Austin Frakt in a February 12, 2021 piece, posted both in Upshot and the Incidental Economist , argues that the Biden administration should establish a committee to determine appropriate prices for pharmaceuticals. This commentary contests both his economic and political arguments.
Frakt’s argument seems to be based on the following claims:
- There exists a tradeoff between lower prices for today’s patients and research and development (R & D) toward more and better products to serve future patients.
- Pharmaceutical firms’ investment in R & D depends upon the profitability of existing drugs.
- Some countries have legislated a centralized process that evaluates the benefits and costs of adding specific pharmaceuticals to their national health insurance programs. For example, see the price per Quality Adjusted Life Year guidelines (at roughly $40,000 per QALY) set by NICE (The National Institute for Clinical Health and Excellence) in England.
- Other countries have based their drug pricing policy on comparable prices in some high income countries. At one point, President Trump proposed such a policy.
Another argument consistent with the above, but not posited by Frakt, could be based on strong support in both major political parties (and public opinion polls) for public policy action to limit drug pricing. Clearly, at least in recent times, the pharmaceutical industry has lobbied (and funded) successfully in opposition to such action.
Michael Kremer, 2019 Nobel Prize winner in Economics, has proposed several ways to separate the innovation component (research and development – R & D) of pharmaceutical prices from the production component, and, thus, counteract the market power inherent in patent-based pricing. For example, either advanced market commitments or patent buyouts by governments could be used to cover the innovation and development portion of drug development. Since R & D comprise most of the cost of pharmaceuticals, the remaining cost, related to production and delivery, would be affordable to most Americans.
The committee approach that Frakt suggests would have to overcome substantial political barriers that have restricted previous public policy attempts to estimate value to determine appropriate pricing. After its establishment in 1977, The Office of Technology Assessment performed the type of cost-effectiveness or cost-utility analysis that Frakt suggests. After the Republican sweep in the 1994 elections, Congress abolished this office as counter to the interests of the Republican party. The Affordable Care Act, pushed through in 2010 with no Republican supporters in either house, prohibited Medicare from using cost-effectiveness analysis or related attempts to determine which pharmaceuticals delivered value. So, introducing trade-offs between present and future recipients into the policy discussion is unlikely to be greeted with open arms by either party.
In a 1998 Quarterly Journal of Economics paper entitled “Patent Buyouts: A Mechanism for Encouraging Innovation,” Kremer argued that “Such patent buyouts could potentially eliminate monopoly price distortions and incentives for rent-stealing duplicative research created by patents, while increasing incentives for original research. Governments could offer to purchase patents at their estimated private value, as determined by an auction… Most patents purchased would be placed in the public domain, but to induce bidders to reveal their valuations, a few would be sold to the highest bidder.”
Given the essential role to be played by vaccines in developing economies (2020 American Economic Review Papers and Proceedings), Kremer and his co-authors proposed advanced market commitments as an essential component to aligning market prices with the marginal cost of production. When the social benefits of a program far exceed the private benefits to producers, as they do for vaccinations for any contagious disease, public policy intervention is necessary to address the positive external benefits. For example, when drug development is close to market ready, Kremer et al. propose that governments make advance commitments to purchase a particular capacity or number of doses to encourage sufficient volume. Then the marginal cost of delivering the drugs can be made low enough to ensure affordable access. To induce research and development, governments might identify a fixed total budget to be spent on each pharmaceutical to be allocated among competing companies. Kremer et al. use a pneumonia vaccine example ($3.5 per dose and $1.5 billion of total funding) to illustrate the total commitment to be made to the delivery of the vaccine. Market competition then would be used to allocate the funds among the interested firms.
In response to the COVID-19 pandemic, the Trump administration’s WARP speed program shares some features of the Kremer proposal. For example, the administration made an advanced commitment of $1.9 billion to Pfizer and BioNTech for the delivery of one million doses of their vaccine. The WARP speed project also made advanced commitments for both development and production to Moderna, Johnson and Johnson, Astra-Zeneca, Novavax and Sanofi-Glaxo Smith Kline. But rather than have interested firms compete for a fixed commitment of funds, the WARP speed program, chose to pay different amounts per delivered dose with prices ranging from $4 per dose to Astra-Zeneca to over $20 per dose to Moderna.
The approach suggested by Michael Kremer would seem to meet both the economic and political hurdles that a “blue ribbon” technical committee would not meet. Although such committees have made recommendations based on comparing costs and benefits in the past, Congress has repeatedly rejected their advice. In addition to the Office of Technology Assessment abolishment and the Affordable Care Act prohibitions, Congress has repeatedly rejected the guidance of the Medicare Payment Advisory Commission as well as the 1998 National Bipartisan Commission on Medicare. Why should we believe that today’s political environment will be more friendly than it has been in the last 25 years?
The advanced market commitments or patent buyout approaches have the virtue of consistency with the WARP speed vaccine development program. Furthermore, even the leadership of the Democratic party points to this program as a major success in responding to the COVID-19 pandemic. Of course, many challenges to program design would have to be overcome such as: 1) how value will be determined, 2) how many firms should be offered opportunities to receive funding, and 3) the nature of the advanced commitment. A number of pilot projects for drugs that address both contagious diseases and chronic diseases should be conducted to determine which approaches are most cost-effective. Clearly, discussion of these details would extend well beyond what can be fit in this commentary.
Of course, any program will have weaknesses and need to be modified; nevertheless, following the lines suggested by Kremer and his colleagues, there is the potential to generate both lower prices of pharmaceuticals used to serve today’s recipients AND more productive research and development initiatives to serve future patients.
No Con Economics 