Ross Duffin's blog

Prescription Drug Prices

February 7, 2005

I found it really interesting, during the election of 2004, to see everybody miss the entire point in the debate over prescription drug prices. The Bush administration had negotiated a deal with the drug companies, where seniors could get a card that would subsidize their drug costs, but the cost of the drugs was set by the manufacturers, and the deal stipulated that it was not negotiable. The Democrats derided this plan, saying that it didn't lower the cost sufficiently and that, like some individual states, the US ought to allow its citizens to import drugs from Canada where they cost much less.

The problem with the Bush plan was that it was so unbelievably complicated, with so many different organizations offering cards with slightly different benefits, and it didn't solve the basic problem of lowering prescription drug costs. These were private insurance companies, however, and that kept the Bush government happy because it meant that private enterprise was making money and doing its efficient, free-market thing, instead of the big bad bureaucracy of the federal government trying to run it.

The Bush administration first tried to maintain that Canadian drugs were suspect, that they didn't have the kinds of quality controls the US did, and that people would die if they used Canadian drugs. Then word got out that Canadian drugs were the same as US drugs—some manufactured in the US and some in other parts of the world. Even some of the drugs sold in the US by US manufacturers were made in other parts of the world, as it turned out. So it became harder to make the point that Canadian drugs were somehow inferior. Then in the early fall of 2004, when the US flu vaccine supply fell through, and some precious extra vaccine was made available by Canada, the Bush administration had to back off the scare-mongering and badmouthing of the Canadian product. OK, point made.

The real problem with the Democratic plan was that the US is a much, much bigger country than Canada, and Canadian pharmacies couldn't hope to fill the US market, particularly on a national scale. Even with only a handful of states allowing their citizens to purchase Canadian drugs—a loophole the US was working to close anyway—the supply of drugs in Canada was not going to be enough to meet demand. Why is that?

Well, it's because the drug manufacturers were squeezing the Canadian market, and limiting the supply, so there wouldn't be enough to export. In fact, even while the election was going on, the Canadian government knew about this and began talking about limiting drug exports to ensure that there would be enough for the domestic market. So the Democratic plan had no hope of succeeding—something I helpfully tried to point out, only to get on some email list and receive campaign updates several times a day. But the question that was never asked in all of this is still worth asking: why are drugs cheaper in Canada (and in many other countries) than they are in the US? I will get to that, but first, we need to know why drugs cost so much money in the US.

Drugs companies in the US set the prices of their prescription drugs according to the cost of manufacturing plus the cost of research & development (of current and future drugs) plus the cost of advertising, and so on. I would say that the profits the drug companies are making are obscene, but as long as the companies can convince the Federal Trade Commission that they are not colluding with other companies to fix the price at an artificially high level, they are acting within the law. It’s nice for them that they have a monopoly on new drugs, at least for a few years until the law allows other companies to make generic versions of the drugs (while still paying a royalty to the original manufacturer), but it's new drugs, especially, that make the money.

One part of this equation that has changed drastically over the last few years is the cost of advertising. It used to be that drug companies marketed prescription drugs to physicians, who were, after all, the only ones who could decide to prescribe them, and thus controled the market. But drug companies discovered that they could market directly to consumers—there was no law against it, after all—and while the cost was much greater in marketing to the general public, they could get huge results. Consumers couldn't purchase the drugs directly over the counter, like they can with non-prescription remedies, but they could "ask their doctors" about the drug, and put pressure on them to prescribe it. This direct marketing of prescription drugs became more and more effective, as ignorant consumers put pressure on doctors to prescribe drugs they had heard about on TV. Even watching the network news, there are sometimes two or three prescription drug ads in a row in a single commercial break! It must be working. The billions of dollars spent on direct marketing is selling more drugs than marketing to physicians ever did. But, of course, it costs a whole lot more, and that cost is getting passed along to the consumer, whether by the direct payment for the medication, or the payment of higher insurance premiums to cover the higher cost of the drugs.

One famous case where the benefits of this system to the consumer were dubious but the benefits to the drug company were enormous occurred with the drugs Prilosec and Nexium, which were made by the same manufacturer. Prilosec was a very effective product and got prescribed a tremendous amount by doctors. But the monopoly on the drug was running out, so the company was faced with drastic cuts in profits as generics became available and the price of Prilosec plummeted in response to the competition. So they made some very small adjustments to the Prilosec formula and got a new patent under the name Nexium. Well, if it's virtually the same, why wouldn't doctors and consumers just go on purchasing Prilosec at its new lower cost? Because the company mounted a HUGE campaign for Nexium, so that consumers would demand the newer drug over the old one, even though the benefits were marginal at best. Why did the drug company do this? Because they had a monopoly on Nexium and were losing the monopoly on Prilosec. Is this in the bests interests of Americans, particularly when the astronomical costs of marketing drugs like that are simply added on to the cost of the medicine? That question is supposed to be irrelevant, because it's a free market society, and the companies are simply charging what the market will bear and what the hospitals, insurance companies and, ultimately, the conumers will pay. But the drug companies are still making obscene profits, and this brings back to the question of lower drug prices in Canada.

Drug prices are lower in Canada because a panel of experts looks at the cost of research and development, and the cost of manufacturing, and decides what a fair price should be for the product. They tell this to the drug companies and the companies charge that amount for their product, or they don't sell it in Canada. The same thing happens in other countries too. It's called price controls. The drug companies don't like it, but they abide by it, because even at the lower price, they are still making lots of money, and they want to sell their products there. So that's why drug prices are lower in Canada. Why couldn't it work here too?

First of all, "price controls" smack of government interference in the free market, so it's not something that the US government would ever agree to, since it's not capitalism and therefore not the American way. What I suggest to achieve the same end is for the US government to negotiate a lower cost from the drug companies. This is something the Bush administration said it wouldn't do with its prescription drug plan of 2004, but it happens all the time already with drugs used in Veterans hospitals all over the country. A lower cost is negotiated by a large user and the companies sell the product at that price. The larger the user, the more clout they have in negotiating the lower price. So if the US government were to negotiate a lower price on behalf of all the users in the country, drug companies would have to abide by it. In fact, they would want to abide by it because they want access to that market. Great idea, huh? But let's not call it price controls, let's call negotiating a better business deal. That sounds so much more American, doesn't it?