Why are US drugs prices so high? Because of government!

Progressive lawmakers in the US have not had much to celebrate lately, but they gained some traction late February, when President Trump gave his support to a bill opening up for the import of prescription drugs from Canada, where these drugs sell for much lower prices than south of the border. Trump has himself been chastising the drugs companies for ‘getting away with murder’ on drugs pricing in the US. But why is it so?

Drugs are expensive to develop. Pharmaceutical companies spend literally billions on research, testing, development and bringing to market new drugs. On the other hand, drugs are cheap to produce. Once a drug is developed, the marginal cost to produce another pill is low. This allows drugs manufacturers to sell their expensive products at low prices in poor parts of the world, once their initial outlay on R&D has been covered. But when pharmaceutical companies try to recoup their initial investment, particularly American patients pay a disproportionately high part. Drugs prices in the US are notoriously high compared to the rest of the world. This sounds counterintuitive to any student of a free market, but alas, pharma is anything but a free market.

The granting of patents and the highly regulated nature of the pharmaceutical marketplace means government holds large leverage over the pharma industry. State monopoly, single payer health services take full advantage of this. The reason why drugs are cheaper in Britain is not because ‘the buying power of the NHS is vast’, as it’s often claimed. That is not surprising, as this argument is rarely applied in other markets. A free market drives prices down because of competitive supply. Large consumers may negotiate volume discounts but not to anywhere near the extend that we see in pharma. Competition drives profit margins down but the consumer can never negotiate the price below the cost. What happens in health care is effectively blackmail: there is only one buyer, who happens to be the government and who therefore makes the rules, grans patents, writes regulation etc. It is negotiation at the point of a gun. It is not surprising that governments are often successful. And due to the low marginal production cost, the pharmaceutical companies can still turn a profit on selling at the lower price. But the bill for research and development has to be paid by someone. In steps the Americans, with their comparatively free market with multiple private buyers. The pharmaceutical companies effectively charge American patients what they cannot charge others. Idiosyncrasies in American health care, like ‘Cadillac’ health care plans, reduces US consumers price sensitivity. The result is that the US spends vastly more on drugs than the rest of the world.

One could ask ‘why doesn’t the US set up a state sponsored buyer which holds similar leverage to European single payer health care systems’? The truth is, they could. And Trump has been floating the idea of allowing Medicare to negotiate drugs prices on behalf of the health care sector. But the result would not be cheaper, but fewer drugs. The return on equity in pharma is, according to Stern Business School,  a respectable but not outstanding 9.5%. Couple that with the risky nature of drugs development, and it is clear that there are no abnormal profits that can just absorb the lower prices. The standard cries of profiteering are as usual misplaced, and not surprisingly so, as pharmaceutics is a competitive industry. If the US stopped effectively subsidizing the rest of the world, drugs development would simply be retarded.

From their standpoint of subjective moral superiority, European advocates of single payer health care assume that the higher cost of medical care in the US must be down to the nature of the freer market Americans enjoy. The truth is, it is down to the blackmailing of pharmaceutical companies undertaken by these single payer systems, a practice that saddles sick Americans with larger bills. And where’s the moral in that?

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