I’m trying to figure out a model to make the following make sense to me regarding the US negotiating or not negotiating drug prices through the purchasing power of Medicare. I’m picking on Enplaned from comments just because this is a fairly common argument structure:
Health authorities of other countries routinely get lower prices for their citizens on drugs than are charged in the US. What this means is that US consumers effectively subsidize those of Europe, for instance. This makes sense for drug companies because selling it for less in Italy or Germany or whatever is still additional profit, assuming it’s greater than the cost of production.
What’s the model that produces this statement?
My best bet at figuring out a model is one that assumes drug distributors are actually profit satisficing entities and not profit maximization entities.
By this I mean the implied model assumes that the C-level of a major multi-national drug company will decide that they want a set annual return on equity for the next fiscal year. They can sell in three markets. The United States, the rest of the OECD (middle class and higher industrial countries) and the rest of the world. Rest of the world is broke so most of the sales of expensive drugs there are marketing loss leaders and charity care. The primary decision point then is how to allocate profits from the disjointed US market where almost no one with market power can say no and the rest of the OECD where locally concentrated buyer power can effectively say no. So it is an allocation decision that the US will supply 75% of the net profit and the rest of the OECD will supply 25% of the profit. Now under this profit satisficing model if Medicare is authorized to say no and exclude certain drugs from coverage, the US, all else being equal would now only supply 60% of the profit and without any other changes the OECD would supply 25% of the profit and then there would be a 15% decrease in net profits. However in this story, the drug companies now will raise rates in the rest of the OECD so they supply 40% of the profits so total profits under either scenario are the same.
I have a hard time buying this and reconciling this implicit model with the left/liberal critique that drug companies are soulless bastards who are trying to make money above all else.
What if we follow the logic of profit maximization through the entire drug pricing decision chain?
Here I’ll be ripping off a lot of the logic in the argument against cost shifting when payer mix changes for hospitals as I think these are functionally isomorphs.
The first decision a drug maker has to make when selling to either the US or the rest of the OECD is what is the minimum price that is not a guaranteed incremental money loser to sell at. A drug maker won’t sell a dose at less than the marginal cost of production. It will attempt to sell as many doses at a price level as high above the marginal cost as possible. In time period 1, Medicare can not negotiate so the American drug buying market is extremely fragmented and weak while the rest of the OECD buyers are fairly strong for their respective national markets. A negotiation between the drug maker and the rest of the OECD has a plausible agreement zone if the per dose price is above the marginal price of production for the drug maker and below the maximum willingness to pay for a buyer. If there is space between these two points and maximum willingness to pay is above the marginal price, then an agreement will be reached. Where that agreement is reached will be a function of negotiating skill and the existence of next best alternatives as near substitutes for the buyers. The same set of negotiations occur between the drug maker and a dozen American pharmacy benefit managers who all have far less power to say no and thus their aggregate maximum willingness to pay is higher. The higher paying customers will have priority to get the last incremental dose available but the agreements are not linked to each other.
Now let’s say Medicare is given the power to negotiate and say no much like the Veterans Administration can say no. The drug maker will still sell if the Medicare maximum willingness to pay is above marginal cost. The difference in this time period is that the single negotiator now has a credible threat to leave and its maximum willingness to pay is less. The shared plausible agreement zone shrinks. So US drugs will cost less as Medicare can credibly threaten to divert billions of dollars of business from Company A to Company B if Company A is asking for an arm, a leg and a kidney while Company B is just holding out for an appendix.
The same negotiation is happening with the rest of the OECD. Deals will be reached as long as the maximum willingness to pay is more than marginal, incremental cost of production. Nothing has changed here. It is the same discussion in Year 2 as it was in Year 1 when the Americans were fragmented. If anything there could be an minor decrease in the rest of the OECD willingness to pay as they now know that the Americans won’t set as high of a price for the last incremental dose available.
Under a profit maximization model where the US now has a single point of negotiation for a significant portion of US drug expenses and it has the ability to issue a strong NO, the rest of the world will either see no change in their plausible agreement zone or a slight improvement in terms.
I think it is important to have a decent functional model that is overly simplistic but tractable in order to make our predictions and our policy preferences clear. I can’ figure out the model where lower US prices automatically lead to higher rest of OECD prices without making a profit satisficing assumption which is inconsistent with both evidence and other concurrent ideological priors. Let’s think clearly, so what am I missing here?
UPDATE 1: Both Victor and and DLG have good follow-up in comments about looking at drug pricing in a quasi-public utility model.
What have the Romans Ever done for us raises the great new research vs. hookers and blow question
Marc
We have a system where drug prices here are a large multiple of drug prices everywhere else in the world. Is the cost of providing drugs much higher in the US than elsewhere? If not, doesn’t this simply represent much higher profit here than elsewhere? In a normal functioning market, this would be solved by (for example) foreign countries selling drugs back to the US at lower prices. The reason why this is difficult to do is that there an effective monopoly involved where there is no meaningful price competition.
When we see people buy up companies and jack up the prices of essential medicines (with monopoly control of production) by an order of magnitude we don’t have a functioning market either.
So, basically, the claim is that the drug companies have rigged the rules to prevent effective competition for their products in the US, generating huge profits at our expense. I don’t buy for a minute the claim that the only difference between the US and overseas market is fragmented buying power here – that doesn’t help the victims of Shrelki et al. We have a set of rules that ensure high prices, and the inability to get medicine from, say, Canada is a simple example of such rules.
David ?Canadian Anchor Baby? Koch
I was told there would be no math on this blog
Richard Mayhew
@Marc: agreed completely that our IP rules are jacked up but I am looking for a simplified model with as few moving parts as possible.
Ramalama
Atrios says: “…last night 13 Democrats in the Senate voted against allowing cheaper drug imports from The People’s Republic of Canadia.” Including Sen Corey Booker.
randy khan
This seems like pretty simple economics to me. In the current environment, each OECD country is a separate market, and the drug manufacturers are effective monopolies. Boring Econ 101 predicts that in a market like the U.S., where the monopoly faces an atomized group of consumers, it will extract a monopoly profit, while in the markets where it faces a single buyer it will get much closer to cost (defined in Econ 101 as marginal cost plus a normal profit). If you change the U.S. market to more closely resemble the other OECD markets, then prices in the U.S. will go down, and OECD prices will stay about the same. (This ignores the possibility that the U.S. will drive prices lower than what the other OECD countries are paying, and that they will use the information to lower their prices as well, but that’s probably marginal.)
Ohio Mom
This is a little off topic but David Brooks outdid himself today writing about Why Markets Could Work in Healthcare. I wish my family’s combined health issues on him.
Nunca El Jefe
You should contact David Anderson, at Duke. He should be able to help you figure this out and it seems like he’s on your wavelength.
In all seriousness, the two models you outline are the most standard, across any business. The only wrinkle that I would add is that it will be dependent on the market philosophy / market position of each company, meaning, is a company more concerned with top line revenue growth or with maximizing margin? Real behavior will be somewhere in the middle of those things, especially when there is a large enough product mix that different strategies can be implemented simultaneously, so I fear that any model will always be off. Would it be useful for you to think about those two scenarios as limits and then focus on that squishy middle response area?
Skippy-san
All I know is that living here in Germany, drug prices are about 25-30% cheaper than they are in the states. Now mind you I have US insurance so I am treated as PRIVAT when it comes to payment by German Doctors and Pharmacies. That means I have to pay up front and get reimbursed by my insurance.
If I had German insurance the way my wife does you pay less because its build to the insurance company directly.
German insurance is private-but its also mandatory for both employers and employees. The system works in that you pay a premium for a basic policy and the insurance company CANNOT make a profit on that policy. Most Germans have supplemental insurance to cover what the basic policy does not cover-but even those prices are not as bad as they are in the US. The system works. Whenever the GOP says it does not work in Europe or its all socialized medicine-they are lying their asses off.
gene108
@Ramalama:
Pharma is a major chunk of the NJ economy. Booker and Menendez both voted to block imports from Canada. It’s their job to represent the important businesses in their state. There’s nothing more nefarious to it than that. Booker’s been good so far in the opposition. There’s no need to try to knee cap him for not being a perfectly pure.
Richard Mayhew
@randy khan: It is very simple economics and that is why I want to make the assumptions clearer to get at what I think is an error in thinking.
scottinnj
Couple thoughts (no solutions)
1) I think you are right to posit that price>marginal cost however I think for the drug companies the are more on the high fixed cost/low marginal cost structure i.e the marginal cost to make one more pill of Lipitor is very low. Compared to say a box of Kraft Macaroni and Cheese or jeans from the Gap where the variable labor/raw materials are more significant.
2) At least outside the US the demand curve is kinked not straight. Meaning (using made up data to get the point across) the UK may decide that if Lipitor is $4/pill and the best generic is $2.50/pill, if they think that Lipitor is only worth $1 more than the generic, demand at any point from $4 to $3.51 is zero, but at $2.49 the demand is YUGE and doesn’t go up at all if you move to $2.48/per Lipitor pill. Unlike a pair of Levi’s jeans where you can do an analysis on what happens if I price at $21/pair, $20.75, $20.50 and so forth like your traditional demand curve. Have to dust off my old econ books but with kinked curves I think you get some weird outcomes.
3) This is where some game theory comes in – I assume that the French, UK, German and Australian Politburo Socialist Price Fixing Committee see each other’s data. So there is a degree of signalling going on i.e Pfizer knows that if the UK is paying $2.60 for Lipitor and France negotiates it down to $2.50, the UK Price Czar will call Pfizer. Since the Autocrats know the marginal cost is likely close to zero, and per point 2 it is kind of all or nothing the drug companies need to signal somehow where the price point is that they will walk to avoid a race to the bottom.
4) Supply considerations are how substitutable products are for one another. A steak at Peter Luger isn’t a substitute for a steak from Applebees. However I think as incremental innovation has slowed the gap with generic is narrowing, though I will defer to you. In other words the gap between Lipitor and the 5 year old version that is generic is narrower than the gap between that 5 year old version and the one before that. Or to put another way by definition the average generic is getting meaningfully better each year. Seems to me that is a big long term headwind for the sector.
scottinnj
@scottinnj: Meant $3.49 not $2.49 in bullet 2 i.e. if Lipitor is only worth $1/more a pill if it is $0.99 more they will win all of the statin biz in the UK. That isn’t literally true of course but what I’m trying to say is that you have a curve where only small changes in price have a big impact in demand.
Barbara
@gene108: I feel constrained to make this statement any time someone mentions the subject of importing drugs from Canada. We are not importing drugs. We are importing Canada’s regulatory approach to setting prices for drugs. Legislation that permits the importation of drugs is a big fat admission by Congress that it is completely worthless when it comes to advancing the interests of the American people, and that many if not most of us would be better off living under Canadian rule.
As to the OP — I am pretty sure I am the source of this idea, which, as others have said, is non-controversial economic dogma in most markets. I would give one caveat — the relative pricing (and profitability) that a manufacturer can set will affect its allocation of money to marketing, research, willingness to set ultra low prices in emerging countries, dividends, etc. So it’s not as if nothing might change, but it is unlikely to be the prices that are charged to other European countries.
JimV
My model:
1. Drug (medication) prices in the U.S. are unfair. I can give several examples of this if necessary.
2. It is much easier to reverse-engineer drugs than develop new ones.
3. If drug companies try to get exorbitant prices in other countries where they don’t have much influence on the governments, those governments will permit local companies to reverse-engineer the drugs, and Americans will start going to those countries to get cheap drugs.
4. Therefore, profit-maximization requires keeping prices reasonable outside the U.S., to prevent wide-scale reverse-engineering.
This is a similar model to Walmart’s price-matching strategy.
Barbara
@scottinnj: Generics are a big headwind, and that’s why manufacturers have continued to engage in intense regulatory arbitrage to head off even one or two years of generic competition wherever they can. It’s also why manufacturers have begun to engage in outrageous initial price setting for branded, still on patent drugs. But I still think the biggest outrage about modern pharmaceuticals isn’t how expensive they are, per se, it’s how weak most of them are when it comes to actually advancing any medical purpose. So while the drugs that cure Hepatitis C are expensive, they actually do cure the disease, which has significant cost and quality of life implications for millions of people. If curing your Hep C means you don’t languish in a hospital totally disabled while waiting for a liver transplant, the cost doesn’t seem so high. Compared to, say, the latest chemotherapy that delivers an average additional three weeks of life under the BEST of conditions, the cost also doesn’t seem high. In a lot of ways what is needed is a better way of defining efficacy for products.
Armadillo
Are you sure that markets outside the OECD are all loss leaders/charity? Or that the charitable activities outside the OECD are not provided with a plan to make ROI a few years down the road?
Barbara
@JimV: Your number 3 is wrong.
“3. If drug companies try to get exorbitant prices in other countries where they don’t have much influence on the governments, the companies will go to the United States government to put enormous trade related pressure on those governments that might otherwise permit local companies to reverse-engineer the drugs, in order to prevent Americans from going to those countries to get cheap drugs.
See, Exhibit A, the TransPacific Partnership provisions on pharmaceuticals.
See, also, the intense opposition to permitting importation of drugs from Canada.
quercus
I don’t know much about drug economics, but just from Econ 101 principles, I don’t think it requires a ‘profit satisficing’ model to have the US ‘subsidize’ OECD. Particularly so, since drugs are high fixed cost (research, testing) and low marginal cost (making one more pill is relatively cheap). Even with a manufacturer selling for as much as the market will bear in every region, a drug could well be sold in OECD at above marginal but below overall cost, while in the U.S. at a higher price above average overall cost. The manufacturer is still making a profit on each extra pill sold in the OECD so they’ll keep selling there, but would never invest in the research in the first place if they didn’t have the US market to cover the fixed costs.
DLG
Hi Richard. Economist here who used to teach about this type of pricing in non-health care settings.
Your argument is basically sound. Economists would label what you are describing as “first degree price discrimination” modified to account for bilateral bargaining. (The standard classroom model of price discrimination assumes that consumers/purchasers can only accept or reject a take-it-or leave-it offer from the producer, rather than negotiating.)
However, there are coherent ways to extend this model such that concerns about distribution of costs and benefits between different purchasers makes sense. You come close when you briefly allude to a target rate of return. But instead of “saticficing,” consider that there might be some economic or policy reason that the producer “must” earn some minimum amount of total revenue minus variable costs. In a number of settings, such as utilities (“natural monopolies”) and (I imagine) hospitals, this reason is usually given as the need to cover the producer’s fixed costs (minimal configuration of plant, equipment, and staffing, adminstrative overhead, etc.) plus a “fair” rate of return. Then some combination of consumers must pay combined total mark-ups large enough to cover those fixed costs. Otherwise the business will require subsidies or go bankrupt.
There is a huge literature about utility regulation and price-setting that addresses this in excrutiating detail. Similar reasoning also shows up in economic critiques of crude (i.e. average cost based) anti-dumping policy in trade. (Ironically, in those cases the complaint is that U.S. consumers are paying less than others.)
In the pharma context, I believe the usual, sometimes implicit, argument is that the producers “must” earn a minimum total over variable costs as a matter of policy, Specifically, to creating incentives and funding for R&D to creat the next generations of drugs. If (!!!) drug company total operating margins are near such a minimum and devolopment of new drugs via private R&D is considered a necessity; then reducing total margins in one market (e.g. Europe) “forces” policy-makers in the other (e.g. U.S.) to allow higher margins. This is I think the sophisticated version of the argument that we (the U.S.) are cross-subsidizing the drug prices of “free-riding” foreign markets.
Even this more sophisticated argument leaves aside at least three questions: 1. Are drug company operating profits really near the minimum to fund and incentivize development of new drugs? 2. Is private R&D really the best way to fund development of new drugs? — Will that give us the new drugs we really need? (A large portion of initial R is acutally already publicly funded.) 3. Do consumers and policy-makers in other markets actually care as much as we do about the new drugs private pharma is/could be developing?
Snarki, child of Loki
“3. If drug companies try to get exorbitant prices in other countries where they don’t have much influence on the governments,”
IOW, the US government is bought and paid for by Big Pharma. As if we didn’t already know.
Ramalama
Doctors without Borders / Médecins Sans Frontières turned down 1 million vaccines to get Pharma to stop the obscene profit mode.
Donations are “often used as a way to make others ‘pay up.’ By giving the pneumonia vaccine away for free, pharmaceutical corporations can use this as justification for why prices remain high for others, including other humanitarian organizations and developing countries that also can’t afford the vaccine.”
jonas
@Skippy-san: Same experience in Austria. One difference: health care providers, esp. doctors, simply don’t make as much in Europe as they do in the US. Don’t get me wrong — they make very good livings. But you’d probably have to go to some super-elite private clinic in Switzerland or something to find a physician making more than the equivalent of $150,000 a year or so. There are a lot of doctors, esp. specialists, in the US who make more than that in a *month*. Same goes for hospital administrators, etc.
liberal
Pharma spends tons of “research” money on me, too drugs and drugs they think will sell well even if they aren’t that clinically effective. So this entire line of inquiry is pointless.
jonas
Related to this, I was told once by a woman whose family owned a small Apotheke in a German town that the reason Germans are so into “alternative” medicine, especially stuff like herbal remedies and assorted homeopathic woo is that pharmacies always upsell their customers on that stuff because they don’t make any money on traditional pharmaceuticals and prescription drugs. Pharmacists in Germany are allowed a lot more leeway to dispense medical advice than they are here and the customer usually walks out with some wolfsbane extract rather than an Rx for a traditional drug.
MomSense
@gene108:
No need to knee cap him especially since it was just an amendment to a resolution. If the amendment had passed it wouldn’t have done much of anything since the next step is budget reconciliation and there’s no way the house is including that drug importation provision in their version.
This has more to do with Wilmerbros trying to kneecap someone they perceive as a threat to Wilmer’s coronation in 2020.
RepubAnon
I should note that these models fail to take into account research and development costs. For a compound to make it to market, it must be discovered, tested in labs (and pass), tested in animals (and pass), and tested in controlled clinical settings on selected humans at various levels, and pass those tests. Only after all these things are done does the compound make it to market… and many compounds fail at some point of the process (and never make it to market).
Once a drug is proven safe and effective, it must be manufactured safely. (It’s one thing to produce a compound in a high school lab, quite another to produce it in a way that doesn’t introduce unwanted contaminants – like human hair, cat dander, germs, viruses…)
So, a model for drug prices must take into account the research and development (“R&D”) costs as well as the fixed costs of running a facility to safely produce the drugs (we don’t want germs in the finished product) – and advertising. These things cost money. This is why generics are less expensive: they don’t have the R&D costs, only the manufacturing and advertising costs.
At present, the US subsidizes research and development for the rest of the world – where price negotiations are more closely linked to fixed manufacturing costs (the cost of running the factory) and marginal manufacturing costs (the cost of making one more dose). In addition to salaries, profits from drug sales go into researching new products. Cut those profits through negotiating prices, and the pharmaceutical industry must pull back on R&D investments to preserve overall profitability. Researching the efficacy of a new compound is expensive – so fewer new candidates would make it to the next round of testing.
Research will still be done, of course, just not as much. Remember that academia isn’t getting as much research funding as before, either – gotta keep the football team competitive.
Frank McCormick
That “error in thinking” is actually originating from the drug companies and their apologists *cough* Megan McArdle *cough* . It’s too bad if anyone on the left has actually fallen for this.
Having been to the temple that is the headquarters of a major US drug manufacturer, any cries of “poor” from a pharmaceutical industry are falling on deaf ears.
Dirk Reinecke
I think an important element to consider is the practice of marketing medicine to the general public. This is a uniquely american habit and it certainly drives up the cost, hence the price is also increased.
Victor Matheson
Another economist here, and I agree with DLG. It’s not at the pricing level that the US subsidizes the OECD but at the R&D level. Here’s a simple model. Suppose you have a single use drug used by everyone (say a vaccine) that sells for different prices in different locations based on bargaining power and income. You give the drug away in developing countries because they are poor. You sell the drug for $1 above MC to the 500 million OECD popoulation and for $3 above MC to the 300 million Americans. Profits to the drug company are $1,400 million in total from all markets.
If R&D costs are $1 billion, this drug gets developed with American profits paying for 2/3 of the R&D. Basically Europe gets a free ride on the development of a useful drug thanks to high profits in the US. The developing world gets a free ride too, but that’s not considered nearly as unfair.
Now suppose that the US aggressively bargains down to $1 over MC per person. Now we are down to only $800 million in drug profit worldwide, so the drug doesn’t get developed.
Simplistic model, but perhaps informative and this is only a blog post comment.
Victor Matheson
RepubAnon beat me to the same argument.
Major Major Major Major
@RepubAnon: @Victor Matheson: this is what a very good MPH friend of mine says as well. A big portion of our high prices are an inefficient, opaque R&D subsidy.
MPAVictoria
“If R&D costs are $1 billion, this drug gets developed with American profits paying for 2/3 of the R&D. Basically Europe gets a free ride on the development of a useful drug thanks to high profits in the US. The developing world gets a free ride too, but that’s not considered nearly as unfair.”
This only makes sense if you ignore the public money that OECD countries put into R&D and post secondary education. The idea that the US is subsidizing anything but high Pharma CEO salaries is pretty laughable.
Это курам на смех
@MomSense: In service to his grandstanding ego, Sanders himself will kneecap any moderate Democrat who steps up to run in 2020.
Bernie Sanders slams Democrats for lacking ‘guts’ to fight Big Pharma
Bernie’s brand of progressives are the enemies of progress.
Shantanu Saha
In other words, the OECD pays the mortgage, Medicare pays for the hookers and blow.
MaxUtil
@Это курам на смех: Criticizing legislators on their votes on very real issues of very real concern to progressives is not “kneecapping” anyone. There’s a time and a place for unity and withholding criticism in the interests of electoral success. But “progress” does not mean you can’t ever put pressure on a politician or party to support certain policies.
Marc
@MaxUtil: Some people here will never forgive Sanders for mounting a primary challenge to Clinton, so anything that he’s for, they’re against. I can’t make sense otherwise of being upset with liberals for lobbying for Canadian drug imports.
What Have the Romans Ever Done for Us?
@randy khan: I think Randy here has the right answer as to the dynamics. When they say the U.S. is subsidizing the rest of the world I think what they are arguing is that those excess drug company profits extracted from the splintered U.S. market (one seller, many buyers) are plowed back into research and developing new and better treatments that the world then gets to benefit from at cost. That assumes that said profits are plowed back into R & D and that this private R & D and not basic scientific funding for research from the U.S. government is responsible for many advances in health improving technology. If the profits are plowed into hookers and blow (or 6th vacation homes) for the drug company execs and shareholders then we’re just getting screwed but not really subsidizing anything but more lavish lifestyles for pharmaceutical company execs. In reality it’s probably a bit of both.
Jacel
@Ramalama: I haven’t found details about the overall group of amendments related to the ACA. My impression was that most of the amendments put forward by Democrats were to lock-in some existing benefits of the ACA. The Canadian drug provision is the only one I’ve heard about that went beyond the existing ACA provisions. More Democratic senators (not just Booker) might have voted against this one as being off-message from the other amendments included at that time.
Miss Bianca
@Marc: Other than the concerns these Senators raised about drug safety standards, you mean?
scottinnj
@Dirk Reinecke: And I think any politician that ran on a platform of banning drug commercials would win the EC 538-0. I fail to see how society is better off from these commercials.
BethanyAnne
There are probably several ways of spending money one drugs that are better than what we have (could there be worse for the consumer?). The one I have hoped to see is that we find a way to separate R&D and production. Maybe we could set bounties for drug development, and move production entirely away from the current model. Have the government issue separate contracts for drug production. That way we could pay for the hard risky work with funds separate from the funds that buy the medicines.
Ramalama
@Jacel:
Here’s Booker’s tweet:
And here:
Canard. /canard.
Barbara
@MaxUtil: I don’t blame legislators for banning the importation of drugs from Canada. First, ask the Canadian government how it feels about it, and the answer you will get is, that there is a very real risk that Canada will face a limitation on the quantities of drugs available to Canada so that the Canadian government will have to take action to protect Canadians from losing access. (This is what has been threatened in the past.) Drug manufacturers might refuse to locate manufacturing facilities in Canada. Which means that this kind of legislation will never be more than showboating. As much as I understand the appeal, we can’t make ourselves better off by outsourcing regulatory development to Canada. If someone wants to propose this, I don’t really care, but stop pretending it’s an actual solution to a real problem. It’s not. It never will be and it’s pathetic to spend political capital on it.
richclayton3
Like Scottnnj, I’m a little puzzled that you did not try to incorporate any fixed cost into your model. I would assume that if a proponent of drug importation were to respond, they would correctly point out that in a high fixed cost industry, firms need to cover those fixed costs, and so will not generally price at marginal cost. Fixed costs are key to explaining why prices are above marginal cost (why the pharma firms have market power), and if facing a decentralized product market, such a firm may be able to generate very large mark ups. But if selling to a centralized or coordinated market (like a public health system), the mark-up would be limited (though just how much is an open question, given complications like substitutes, acuity of demand, and political blowback). If facing both, it seems likely that the mark-up would be high in the decentralized market, low in the centralized market, and the R&D spending would be higher than if the same firm faced noting but centralized product markets. In that sense, the decentralized market can be thought of as subsidizing R&D that benefits the centralized market (bearing in mind that much of that R&D would be non-rival and only partially excludable).
Barbara
@BethanyAnne: Drug approval and markets in the U.S. are based on an IP paradigm that worked pretty well until about 30 years ago. Basically, it makes no sense (outside of generic process) to get anything approved by the FDA unless you have an in force patent, because the costs of approval are high, and you need to be able to recapture at least some of those profits by having the exclusive right to distribute/license the resulting innovation. What’s wrong with this model now?
1. Not every patent constitutes real innovation, and manufacturers have become experts at continuing patents by inserting basically trivial “changes” and the PTO just hasn’t been effective enough over this (and lots of other) patent abuses. This is coupled with an FDA view of efficacy that is simply too generous and results in a lot of basically ineffective drugs.
2. Not everything that constitutes innovation can be patented. The most obvious example of this is that there might be existing drugs that could be repurposed or found effective for new conditions but there is no mechanism in the law that gives manufacturers the incentive to research this proposition and getting it approved for a new indication.
3. Even more problematic, we have no systematic process for finding non-drug therapeutic means to alleviating or curing illness. We now assume that drugs are the answer, and the fact that so much research is being funded by drug manufacturers has made a lot of medical research a kind of monoculture for finding the right drug, regardless whether drugs will ever be the answer. Obesity is an example of this. It turns out that surgery is probably a better way to treat pathologic obesity.
Barbara
@richclayton3: It’s important to divide research from development. A lot of research is actually conducted by the U.S. government, especially when it identifies a public health need for a drug. Developing the drug, showing that it is efficacious and non-toxic, is a process that drug companies are good at, and it is expensive but it is not the same thing as finding the drug. There are things that could be done to make this process more efficient, the most noteworthy being the creation of a consortium of countries that follow approximately similar conventions in testing safety (at least) and possibly efficacy. Even being able to use the same clinical trials across countries would be helpful. So if the first country to approve a drug is Germany, and Germany’s requirements for clinical trials are broadly similar to those of the U.S., there ought to be some way of not having to do everything over again. There could even be an international convention that sets standards.
Skippy-san
@jonas: I know. It is the same way in Japan, where I used to live. They still live very well-and I think some of that not being obscenely rich is offset by the fact that the quality of life is so high in Austria and Japan.
Doug
@Barbara: “Even being able to use the same clinical trials across countries would be helpful.”
This is actually done. Most obviously, the EU has approval processes that allow for the same approval to be valid in all member states (plus EFTA and a couple more). Companies will run global Phase III trials and then use the data for submissions to the relevant authorities for approval. So it’s the same trial, but the approval process is different in each country and the data have to be submitted to the national regulator.
This is getting better, but slowly. I am led to understand that some time previously, Japan insisted on registrational trials being run only in Japan because the national regulator argued that Japanese people were sufficiently different from the rest of humanity that they needed their own set of clinical trials. That this gave Japanese pharma companies a leg up in the local market was surely coincidental, as was the money it brought in for clinical trials run locally. On the one hand, standards are changing toward global trials. On the other, they were not entirely wrong, ethnic differences are sometimes medically relevant.