Introduction

Are Drug Prices Too High?

Pharma’s Role in Promoting Research

The Effect of Drug Prices on Innovation

Possible Policy Solutions

Conclusion

Endnotes

Introduction

Drug prices are once again a major focus of public policy in Washington D.C. President Trump has stated that reducing drug prices is one of his highest priorities.[1] The administration recently issued new regulations requiring manufactures to list the price of their drugs in television ads.[2] Congress has already passed the Know the Lowest Price Act and the Patient Right to Know Drug Prices Act, both of which try to promote transparency in prices.[3] The Senate Special Committee on Aging recently conducted a series of hearings on drug pricing.[4] And the Senate’s bipartisan Prescription Drug Pricing Reduction Act would reduce government spending on drugs by an estimated $100 billion over the next decade.[5]

This renewed attention is due to several factors. In a few cases, companies have dramatically raised the prices of specific drugs in order to generate more profits.[6] Although these instances have been relatively rare, they have generated a great deal of publicity and comment. In other cases, new drugs have been introduced with large price tags. For instance, Novartis recently announced its new drug Zolgensma, which treats spinal muscular atrophy, will be priced at $2.1 million for a one-time therapy.[7] A large reason for the high cost is that relatively few people suffer from the disease and thus the cost of development must be spread over fewer patients. Finally, the rising cost of health care, including drugs, is placing greater pressure on individuals, insurers, and public budgets. A recent report by Accenture revealed a $30 billion gap between the expected profits of drug companies from new drug launches and the projected drug spending of the public health programs in developed countries.[8]

Public policy demands a constant array of trade-offs whose difficulty only makes them more important. For prescription drugs these trade-offs occur on at least three levels. At the first level, policymakers must weigh the benefits of devoting more resources to health care as opposed to other important social needs such as infrastructure, education, and income support. Second, within health care they must balance spending on pharmaceuticals against other forms of health care, the prices of which have also been rising. These trade-offs may not be so stark, however, as in many cases the use of prescription drugs reduces the cost of other forms of health care.[9] There is also the difficult question of whether to devote extensive resources to help a few people with severe conditions at the expense of slightly better care for the majority. Attempts to evaluate the worth of different treatments require that we assign a cost to human life. But this cost is extremely subjective and cannot be determined by economic considerations alone.[10]

Finally, policymakers must choose between the respective demands of current and future patients. Government price controls and other measures to reduce drug prices, such as weakened intellectual property protection will undoubtedly help current patients. But this will come at a cost. Money not consumed today can be invested for tomorrow. For the issue of pharmaceutical drugs, an overwhelming body of academic research shows that price controls will significantly restrict the number of new drugs in the future. The pharmaceutical industry is the epitome of a dynamic high-tech industry, wherein the profits from one generation of products go to pay the high development costs for the next generation. Artificially reducing drug revenues today will not only cause companies to cut back on their future research—meaning the next generation will benefit less from new drug discoveries—it will jeopardize U.S. leadership in an industry that punches above its weight in funding research and employing scientists.[11]

An overwhelming body of academic research shows that price controls will significantly restrict the number of new drugs in the future.

All of these trade-offs are inevitable. Because there is no one right answer, many of these decisions should be subject to the political process, wherein policymakers can weigh the views and interests of different groups. This report does not presume to make these decisions for society. However, it is critical that when making these decisions, policymakers clearly understand the benefits and costs of each option. The purpose of this report is threefold. First, it reviews some of the data regarding drug spending. Second, it reviews the pharmaceutical industry’s strong record in funding research and employing scientists. Finally, it summarizes the academic research showing a strong causal link between current drug prices and revenues on the one hand and future research and discoveries on the other.

Are Drug Prices Too High?

In order to maximize social welfare with limited resources, policymakers need to appreciate the costs and benefits of each decision they make. In the context of drug prices, they need to clearly understand the strong link between current revenues (which may or may not be the same as consumer prices) and the generation of future drugs. Put simply, drug companies must make significant profits on their best-selling drugs in one generation in order to reinvest in the next generation. A large portion of these “profits” goes to three sources before they are available for distribution to shareholders. First, the revenues must cover the costs of the high number of failed research efforts, most of which generate no revenues. Second, they must pay for the long delays between initial research and product sales. These capital expenditures account for roughly half of the total costs of developing new drugs. Finally, a large portion of the remainder goes into new research on the next generation of drugs. Market investors quickly notice whenever companies do not have a group of promising drugs in their pipelines.

Put simply, drug companies must make significant profits on their best-selling drugs in one generation in order to reinvest in the next generation.

As figure 1 points out, change in total spending on retail pharmaceuticals varied dramatically between 2000 and 2017. Although spending rose in later years, the increases were mostly modest. The total number of pharmaceutical doses sold (the volume of drugs) also increased, in part because of the increase in the U.S. population (up an average of 0.84 percent per year since 2000) and the increase in the elderly population which on average consumes more drugs (the population of Americans older than 65 years of old has increased an average of 2.27 percent per year since 2000).[12]

Figure 1: Annual change in total U.S. retail pharmaceutical spending[13]

Figure 2, on the other hand, shows that the source of spending has changed dramatically. In 1960, fully 96 percent of all prescription drugs were paid for out of pocket. By 1980, this had fallen to 71.3 percent, and by 2000, it was 27.8 percent. In 2017, only 14 percent of prescription drugs were paid for out of pocket. Private insurance and Medicare/Medicaid paid for 42.0 percent and 40.2 percent, respectively. By 2027, the Centers for Medicare and Medicaid Services (CMS) expects the portion to decline to 12.8 percent. This trend has made many patients less sensitive to the cost of their medications.

Figure 2: Percentage of retail prescription drugs paid for out of pocket[14]
 

Figure 3 shows retail pharmaceutical sales as a percent of total health care spending. Although the fraction rose from 1980 to 2000, it has declined slightly since 2002 and is slightly lower than where it was in 1960. It is also projected to be relatively flat for the next decade.

Figure 3: Retail prescription drug spending and projections as a percentage of total health care spending: 1960–2027[15]