The Case For Regulating Drug Prices

Perhaps the most important reason for rising health insurance costs is continued large, and sometimes astronomical, increases in the price of pharmaceutical products.  These increases don't apply to aspirin or antacids.  They tend to appear in the price of lifesaving drugs.  Or they are imposed on drugs for serious medical conditions that require treatment if the patient is to have a decent quality of life. 

Also alarming is the fact that the people behind the rising prices are sometimes speculators, who purchase the rights to the drug and then ratchet up the cost.  While some major pharmaceutical companies may be able to point to substantial research and development costs as a reason for the expensive prices of new drugs, a speculator who buys the rights to established drugs and takes advantage of seriously ill patients is doing something that, as Berkshire Hathaway Vice Chairman Charlie Munger put it, is "deeply immoral."

In addition, those drug companies that can legitimately claim to have significant research and development costs aren't necessarily playing fair.  Many, and perhaps most, other countries around the world already regulate pharmaceutical prices.  Frequently, the prices they permit are so low that pharmaceutical companies may not recoup much, if any, of their R & D expenses.  So the drug manufacturers often seek to recover most or all of the R& D expenses from American consumers.  Americans are paying through the nose so people in other countries can enjoy low health care costs.

How can drug prices shoot up like a geyser when the economy is sluggish, incomes stagnant and general inflation almost nonexistent?  In a word, health insurance.  Health insurance programs allow drug companies to spread the cost of expensive drugs across large numbers of insured people, most of whom don't need the expensive drugs.  Even though health insurers are taking many steps to control drug price increases on many pedestrian pharmaceutical products, the price levitators have concentrated their immorality on drugs that people badly need.  It's hard for insurers to combat these price increases, since many patients may suffer dire consequences without the expensive drugs. 

While price controls are generally undesirable, as they can produce misallocation of resources, we are seeing a failure of market forces with expensive pharmaceutical products.  The prices American consumers pay aren't the result of the free interplay of competitive markets.  They are the product of exploitation of very ill people through speculative excess and the misallocation of outsized amounts of R & D expenses to Americans.  People with major medical problems have what economists call inelastic demand, a desire or need for a product that is unaffected by its price.  If you're dying, you'll pay any price for a medication that will let you live.  Price isn't a consideration if you otherwise have to live with terrible suffering.  Other countries around the world (including major industrial nations) don't allow drug companies to exploit this inelasticity of demand of their seriously ill citizens.  Why should Americans be hammered over the head?

There's no need for price regulation of most pharmaceutical products.  Go into any drug store and you'll see lots of price competition for lots of products.  These can be left alone.  The drugs that need regulation are the ones for which there aren't competitive and effective substitutes, especially if they are used for serious or life threatening ailments or conditions.  Lobbyists for the pharmaceutical companies and their running dog economists will endeavor to over-complicate the issues, asking how can a bureaucrat come up with a more rational pricing scheme than market forces.  However, let us note that market forces aren't working rationally in the drug market and most of the rest of the world doesn't get into a tizzy over the self-serving palaver of the drug industry. 

It may be difficult to construct a model for price regulation that the economics profession as a whole would consider elegant.  But how can it be elegant or fair for Americans to bear pharmaceutical R& D costs for most of the rest of the world?  How about allocating some of that cost to persons in Europe and Asia, many of whom live in wealthy, industrialized nations?  How can it be socially beneficial for speculators to exploit the inelastic demand of seriously ill people?  Perhaps price regulation models couldn't be certain of offering more than rough justice to the drug companies.  But rough justice to them is better than gross injustice to the seriously or desperately ill and to the Americans who pay already high and ever rising health insurance premiums.