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An Industry Under Fire by Jon Palfreman
Palfreman is the producer of FRONTLINE's "The Other Drug War" and spent eight months researching and reporting on the high cost of prescription drugs for Americans. In this article he offers his reflections on the powerful and closed pharmaceutical industry and weighs the five most common arguments heard against it.

+ Argument 1. Price gouging

Critics claim the industry overcharges Americans for prescription drugs. While most insured Americans have little idea of the retail price of their Rx drugs, uninsured seniors know it all too well: up to 150 dollars for a one month's supply of a brand name drug like Lipitor or Fosamax. And, critics complain, these same drugs are sold for less everywhere else in the world--sometimes much less

Evaluating this argument:

This is the big argument. Critics complain that drugs are very expensive to buy. The industry replies that drugs are very expensive to develop. Just how expensive is difficult to know since drug companies are secretive about what they spend. But according to health economist Uwe Reinhardt, the average cost for each new successful drug is "somewhere in the hundreds of millions." Why so much? It's because finding new drugs is a bit like drilling for oil. Says Reinhardt, "When you drill for oil you drill a lot of dry holes, and eventually you hit a gusher. And all the cost of the dry holes have to be recovered from the oil in the gusher. The same is true in the pharmaceutical industry. All of the dead ends that they run into, the cost of that has to be charged ultimately to the successful drug."

In the drug business the gushers are called blockbusters (a blockbuster is a drug that earns more than 500 million annually). A large company like Merck has a handful of blockbusters (which currently includes Zocor, Singulair, Fosamax and Vioxx), which, they argue, must pay for all Merck's pharmaceutical dry holes. If they charged less, the argument goes, they would make less profit and invest less in R&D.

Critics are skeptical and cite a number of points. Number one, pharmaceuticals is the most profitable industry in America and has been for a decade. Number two, if high prices are essential to R&D, why, then, are foreigners able to buy the same drugs for less? Number three, drug company hand wringing about R&D would be more convincing if the industry spent less marketing to doctors and consumers.

Such arguments lead inexorably to schemes like Maine Rx, Maine's law which forces drug companies to offer uninsured seniors discounted prices. One of several state schemes aimed at controlling drug prices, Maine Rx has clearly unnerved the drug industry. In May, 2003, the US Supreme Court upheld Maine's right to proceed with Maine Rx. The industry rightly fears that other states might follow suit.

Why does the industry fear government price controls so intensely? According to Marjory Powell of PhRMA , price controls will kill innovation. "When government imposes price controls on an industry, innovation dries up... The pharmaceutical industry in the United States, because it's not been operating under price controls, is the engine of new research and development." But critics like Angell dismiss this as scaremongering. "It's a threat, it's a threat to the American public. They are saying "don't mess with us do nothing about our obscene profits, do nothing about these unsustainable increases in prices or else we will not give you your miracle cures."

To get beyond this rhetoric and reveal the true public health benefits and risks of price regulation, you have to try and put yourself in the position of a pharmaceutical company. Imagine you are the CEO of Drug Inc. You have many private sector clients--HMOs, hospitals etc-- who try to negotiate the best price. But even the largest of these private clients commands no more than 1% of the total market. You also have one big government client, Medicaid, which on average buys 16% of your drugs. By federal law, Medicaid is guaranteed the lowest price given to any private customer.

Now imagine a situation where Maine Rx is copied by 50 states, or even worse, one where the current Medicare system is amended to cover all seniors for Rx drugs. In this extreme latter case, the government's Medicaid and Medicare programs would now buy around half of all of your drugs. At this stage, according to economists, the government would become what economists call a monopsony buyer, a purchaser with such market clout that it could dictate prices.1

It's not hard to see why the drug industry would not want this to happen. Their legendary profits would fall. The question is: should Americans care? Do we have a selfish interest in having profitable drug companies? Or is it better for us to enjoy cheaper prices like Canada and Europe?

In other words, if (due to state and federal price regulation) the industry became less profitable, how would that affect ordinary Americans? I asked Princeton economist Uwe Reinhardt ,and pharmaceutical industry analyst, Richard Evans, for their best guess.

Industry analyst Richard Evans was in no doubt. "If we controlled prices today, then management is going to spend less on R&D and we're going to get fewer products tomorrow. So if we want price controls today we've just got to realize that we're a capitalist society, we finance these companies and control these companies and measure these companies through the capital markets. They're going to restrain R&D which means we're going to get fewer products. It is an inevitable trade." Uwe Reinhardt agreed, "If the revenue stream to the drug industry [went] down, I think it would be crazy to assume that that would not affect research and development. It would."

But what does "fewer products" mean? How specifically might this affect us?

According to these industry watchers, the most likely cuts would not be blockbuster products where there's a big market. In Reinhardt's view "They would cut smaller niche products with high risk." Typical of such niche product is Lilly's drug for septic shock, Xigris. Used in hospitals, this potentially life saving drug costs more than $6,000 per treatment. Richard Evans thinks that in a regime where government sets prices, Lilly would never develop such a drug. A better known example, in his view, is the recently announced Roche drug for HIV called fuzeon--the only drug for AIDS patients who have become resistant to other therapies--which is currently priced at $ 22,000. Says Evans, "It's an exceedingly expensive drug to manufacture. If back in the days when you were just planning that drug if you felt that you wouldn't have the ability to set that price in other words that price would be set for you, you never would have developed that drug."

If Evans and Reinhardt are right, we appear to be approaching a time when we have to make a trade off. If we want affordable drugs today for everyone, then we might have to forego some potential drugs tomorrow for certain niche patient groups.

Which brings us back to the original question. Are the companies price gouging, or are they simply maximizing profits in the last unregulated market in the world in order to pursue long range, risky R&D projects? I think the drug companies at least earn a split decision on this issue.

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posted june 19, 2003; last updated july 8, 2003

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