drugs. If firms had to charge a single high price throughout the world, consumers in less-developed countries could not afford to buy any new drugs, and U.S. consumers would pay all of the R&D costs. Allowing a firm to charge the appropriate price for each market -- that is, different prices in different parts of the world -- benefits consumers everywhere.

This is not to say that there are no "free-riders" in the world community -- countries which refuse to enforce patent rights, or use price controls to force companies to sell their products at below-market prices. But the answer to this problem is not for the U.S. to join the free-riders. Joining the free-riders would mean less research and fewer new drugs. Instead, the United States should continue to insist upon the protection of intellectual property rights in other countries, and should equally call on our trading partners, such as Japan and France, to let the market set pharmaceutical prices, not government bureaucrats. Acting at home, the United States could lower the cost of drug development by reforming its tort system, which imposes large costs on pharmaceutical manufacturers, and the entire healthcare sector, and by further streamlining the drug approval process.

The U.S. pharmaceutical industry is in a sense a victim of its own success. Overall spending on drugs has doubled in the past decade, but not because of price increases. Spending has increased because innovation has increased. Revolutionary new medicines have been discovered for the treatment of heart disease, Alzheimer's, diabetes, osteoporosis, arthritis, depression, obesity, blood pressure and other illnesses. In other words, we're spending more on drugs because we're using drugs more, and substituting pharmaceutical therapy for surgery, hospitalization, longterm care, and other forms of treatment.

The new drugs are so much better than the previous generation that if one controls for quality, it's clear that the cost of treating these diseases has actually been falling, not rising. Nevertheless, the increased spending on drugs has made the pharmaceutical firms a target for politicians seeking electoral advantage over sound public policy. Politicians may be focused on the next election. We can hope, however, that U.S. consumers of pharmaceuticals will take a longer view. Will consumers ten years from now be able to choose from a new generation of revolutionary drugs? They won't, if price controls are imposed today.

Dr. Alex Tabarrok is research director at The Independent Institute in Oakland, CA. This essay is adapted from Dr. Tabarrok's article originally published May 31, 2000 in The Patriot-News in Harrisburg, PA.