The Lone Economist Does Drugs

The prices of some life-saving drugs are astronomical in the United States with some treatments costing over $100,000 over the course of a year. Unlike its pricing policies for other types of healthcare, Medicare pays roughly the same for prescription drugs as private insurers.

This policy has come under attack by several policy-makers and politicians from both parties. The proposals differ in some details, but they generally advocate a more aggressive stance by Medicare to negotiate with pharmaceutical companies. These strategies range from using the government ‘s considerable market power – this is how it dictates prices for surgical procedures — to suspension of patent rights.

The Lone Economist agrees that the current policy leaves much to be desired. Medicare pays too much for these drugs and a more intelligent system would result in lower prices and longer lives. But like the proposals to eliminate the health insurance coverage gap, i.e. Medicare For All and The Public Option, the drug price proposals attack the symptoms and not the causes while ignoring the good parts of the status quo. In our effort to make the goose lay more golden eggs, let’s not kill the goose.

Granted, the causes of high drug prices are complex. An intelligent policy proposal would require a careful analysis of facts, an unsparing assessment of theories. Such analyses do not easily translate into marketable shibboleths. But the alternative is to squander real opportunities to improve the situation and ultimately result in policies that do more harm than good.

The next several posts will explain the complexity of the pharmaceutical industry using standard economic concepts. Here is a very brief synopsis of the major points:

  1. Cost structure: Unlike medical and surgical services, a large majority of the cost of producing pharmaceutical goods is incurred before the first unit is sold, i.e. the costs are “sunk”. It requires large investments of capital. The marginal cost of an extra unit is very small. The average cost declines significantly with higher levels of output.
  2. Corporate conduct: Pharmaceutical companies are multi-national corporations. They maximize profits by exploiting differences in national regulations, wealth and culture. Regardless of how unfair it may seem, labeling this behavior “bad” is not helpful. But it does point to an optimal strategy.
  3. Market efficiency: The principles of mutually beneficial exchange show that there are available reallocations that result in improvements for all parties.
  4. The bottom line: The governments of the U.S. and other countries and private insurers should form an international agency to negotiate with pharmaceutical corporations. This would result in lower prices and death rates world-wide and no decrease in pharmaceutical investment levels.

Published by TheLoneEconomist

I am a PhD economist who studies just about anything and proudly specializes in nothing.

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