A prescription for sanity
All the clamor over our soaring health costs runs the risk of producing a dangerously wrong prescription. An aging population of baby boomers will begin to retire at the end of this decade. By 2050, Medicare and Medicaid alone could eat up 21 percent of gross domestic product. Drug companies are caught in the headlights because prices are relatively high and the companies are very profitable. Case closed? Not at all. The tendency to demonize the drug companies badly confuses just what's going on in our society.
In an important article in the New Yorker , Malcolm Gladwell identifies the primary push behind the 9.1 percent increase in drug spending: While just 3 percent was due to price increases, the rest was largely the result of increased usage. Volume is up because we are aggressively treating diseases like AIDS and asthma. But that's a net benefit. There's a lot of research showing that newer drugs are not only better for patients but, despite their price, cost us less in the long run. Susan Horn, having studied 2,500 patients from six HMO s in 1996, concluded that when we limit access to medication, patients fall back on emergency rooms and hospitals, which cost society more.
In contrast to drug costs, all but 1 percent of the 9 percent increase in hospital expenditures last year was driven by inflation. Yes, but what about those prices? It's true that we pay more for brand-name drugs that are under patent protections--but we pay less for generic drugs. Our generics are among the cheapest in the world, and more of our brand-name drugs are coming off patent every year.
Dollars--and sense. But isn't the answer to brand-name drugs to import them from cheaper sources, like Canada? It's a superficially attractive notion, but the small print bears some study. Importing drugs from countries with price controls will do little to keep prices down in the United States, and here we run into the fundamental economics of health and medicine. Forcing prices down may be good politics, but it is terrible medicine. High-quality miracle drugs don't come cheaply in an era of onerous Food and Drug Administration safety and efficiency standards. It costs roughly $800 million to bring a major new drug to market. It's true that, once approved, such drugs cost little to manufacture, hence the fat profits. But if profits are sharply cut, there will be less money for research and development. Forcing down American drug prices would, by some estimates, produce a cutback on R&D of as much as 25 to 30 percent.
Basically, American consumers are subsidizing other countries in the western world. We pay about 50 percent more for patented drugs--but we invest about 20 times as much in pharmaceutical R&D. This is known as the "free rider" problem. Since it is the U.S. market where new breakthrough medicines are invented and introduced, the rest of the world gets a free ride by mandating prices lower than ours. They are still higher than the drug companies' marginal production costs but below the costs necessary to recover the investment required for future research and development. And if these drugs are sent back to the United States, we become a free rider on ourselves, and that situation wouldn't last long.
Either there would be shortages and higher prices in countries like Canada, which would then clamp down on their own pharmacists and distributors to keep their drugs from going to the United States--a policy advocated by the Canadian minister of health--or the big American drug companies would cut off their supplies to Canada. If, in effect, you extend the lower prices brought about through price controls in Canada to the primary U.S. market (which is 10 times as large as Canada's), in almost no time at all there wouldn't be any American-made drugs in Canada, cheap or otherwise. The drug companies are simply not going to sell their goods at low prices there so that Canadian vendors can turn around and sell them at higher prices back in the United States.
So even if we overlook the fact that drugs in Canada might be counterfeited, adulterated, or mishandled, Canada-level pricing would dramatically slow the pace of new drug development. As Michael Porter wrote in the Harvard Business Review, "Competition at the wrong level has been exacerbated by the pursuit of the wrong objective: reducing cost. . . . The right goal is to improve value (quality of health outcomes per dollar expended), and value can only be measured at the disease and treatment level."
Which is why the National Institutes of Health advocates using a lot more drugs to achieve the result that really matters--good health. Instead of worrying about restraining or reducing drug costs, we should be focusing on staying healthier and achieving better health outcomes. That's the heart of the matter.
This story appears in the November 22, 2004 print edition of U.S. News & World Report.