Right Diagnosis, Wrong Cure: Examining the True Cost of Drug Price Controls

Greetings everyone and welcome. Cost of living and affordability are high on most Americans list of concerns. Prescription drugs are no exception. Americans are rightly frustrated and confused about why we pay two to three times the price for the same patented drugs that the citizens of other developed nations pay. But what's missing from this conversation is the reality that it takes billions of dollars in upfront investment to discover, research, develop, and bring new drugs to the market. And the ability to recoup that revenue through a temporary period of monopoly over the drug is a high-powered incentive needed for that investment. It's no surprise then that less expected future revenue means less investment in R&D. And the high sunk cost of failed projects and trials before blockbuster drugs are discovered mean the companies must make a 60% profit on their commercially successful drugs to get just a 4% return on their overall assets, according to the Congressional Budget Office. Americans might pay more for patented drugs, with prescription drugs accounting for 9% of the federal health budget, but being the source of this disproportionate amount of global revenue means that we can access the most and newest drugs before citizens of other countries. America also witnesses faster entry of generic drugs in other countries, and this puts downward pressure on prices. But there would be nothing for generic manufacturers to replicate if it wasn't for the commercial incentive to discover and bring new drugs out in the first place. Despite all this, Democratic and Republican administrations alike have tried to replicate some of the tactics that other governments and their single-payer health care systems use to keep the prices low. Under the Biden administration's Inflation Reduction Act, makers of some patented drugs must enter into negotiations with the government to set a so-called maximum fair price for their drugs, and failure to sell at that price means incurring financial penalties. This effectively reduces the exclusivity period for small molecule drug to just eight years after FDA approval, and a biologic to about 13 years. Shifting incentives to fund research between projects based on things other than what is most useful and valued by the public. More recently, the second Trump administration introduced an executive order on most favored nation drug prices that threatens manufacturers who don't lower their prices to the prices they charge in other countries with targeted lawsuits, antitrust investigations, tariffs, and even revocation of the approval for their drugs if they don't comply. The legal authority of the administration to do this is questionable and it will likely be challenged as the first administration was when it tried to do something similar. However, a number of companies have still entered into voluntary agreements with the government to lower their prices, most notably makers of the GLP-1 drugs. This might seem like a great win right now, but it remains to be seen how this will affect research and development for such new drugs in the future, especially considering that many of these cures help keep Americans out of the hospital, and hospitalizations remain one of the biggest costs that our public health care system incurs. To unpack all of this, I'm joined by Professor Tomas Philipson of UChicago, who was also a senior economic advisor of the first Trump administration. Welcome, Tomas. >> Morning. >> All right, so help set the scene for us. Uh why are American patented medicines so much cheaper in other countries and why can't we just do what they do? Why do we pay so much more? >> Yeah, so the first thing I want to argue is that essentially US is paying less than other countries for prescription drugs. And uh that sounds strange to many people who are in the policy circle. Uh so, let me explain where I'm coming from on that argument, which I think is definitely true. The reason is that about 93% of prescription drugs in the US are generic for generics off-patent drugs, essentially. And US is uh roughly uh benchmarked paying half the price of generics relative to other countries, particularly in Europe. So, more than nine out of 10 times you go to the pharmacy, you're paying half of what other countries pay in the US, essentially. Obviously, we're paying more for brand-name drugs, on-patent drugs. And essentially, that order of magnitude is roughly three 3x relative to other countries. So, and it varies a lot across across those countries. Uh but if you look at the average prescription price, therefore, which we usually weigh by volume when we take average prices, uh our prices are actually for the government, uh Medicaid and Medicare, about 18% below uh at the average price of a prescription abroad in Europe. So, I think that's very important for several reasons. And this is all on our our center webpage, by the way, if you're interested for this exact sources to all of them on the initiative for choice and competition in healthcare, which is at the University of Chicago Department of Economics. And the reason why this is important is that essentially, people will argue, "But wait Wait a minute, Thomas. Spending is much higher on brand-name drugs. In fact, 80% of spending, roughly, is on brand-name drugs compared to generics." And the way that's misleading is because the reason spending is so high on on um on uh brand-name drugs in the US is because generics are so cheap. So, if generics were free, uh then we would have 100% of spending be being on brand-name drugs, essentially. And presumably, all the patients would be better who got 93% of their prescriptions for free, even though 100% of the in that case would be spent on uh brand-name drugs. So, the fact that we have this system in the US where we have a 90 more than 90% generic market share relative to Europe which has many times 70 or 75% market share of generics. And also in addition they they pay more for generics so they have lower penetration or lower volume potentially do due to that they pay essentially more for generics is not surprising that they therefore potentially have lower volumes relative to US. But because they have lower volume and pay more essentially their spending on generics as a sure spending is a much much higher. So I think that's important to to recognize we have the Hatch-Waxman system in the US which has fierce competition for generics and generics is by far the most common form nine out of 10 prescriptions are generics. So we're actually living in a world where we're the most favored nation for prescription drug prices in the US. >> Great. You know, I think that's something that a lot of people end up missing out on. You know, the fact that we are such a huge market for drugs means that we do get access even to generics a lot faster than other countries do. And also as you pointed out we have those regulatory settings including the Hatch-Waxman Act that foster a generic entry. So you mentioned your study which found that uh uh US public sector prices for drugs are prescription drugs are 18% lower than comparable peer nations like France, Germany, Canada, and Japan. Um so what does the data then say about private sector prices? So like what are insurance plans pay? >> Yeah, we have actually replicated as we're in the process of trying to extend the study to commercial plans. Obviously commercial plans pay above Medicare and particularly Medicaid who has a 23% discount relative to uh commercial plans. Uh but it's still true because uh of the high uh uh penetration of generics in commercial plants because they they are obviously into the cost savings of generics. So, you know, in many states therefore mandated even for both public and private uh payers essentially have uh generic penetration uh that is very high. So, even though the numbers are not as stark, it's still true that average prescription drug prices, even when you include the commercial sector in the US, is lower in the US relative to abroad. >> Great. Cool. I'm I'm definitely looking forward to the seeing that study. So, why does the media and policy debate almost exclusively focus on brand name list prices? And what are the consequences of policy makers designing price controls based on the sort of incomplete data that doesn't look at what people actually pay? >> Yeah, there's a very important point here that we are uh also in the process of analyzing when this will come out in a couple weeks. Which is if you only focus on brand name prices, you will miss you will basically have very adverse effect uh many times on price controls on those brand name drugs essentially. So, if you take IRA, the Inflation Reduction Act, which controls prices at the last three or four years of your exclusivity period, they only come in at the end of the exclusivity period with the negotiations. And the problem with that is that you basically are interfering with generic entry after the patent expire. So, generic manufacturers, the Association of Affordable Medicine, raised this issue very quickly after the IRA was was uh implemented that that you're now basically limiting competition in the generic market after the molecule expires. So, that's a major issue. There's two issues there. The generic manufacturers don't know exactly who what drugs are going to be negotiated, so they don't know it takes a year or two to prepare to hit a target that is expiring. But, if the public sector through negotiations come in first, all their investments are in vain. So, there's a lot of uncertainty for them, which is the target that we're actually going to attack with price competition when the patent expire. That's one issue. But, even if you have that's being cleared, the fact that the government lowers the uh revenue of these companies dramatically with negotiations make them less of a useful target for generics. They want to come in and get the first guy get the 180 days where they're alone, and then get more and more entries coming in. That whole process the uh manufacturing association of generics have now been upended, according to them, and therefore competition is not as fierce after the patent expire, meaning prices are not going down as much as they otherwise would when a big brand-name drug goes off patent. Remember, IRA goes after the highest spending brand-name drugs. So, those are the ones where the generics have the most fierce competition coming in after the patent, essentially. So, here's the bottom line of this, which is very important. You may lower brand-name prices at the last end of the exclusivity period, but if you raise prices after that exclusivity period, it may turn out that that's more important because the three or four years of reductions may be dominated by, you know, 20 years of generic prices being higher than they should be, essentially, after the the patent expires. So, it may be essentially that for some drugs we're finding that these price controls essentially increases the lifetime price of the of the molecule as opposed to decreases it because the you don't make up the brand savings with generic or you basically have offsetting generic effects after the patent expires that dominate the the savings of the brands once before the exclusivity runs out. >> That's really interesting and you know, I think it's you know, we all know that in theory price controls lead to shortages. But they also create this sort of significant uncertainty and you know, it clearly seems like that's a that's a huge issue in these sectors which are characterized by huge upfront investments and expectations about future revenue. So you established that for every 1% cut to pharmaceutical revenue, there would be a roughly 1.5% drop in pharma R&D. So how would this decline affect other costs in the health care system in the long run? >> Well, that actually is not our finding that we we have used that finding to study the effects of you know, if IRA reduces revenue, how much does R&D get cut and therefore how many fewer drugs get introduced. But that number comes actually from an average of the entire economic literature on this which is studied quite extensively. There's about 15 papers in that literature on estimating the elasticity of R&D to revenues essentially. So just to make clear that that's not our number. That comes from the a broader economic literature. So so that's a that's an important caveat to that. But how does drugs essentially affect the rest of health care? This there it depends on the drug class. So in certain drug classes certainly drug spending raises total health care spending. But But many drug classes the increase in drug spending is more than offset in future reductions of other forms of spending. So, other forms of spending goes down more than drug spending goes up. So, think of SSRIs replacing the manual labor cost of shrinks. Think of GLP-1s having offsetting effects on diabetic care or heart disease care, etc. And think of similar with statins in heart disease having offsetting effects on you know, surgical expenditure at hospitals. So, these are usually called cost offsets. And many times it is the case that the increased drug spending even for the big sort of poster child when people thought drug spending was getting too high, which was Sovaldi for Gilead of hepatitis C, it turned out that Sovaldi spending was the increase on Sovaldi spending for curing hepatitis C was dominated by the reduction in future cost of liver transplants, etc. that were saved from people not having you know, more severe liver disease. So, it's many times the case that future health care spending more than offsets drug spending. Now, the CBO doesn't score it that way when they do federal impact analysis because they basically take a very biased stand on the literature. So, they only say for every [clears throat] $1 increase in drug spending, you only save 20 cents. But that's a very strange take on the literature that we have summarized in other papers. >> Great, you know, and I I think that's just so important, right? Because hospitalizations alone account for about 30% of federal health care budget, and that's more than three times what you know, the federal budget is spending on drugs. So, this year you pointed out that nearly 60% of cancer drug improvements between 2000 and 2024 focus on treating the disease earlier in its course. So, why are price controls uniquely destructive to these earlier stage innovations? And what does a patient lose when we disincentivize drugs that prevent long-term complications rather than just treating the late stage symptoms? >> Yeah, the oncology is is a very important case because about half the pipeline almost almost half not fully FDA drugs is oncology. So, it's a very very large drug class, the largest drug class. If you look at oncology how it was impacted from IRA particularly in small molecules. Uh the problem is that essentially when you have new indications, so if you have a uh an oncology drug that works for breast cancer, but you want to extend it to liver cancer or what have you, another new indication, they don't let you get a new extension and exclusivity on the IRA. So, you're still under the 9-year or 13-year time clock uh during IRA essentially. So, what that means is that many times these new drugs that come out after the first drug that are follow-on drugs on the initial innovation are much more productive because they hit lower earlier stages of the cancer. So, instead of creating a metastatic stage four cancer, the next drug follow-on drug to the same molecule is treating it in stage two or stage one ideally. So, you have what we found is essentially that follow-on of innovation hits much earlier stages of cancer. And therefore, when you hit much earlier stages of cancer, you're basically getting much larger treatment effects of these drugs cuz you're you're not at the last step of the cancer where it's meta where it's gone metastatic across the several organs organs. So, I think that's very important because much many times the follow-on innovations are the real valuable ones relative to the initial molecule. So, it's it's essentially saying that once you get a new cancer drug approved, that's just the start of a set of new drugs that can actually be even more beneficial than the initial one. And that's what's being limited by these time clocks not adjusting to new indications. >> Yeah, I think that's a that's a really important point and you know, I've also heard that it's leading to great delays, even if the follow-on innovation eventually happens, delays in them being introduced to population because these exclusivity periods kick in a certain number of years after a kick off, you know, cut out a certain number of years after the initial approval. So, I you know, I think that's another important thing. Uh so, uh the Congressional Budget Office and you mentioned some of the issues that they have with how they score costs. Um they projected that the IRA would only result in a tiny handful of lost drugs, whereas your research shows that it would likely result in 135 fewer new approvals. So, so could you elaborate a little bit more on why there was such a big gap between your economic modeling and the government's projections? >> That's a very good question. So, uh let me start why we got our numbers and then I can speculate what CBO is doing. Uh >> [clears throat] >> so, again, this was not really our analysis. We basically took the CBO's number on revenue reductions from IRA, which they said would be 12%. We then took that to the economic literature and just said, "What is the R&D reduction association associated with a 12% revenue reduction?" According to this literature I mentioned before that measures how much R&D gets reduced when revenue gets reduced. We took that an average of that literature and said, here's how much less R&D is done. And then we have an also an existing literature, what does that mean for new number of drugs coming on the market essentially. So, we are basically taking several literatures and just putting them to CBO's revenue reductions and coming up with those numbers. Now, CBO said that we would lose five drugs in in 30 years or some incredibly low number, uh which it has already been rejected. If you look at earnings calls of public companies who have to report what they're doing to their investors and also can go to jail if they do lie to their investors on these earnings calls, so it's pretty disciplined discussions. In those earnings calls, there was much more pulling of drugs in the pipeline due to IRA than we estimated. So, we are basically too low relative to the flow of new drugs being pulled by the companies. Now, that's an underestimated underestimated of the total effect because some drugs will never be started because of IRA, and we certainly don't see those on the earnings calls. So, I think we are essentially we essentially have underestimated the total effect and see CBO has drastically underestimated. They then released call for sort of a request for information on how they want to revise their estimates of the uh drug introductions in responding to price controls, which is a positive sign on this on their side though is that this is not really their business. CBO was set up to just score budget effects. Implicit though in that in that uh effort, they must score essentially future spending, which is also dependent on innovation obviously. So, they kind of forced to take a stand on this, but they did not certainly did not successfully take a stand on the IRA. >> That's a you know, Thomas Sowell once said that you know, you shouldn't trust people who have nothing to lose by what they say and you can probably better trust people who have a lot to lose. So, I think I think that's also quite important. Uh so, I want to move on to the MFN executive order. So, it seems to me that the rationale behind that proposal and a similar one by Senator Josh Hawley from Missouri is that if we try to force drug makers to sell their drugs at the same price they sell the same drugs overseas to you know, foreign governments that use their buying and optioning power or price controls to keep prices low, in theory that would result in these companies simply raising the price they charge in those countries, maybe achieving some kind of parity and in theory leading to those countries paying whatever the alleged fair market value is for those drugs. Is this likely to be the actual result and who of anyone is likely to step in to fund the sort of R&D if the US contributions decline? >> Well, it is true I believe that if you have to have the same price in the US and and many other countries who have price controls, you will eventually if if the US price comes let's say we take Canada just for the sake of argument. Canada is about 5% of our sales in in in drugs. If you were to lower the US price to Canadian levels, you would most likely face shareholder lawsuit, I would assume because that's basically suicidal. About 75% of global earnings in biopharma occur in the US because the US is the largest market and the richest market, but also because we don't have price controls. So, it's an enormous disproportionate share of funding R&D returns across the world. So, you know, Novo Nordisk is a Danish company. They don't innovate for 5 million potentially obese Danes. They innovate for Medicare and the US market essentially. So, the whole world R&D spending depends on the 75% of earnings coming from the US market essentially. So, if you were to threaten that by trying to mimic the lower price in a smaller country or in Europe, uh this is I mean, this is a strong case that your shareholders would do something to you essentially. Uh and so, the question that becomes if if then you go and try to have upward pressure on foreign countries pricing, they will tell you, "Thank you very very much, but we can't afford your prices." Uh that is actually not true in general because of the argument I've gave in the beginning that it turns out, like I said, that we have cheaper prescription drugs than abroad. So, if they reallocated their generic spending to innovative spending, they could actually do two things at once. One is uh have our prices for uh brand-name drugs, second, spend less in total on drugs because they're basically offsetting that by lower generic spending essentially. If they mimic our Hatch-Waxman uh pricing of generic and brand-name drugs. Obviously, that's not going to take place overnight, but it is a case that can be made that Europeans can essentially spend less on total on drugs and stimulate innovation more like the US. Essentially, but that's not going to happen in the near term, obviously. So, in the near term, they will say, "Thank you very much. We can't afford your prices." And therefore, may potentially either walk, not buy the drug at all, or compulsory license the drug in their country because the manufacturer refuses to lower the US price to accommodate the price in the foreign country, essentially. And if that's the case then MFN leads to more free riding as opposed to less because then US in the extreme case is paying for 100% of the return to innovation if the foreign country either steals the patent or doesn't buy the drug essentially or just waits it out to become generic. So I think that the tying uh prices across countries is not a good idea to attack this. I think the president was right what he did in the UK US trade deal which is have bilateral deals where US had a lot more power in bilateral deals than multilateral deals to force these countries up in their pricing which they did with the UK essentially. So if they can do that with the five largest countries, Germany, they're now having a three on one investigation of Germany they can do that's obviously the largest European country. They can do it with France and Italy and Japan. They're well on their way of getting something through trade negotiations which I think is a much more productive way than tying prices across countries. >> Yeah, absolutely. I'm also weighing on the side of this being more of a trade issue certainly than it is um an issue for some kind of technocratic pricing and you know, there's been plenty of good research from Professor Lichtenberg and others looking into how price discrimination between geographic markets promotes actually better outcomes and preventing it or constraining it will mean will probably result in shortages across the board because you can't allocate those resources efficiently. Uh so I'm a bit curious about why it is that there there's maybe this reluctance in I mean I can understand why foreign developed countries, you know, don't want to shoulder their citizens with higher taxes or higher prices in the short term cuz of the political incentive there. Um, but why don't they have Why have they not decided to go for something like the Hatch-Waxman Act, the settings on making generic entry more fast and easy? >> Well, I think some of the countries like Spain or or Canada, they have very strong generic manufacturers also. So, they are very reluctant to go after their own industries in that regard. But also, we have much more fierce com- private competition in those countries in general. It's not just for generics, but it's true across many, many industries. Uh, but I would, you know, I've been [clears throat] I've been in discussions with several European countries. And there is some potential momentum of getting them to move in this direction. Essentially, they realize that why are we spending money on the copycats as opposed to the guys who came up with this stuff. Uh, and if they did, they could potentially lower their total bill for prescription drugs on average. And so, if that becomes clearer and if that actually has some momentum, which I will hope which I hope it will it will will it will still take uh, a lot of time for those reforms. Maybe one country will do it and then other countries see the value of it, but it's it's still a a very far a long time away. Put it that way. >> Back home, then you know, maybe we could use our trade leverage to nudge them perhaps in the right direction. Well, thanks so much for that. You know, it seems to me that a big takeaway from all this is that we often hear about the trade-off between incentives to innovate and make new drugs and then paying lower prices. But I think, you know, clearly what the evidence is showing that these policies, these price control policies, will also likely fail to achieve the very thing that they want to achieve, which is lower prices, which is lower taxpayer spending, while depriving tons of people of potentially new cures by limiting that competition. So, thank you so much for joining us, Professor Woolson, and look forward to read forward to seeing and reading more of your research as it comes out. >> Right. Thanks for having me. Appreciate it.