Abraham Kaplan famously noted that if you, “give a small boy a hammer, he will find that everything he encounters needs pounding.” Put differently, solving problems requires the right tool, not the convenient tool. Congress should remember this wisdom in its upcoming deliberations regarding the cost of prescription drugs.
The convenient tool when it comes to the health care system’s affordability problem is price controls. After all, the government can limit price increases in any part of the health care system – whether it is the price of pharmaceuticals, reimbursements for hospitals, or the salary of doctors – by simply mandating a maximum price. But, this is the wrong tool if the goal is to increase health care quality and improve health care affordability.
Imagine the consequences if the government capped the salary of doctors at the U.S. median income. Surely many current doctors would conclude that, with such a price cap, there are easier ways to earn a living. As doctors slowly pursued other opportunities, a doctor shortage would arise. Over time, this doctor shortage would worsen as more young people would be discouraged from entering the field. Ultimately, due to the doctor shortage, the quality of health care would decline. Paradoxically, total health care costs could increase because minor afflictions would likely go untreated, causing them to become more expensive ailments.
This logic does not change simply because the price controls are applied to pharmaceuticals, not doctors. If effective price caps were imposed on pharmaceuticals, then current price increases would moderate. The health care system’s underlying problems would only worsen, however.
To start, the price controls would be irrelevant for most patients. Nearly 90 percent of all drugs dispensed in the U.S. in 2016 were generic medicines, according to IMS Health. Therefore, any price control scheme would not apply to the majority of patients who are using inexpensive generics, not more expensive patented products.
It is also important to note that generic medicines are significantly cheaper in the U.S. compared to the other major industrialized countries. In fact, total pharmaceutical spending as a percentage of total health care spendingis lower in the U.S. (12.2 percent) than the average for the 30 nations that comprise the Organization for Economic Cooperation and Development, or OECD, (16.9 percent). This is due to, in part, the prevalence of generic medicines that are more affordable here than in other OECD nations.
While inapplicable to most patients, the minority of patients who take innovative medicines that are still on patent (e.g. the medicines at the frontier of the pharmaceutical market) would be impacted by the proposed price control schemes. And, just like the example of price controls on doctors, the adverse consequences would be, on net, very costly for the U.S. health care system.
The R&D process for innovative drugs is lengthy, requires billions of dollars in outlays ($2.6 billion as of 2016), and is fraught with large risks. Price controls make it more difficult for manufacturers to recoup this cost of capital, diminishing the incentives to innovate and bring new medicines to market. Importantly, the introduction of new drugs has been essential to improving the quality of health care delivered.
For example, in December 2013 and October 2014, the FDA approved two new medications to treat Hepatitis C. These medicines were expensive, but they were also cures for a disease that was previously incurable. Of course, by curing the disease, more expensive (and more invasive) surgeries can now be avoided, which will reduce health care expenditures in the long-run even as pharmaceutical expenditures as a share of total health expenditures increased in the short-run. Price controls risk such benefits in the future.
Price control advocates also misunderstand the complex drug pricing process. As I argued previously, Pharmacy Benefit Managers (PBMs) distort pricing by creating a wedge between a drugs invoice price and its net price, or the price net of all of the discounts and rebates. Price control advocates typically focus on the invoice price, but from an expenditure basis, it is the net price that matters.
Importantly, the differences between invoice and net prices are meaningful. In what has become a typical pattern, invoice prices grew 9.2 percent in 2016 according to IMS Health, but net prices grew a significantly smaller 3.5 percent. Consequently, the effective price increases were not as large as price control advocates indicate.
Ill-advised policies rarely lead to good outcomes. As Congress considers the cost of prescription drugs it should recognize the complexity of the pharmaceutical market as well as the many unintended, but adverse, consequences that price controls will create.
Instead of imposing the seemingly convenient policy of price controls, Congress should focus on the hard work of systemic health care reforms that empower patients and encourage a more innovative health care sector.
Wayne Winegarden, Ph.D. is a Sr. Fellow in Business and Economics at the Pacific Research Institute, and Managing Editor for EconoSTATS