y that is highly efficient and focused. As a result, biotechnology will continue to thrive unce review and regulation.

ontrols proposed by the Administration would not kill biotech. As a result, the policy proay not detect the negative consequences of a smaller, less vibrant industry. Policymakers difficult to deal with the opportunity cost of less research and longer development times. g as the biotechnology industry is not totally destroyed, it can be whittled away and pared due to less investment and the policy community will not know the difference. No one will ention to companies that are not formed or research that is not carried out or breakthrough hat are not developed.

makers should ask themselves if the anticipated savings from controlling launch prices and trictions on the introduction of new technologies are real. They should weigh these 'savings' the risk that the US could loss its leadership in biotechnology.

er, they must weigh these savings against the fact that the real cost killers in the health care are diseases such as AIDS, cancer, Alzheimers and heart failure. There is a real cost, in nic and human term, of reducing the capacity to develop cures and effective treatments for levastating illnesses. Moreover, without them the cost of health care will continue to climb. may be expensive, but disease is even more so.

policymakers should realize that once price controls are in place, they tend to become more Health care costs will continue to climb. The underlying pressures of controlling costs ces the need to intensify controls. In the search for additional measures of cost containnigh profile drugs will be subject to increased scrutiny and regulation, not less. In Europe, and Canada, the introduction of price controls have followed this pattern. (Japan has rebegun to encourage biotechnology by raising the price for innovative drugs.)

ce controls start out as modest market interventions and gradually intensify. In the process, listorted investment by rewarding lower priced imitations of existing products over therainnovation. Policymakers who believe that price controls with make biotechnology commore focused and competitive only have to look at the impact of price regulation

ere.

cent disinvestment in biotechnology suggests that America's biotechnology industry have to be concerned about. The capital markets have already conducted their analysis of price tion and have voted with their feet. If present policy trends are not altered, companies doing highly basic research will get less money and companies with products near approval will ›re. Fewer new companies will form to take the place of others that exit the market. Finalny consolidation, many important research projects that could save and enrich the lives of îs, will be delayed, shelved or sold overseas. And as price controls are tightened and caps w technology and spending are imposed, biotechnology will fail to thrive.

policymakers are of the opinion that less research is a good thing since that would mean drug prices. Again, the tradeoff between low prices and innovation confronts the nation and icymakers. Both the Congress and the White House must decide whether price controls are this cost, and soon. Incredible as it may seem, in both financial and humanitarian terms, the is now for America's still vibrant but increasingly besieged biotechnology industry.

Gordon Public Policy Center

Regulatory Review Project
POLICY REPORT

November 1993

Price Controls: The High Cost of Low Prices

By Robert M. Goldberg, Ph.D., Senior Research Fellow

Introduction: Innocents Abroad

Drug prices are generally lower in Europe and Japan than they are in the United States. To many policymakers, this cross-national difference is an example of how pharmaceutical profiteering makes drugs unaffordable to many Americans. Indeed, for many people of limited means (without Medicaid, which covers most drugs) whose health insurance doesn't cover prescriptions, the price of some drugs can limit access to needed medicine. A related concern is the possibility that many breakthrough therapies will be too expensive for anyone whose health insurance does not cover outpatient drugs.

In fact, most drug prices are lower in developed countries because of government controls on prescription prices. Such controls are used in conjunction with programs that provide universal and total coverage of prescription drug expenditures. Policymakers, concerned about the relative lack of access in the United States, regard controls on drug prices as a necessary element of efforts to expand prescription benefits. Controls are also viewed as a mechanism for protecting consumers from the burden of high drug prices.

However, they should not judge the effectiveness of price regulation by price alone. Forcing down drug prices through government controls carry hidden costs that must be examined.

An international comparison of drug expenditures suggests that price controls are no more effective than markets in controlling drug costs. Further, as Eleanor Chelimsky wrote recently in Science magazine, concern about cost controls have caused policymakers to lose sight of the fact that the quality of care will not "..remain unchanged under a health care system that reforms both cost and access."

Price controls can reduce the number of innovative drugs available and discourage products that are of better quality (fewer side effects, easier to take or treating more conditions) or lower price (generics or price competitive brand drugs). In some cases, price control fail and policymakers resort to rationing drug expenditures. Limits on drug spending can compromise patient care and lead to more costly hospitalization or nursing home care.

Eleanor Chelimsky, "The Political Debate About Health Care: Are We Losing Sight of Quality?" Science, Volume 262, October 22, 1993. Page 525.

161

This suggests that modest changes in market pricing to increase access should be considered in lieu of price controls. There are other ways to insure access to prescription drugs such as increased Supplemental Security Income, providing prescription vouchers or insurance coverage of pharmaceuticals. At the very least, when comparing price controls overseas to pricing freedom here, we must look at the impact on quality of controlling costs and increasing access.

Drug Costs and Price Regulation: A Comparative Analysis

There are important exceptions to the pattern of lower overseas drug prices. For example, drug prices to hospitals are lower in the US than they are in Britain, Sweden and Japan. Certain biotechnology therapy prices are also higher in Europe, Canada and Japan than they are in the United States.

More generally, higher drug prices don't always lead to higher drug costs. Figure 1 shows that per capita drug costs in the US are lower than all but one of the largest developed country markets. Europe, Japan and Canada spend more per capita for pharmaceuticals than does the US.'

One could be excused for expecting that all countries with price controls to have lower per capita drug costs than the US. Following this logic, the UK's exceedingly low per capita costs should be the result

2

Patricia M. Danzon and Jeong Kim, "International Price Comparisons for Pharmaceutials.", The Wharton School, University of Pennsylvania, October, 1993.

3

Spending is expressed in purchasing power parity (PPP) dollars. Pharmaceutical and medical spending in local currencies is divided by the PPP-adjusted dollar rate. PPP-adusted dollar expenditures per person are comparable than unadjusted dollar spending and represent the nearest approximation to internationally comparable consumption levels. See Heinz Redwood, "Price Regulation and Pharmaceutical Research." Oldwicks Press, Suffolk, England, 1993, page 56. A pure exchange rate comparison does not alter the finding that per capita US spending is lower than the largest developed country markets.

of having exceedingly low drug prices. Yet, new drug prices in Britain have been higher than in other European countries..*

More important, the relationship between per capita spending in the US and other developed countries is not a recent or short-term phenomena. It has persisted for nearly 20 years. As Figure 2 demonstrates, per capita drug spending in the US has increased at about the same rate as it has in many other countries. Despite controls limiting price increases to below the rate of inflation, British drug expenditures have increased at an average of 14% a year over the past two years. Similarly, Canadian drug costs have increased at 12% a year even though drug prices have been held to that nation's inflation rate."

Tradeoffs Between Cost Control and Innovation: An International Comparison

European health systems cover nearly 100% of all drug costs, while only half of all such costs are paid for by third parties in the US. Since increased access will mean increased costs for government and private health insurers, it shouldn't be suprising to see policymakers trying to contain costs even as they expand access. The question is not whether costs should be controlled or not. The question is, how to do it? Specifically, are some form of price controls the price we pay to expand access?

Lacy Glenn Thomas, III, "Implicit Industrial Policy: The Triumph of Britain and the Failure of France in Global Pharmaceuticals." School of Business, Emory University, February, 1993. As we will see, low per capita British drug spending is, in part, the product of government controlled prescribing practices that include rationing access to higher priced drugs.

It should be noted that until 1987 Canada required compulsory licensing of brand products. In 1987, compulsory licensing was abolished and a price review board was instituted. Since then, Canadian drug spending has declined by a half of a percentage point a year. During the same time, the annual average rate of growth in US per capita drug spending declined by 1.7% a year. Since 1992, Germany has moved aggressively to cut drug spending and has succeeded by slashing reimbursement rates and establishing drug budgets for doctors. Italy is proposing to cut what the government spends reimbursing prescriptions by 30%.

et system controls cost as well, if not better than, price control regimes. So the deciding issue which system does a better job of promoting quality and patient access to qualitative

ents. Comparing the interaction between cost control and innovation in the United States and instructive in this regard.

6

price controls limit competition based on price and quality. New products are more likely to be I to obtain higher prices as opposed to offer therapeutic innovation or substitution at a lower cost. of price competition in regulated systems reduces incentives for generic drug introductions. Lack >rices for innovative products diminishes the price difference between breakthrough drugs and rs. In turn, the absence of generic competition in Europe generally gives companies an incentive to inor product extensions to achieve higher prices because older prices tend to rise slower than the ation.'

more recent product launches in the US suggests that new drugs do not drive the cost of drugs in ways the public and policymakers assume. In particular generics permit and encourage switching nsive brands to cheaper generics without relying on price controls.

[any new drugs in the US are either generics or follow-on products that come in at lower prices heer product. Several studies show that many of the new products introduced between 1987 and lower priced generics and branded products. For example, cephalexin, a very common ve has declined in price by 53% over 4 years because of generic substitution. In addition, "...it is at quality-adjusted prices of drugs in certain therapeutic classes have declined (original emphasis) with substantial improvements in their characteristics from one generation of products to the

hile prescription volumes increased in 1992, all of the increase came from generic prescriptions. I will accelerate since $10 billion a year of brand drugs lose patent protection by 1995. Generic nt of one drug in a therapeutic class will take market share away from other brand competitors as product it copies. Greater use of generics will be used increasingly by government and private te to control costs.

uoppoli Commission Report, "Per un nuovo metodo di determinazione del prezzo delle specialita : relazione della commissione Ruoppolo," Farmindustria, Supplement to Piazza di Pietra 1/90, Rome

einz Redwood, "Price Regulation and Pharmaceutical Research." Oldwicks Press, Suffolk, England, 46-74. Note that at European Commission report on industrial policy for the pharmaceutical industry s to increase the us of generics to "...stimulate price competition" as part of plan to eliminate price See "EC Industrial Policy Outlined." SCRIP number 1858.

nst R. Berndt and Paul Greenberg, "Price Growth of Prescription Pharmaceutical Preparations: An | Explanation." Paper presented at Competitive Strategies in the Pharmaceutical Industry, American Institute, Washington, DC, October 27-28, 1993, page 12.

vi Griliches and Ian Cockburn, "Generics and New Goods in Pharmaceutical Price Indexes." Paper

at Competitive Strategies in the Pharmaceutical Industry, American Enterprise Institute, Washington, er 27-28, 1993, page 15.

Price Growth of Prescription Pharmaceutical Preparations", page 12.

ick Kolassa, Senior Research Associate, Personal Communication. Research Institute of tical Science, University of Mississippi, December 8, 1993.