Assessing Consumer Gains from a Drug Price Control Policy in the United States

Abstract

1. IntroductionThe on-going public debate over prescription drug prices represents one of the most contentious issues in the history of U.S. health care politics. The commonly held perception that U.S. drug prices are "too high" has been fueled by the fact that real drug prices in the United States have been rising steadily and at a rate faster than that of the general consumer price index for over two decades. As a result, the pharmaceutical industry has come under intense criticism, with both politicians and special interest groups calling for new legislation making pharmaceuticals more affordable, either through legalized reimportation from price-regulated markets such as Canada and the European Union, or more directly through government-imposed price controls.Although these calls for legislative action are not new, the United States does appear to be, for the first time, very close to a major policy change regarding U.S. drug prices.1 The U.S. government might, like all other industrialized governments around the world, soon begin regulating drug prices.2 In addition to several reimportation bills currently on the Senate floor, proposed amendments to the recently passed Medicare Modernization Act of 2003 (MMA) also exist that will allow the U.S. government to negotiate directly with drug manufacturers for Medicare prescription drug purchases (the MMA currently has a noninterference clause), which will amount to approximately 60% of all U.S. drug purchases (Santerre, Vernon, and Giaccotto 2006).Although regulated drug prices in the United States will undoubtedly improve the public's access to today's medicines, and thus generate both cost savings and improved public health, it will simultaneously reduce firms' incentives to invest in pharmaceutical research and development (RD Miller and Frech 2002), as well as the sensitivity of R&D investment to real pharmaceutical prices (Giaccotto, Santerre, and Vernon 2005) and profits (Vernon 2004). Thus, in addition to the short-run benefits associated with lower regulated drug prices, long-run costs also arise. This is precisely the tradeoff the U.S. patent system tries to balance by awarding limited-term patents to new drug products.Even though a policy of regulated drug prices in the United States involves a tradeoff between short-run benefits and long-run costs, the former outcome often receives more attention in policy debates (Scherer 2004). Interestingly, however, efforts to quantify these short-run benefits from a rigorous economic perspective are nonexistent. Therefore, in this article, we attempt to do just that. We also compare our findings with the results from an earlier study by Giaccotto, Santerre, and Vernon (2005)--one that employed the same data and modeling techniques but that measured the economic costs of the same U.S. price control policy--in terms of reduced levels of pharmaceutical innovation. Thus, we are able to weigh the benefits of pharmaceutical price controls (in terms of consumer surplus gains) against the costs (measured in terms of forgone drug discoveries). Although these studies are retrospective in nature (out of necessity), and consider only one type of U.S. price control policy (one that requires pharmaceutical prices grow no faster than the consumer price index), the price control policy simulated is, nevertheless, similar to an actual policy enacted in 1992 for drugs purchased by the government for the Veterans Administration (VA) health system. Moreover, and for the first time, a formal cost-benefit analysis of a particular type of drug price control is possible, and this could offer new insights. …