Illness, Inelastic Demand, Patents, Lobbyists: A Toxic Cocktail Leads to Large Price Distortions

October 13th, 2013 at 1:10 pm

It’s worth reading this NYT piece today about the high cost of medicines in the US relative to other countries, and the stress this causes family budgets (Time provided an even more detailed look at the issue a few months ago).

Here at OTE, we’re always interested in market failures, which is why health care provides a constant flow of material.  It’s not a market in the traditional sense: you show up hungry at the supermarket, they don’t have to feed you; show up sick at the ER, they have to treat you.  Since advanced economies will generally not let citizens perish—or infect others—when they can prevent it, they’ve all taken health care out of the market to one degree or another.

The American case, however, remains more of a public/private hybrid and that has proven far more costly compared to the other systems out there, even controlling for outcomes.  Drug costs provide a clear example of the problem.

The chain that drives this mess is really quite simple to observe and explain.  First, demand is inelasitic.  Your kid needs asthma medicine to breathe, you’ll do whatever it takes to get it.

Inelastic demand, by definition, means diminished sensitivity to price.  But that shouldn’t be the end of the story, because that’s where the wonder of capitalism steps in: in a real market, there’d be numerous competitors fighting over the inelastic dollar, and that would help to lower the price.

But there are two market-killing villains working together to thwart that process: patents and lobbyists.

…competition is often a mirage in today’s health care arena — a surprising number of lifesaving drugs are made by only one manufacturer — and businesses often successfully blunt market forces.

The US patent system is particularly costly and distortionary.  Here, both the courts and the FDA will too often allow a small tweak to an old formula to constitute a new drug that deserves a new patent, and thus block a generic from entering the market for a decade.  Other countries disallow such monopolies.  (One physician in the piece points out that drug companies are still repatenting the gout drug colchicine, “a drug you could find in Egyptian mummies.”)

Big Pharma makes sure the system stays rigged, and shaves off some of the proceeds to fund politicians who are perfectly ready to both throw the market under the bus and keep the government out of addressing the market failure.

In all other developed countries, governments similarly use a variety of tools to make sure that drug manufacturers sell their products at affordable prices. In Germany, regulators set drug wholesale and retail prices. Across Europe, national health authorities refuse to pay more than their neighbors for any drug. In Japan, the price of a drug must go down every two years.

A common American objection to that route is that absent our highly interventionist patent system, innovators wouldn’t have the incentives to invent new treatments.  Again, the international evidence belies this point—medical chemists working under these other systems do not appear to be disincentivized.  But economist Dean Baker has carefully analyzed this problem and offers a set of ways to support innovative research that minimizes monopolistic distortions.

There are at least two quite different ways to fix the problem of soaring drug prices.  One would be for the government to set prices; the other for less binding patent monopolies and more competition.  But go back to where I started: health care’s not a market, so we can’t depend on competition to solve the problem.

For example, the reduction of patents would surely lower the cost of inhalers that treat asthma.  But what if prices didn’t fall enough such that everyone who needed them could afford them (and asthma is particular prevalent in low-income communities)?  The result would be unnecessary and costly hospitalizations, again, a realization that other countries have acted upon: “…because inhalers were so effective at keeping patients out of hospitals, most national health systems made sure they were free or inexpensive.”

In other words, we need to do both: attack the monopolies and play a more active role in setting prices.

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4 comments in reply to "Illness, Inelastic Demand, Patents, Lobbyists: A Toxic Cocktail Leads to Large Price Distortions"

  1. Perplexed says:

    -“The US patent system is particularly costly and distortionary.”

    Its not just the costly and distortionary characteristics that are the problem, its the fact that its ineffective at anything but rent production:

    And the medical industrial complex is only one part of the problem. Why is it so critical to have week by week detailed data on so called “labor markets” but no measurements at all on these hidden monopoly taxes that are collected from everyone and distributed to private interests with no accounting whatsoever; except of course in our income & wealth GINI statistics? .87 wealth GINI and this is still buried the “back pages?” Who’s role is it to push for aggregate measurements of these hidden taxes if not economists? Is there a reason “We the People” should trust “economic science” to develop the measures we need to properly manage the economy when they make no attempt to produce aggregate measures of these critically important statistics?

  2. darms says:

    A particularly egregious example of drug patent abuse that I do not see discussed: albuterol rescue inhalers. Until recently they were as generic a drug gets but they used (I believe) R12 freon as a propellent. But they were recently reformulated to use a CFC-free version of freon (R134a?) which qualified for a new patent meaning instead of being a cheap generic they are now a very expensive ‘brand’. When I had drug coverage this meant instead of $5 they were now $70. For the same drug. How many tons of CFCs could be released by albuterol rescue inhalers?

  3. Sue Harvey says:

    It’s not just the brand name drugs. I take few meds but carry a very basic drug plan thru my former employer.
    Instead of purchasing my Rx thru my insurance plan ($90. vs $11.-self pay ??-pharmacist tried to explain but it didn’t make sense) I started checking prices and began purchasing at Costco. Two generics, one for BP and one statin. Paid out of pocket. Yearly cost approx. $44.+ $160. Went there for a refill Oct 2(coincidence,beginning of care act) my former price of statin 90 days went from approx $35 to $40 up to $61.42. Clerk’s explanation- drug companies have raised their prices even for generics, not just big Pharma but the small ones too. He said they were still keeping their prices down and maybe I could see if another pharmacy might be offering a low price to attract customers or see if Dr might change my Rx. What a hassle, I’m angry at the games