When Price Regulation is the Solution. . .

Scott Alexander writes,

Some people have talked about funding research via “prizes” rather than through an investment-and-profit model. Some people say we should fund it publicly through the NIH or something, which we already sort of do to a degree. Still other people say that we should abolish the FDA, cut the costs of drug development by an order of magnitude, and, um, see what happens. I don’t know about any of those things. I just feel like until you’re ready to set these up and have some idea that they work, do the thing that probably is going to result in people having the best access to the most life-saving drugs. Which right now looks like no price control.

Read the whole thing. His point is that, holding other policies equal, price controls would result in less pharmaceutical innovation and considerable harm.

I am going to drop the “other policies equal” assumption to make a point. That is, whenever someone proposes price controls as a solution, I assume that some other government policy is the problem. In the case of pharmaceuticals, the FDA really does impose huge costs, and those are what feed into drug prices.

To use another example, rent control is often a “solution” to the problem of restrictive land-use regulation. The minimum wage is a “solution” to the problem that payroll taxes and labor market regulations create a large wedge between the cost to firms of employing workers and the take-home pay that finds it way into those workers’ pockets. Price controls in medical care are a “solution” to the problem of government policy that subsidizes demand and restricts supply.

6 thoughts on “When Price Regulation is the Solution. . .

  1. In turn those are just solutions to other problems, those of access and investment. It is all a balancing act.

    • If you believe innovation will be under provided than you may want to encourage it, but it is also possible to over provide it, diverting too many resources into it, so unlimited encouragement is inadvisable either.

  2. Shotty article. Even though he has some experience in this field, its hard to read outsiders on this stuff.

    “And then rich people can buy Harvoni now for $30,000, and poor people will have to wait ten years to buy Harvoni when it costs $100. Right now they’ll unfortunately have to figure out how to make do with the set of medications invented in 2006 and before.”

    No, Medicaid and Medicare will buy the drug, mostly for poor people, for whom they will charge something like $7.00 for a $30,000 drug. Those poor people will mostly have gotten Hep C from needle sharing and hedonistic gay sex (gays make up an incredible amount of the Hep C market, just like the AIDS market). Many middle class people will actually avoid it because of high cost they actually pay themselves unless their viral load is critical.

    Also, the drug company will give a post point of sale rebate to the insurer to ensure they are breakeven even as nearly all the cost gets jacked through the governments reinsurance program. That got them to stop complaining to congress about the price.

    Partly this will show up with taxpayers. Mostly it will show up in lower premium subsidy, which means relatively healthy people who aren’t low income will pay more for their insurance every month and not know this is why. In fact it will be extra hidden because the patent cliff from the last few years should have lowered premiums, but instead its been offset by things like Harvoni, so people see flat premiums and think things are OK but really they’ve been missing out on decreases they should have got because their drugs are cheaper.

    So maybe some middle class person doesn’t get some relatively cheap drug they need because their plan got more expensive to pay for Harvoni and they actually pay their own expenses. Calculate those lives.

    So what if we said they could’t charge $30,000 for Harvoni? Well, I bet it would be developed anyway. If I recall, I’m going back here, the company that bought the drug didn’t even develop it. So we can figure out exactly how much their ROI was and how much extra profit they are extracting for not even developing a drug. Second, if this drug didn’t get developed (or developed as fast), is that the end of the world? Do I care if a bunch of people from fire island get a drug that allows them to put off drinking a fucking themselves to death another few years paid for by the middle class?

    When you start looking at drug expenditures what you notice right away is that an awful lot of the expensive stuff goes towards drugs of often dubious value for poor people who don’t pay for it themselves who probably self-inflicted their condition. Insurers cover this stuff because the government forces them to cover it or because of some backdoor rebate post point of sale.

    • “So what if we said they could’t charge $30,000 for Harvoni? Well, I bet it would be developed anyway. If I recall, I’m going back here, the company that bought the drug didn’t even develop it.”

      Yet they paid ($11 billion, at a premium over expected earnings) for a whole company (Pharmasset), assuming the risk of the FDA disapproving it at any moment. The economics of the company that developed it, for many of the smaller companies is a hits driven model, where they hope to cash out big. Still, Pharmasset paid about $265 million just to develop this one drug (Solvadi) and it had to cover the costs of all of their other less successful developments. Pharmasset was planning to charge $36,000 for a course of treatment. That $265M didn’t come out of nowhere- investors won’t back treatments that have no way of recouping their cost.

      We have engineered a system where it is too easy to steal the taxpayer’s money. Price control is not the answer, as setting prices is difficult to do without incentives.

  3. Standard economics that is taught in intro economics says that higher prices induces greater supply. Under certain restrictive assumptions that is generally true.

    But there are exceptions. One is when the bulk of the firms costs are fixed and variable costs are a minor cost of bring the product to market. Two of the prime examples of this are the oil and drug industries. In both of these industries firms make an estimate of the volume the investment will produce and divide the sunk or fixed cost by that volume to determine the price to charge to cover their sunk cost. If for some reason they realize a larger volume than they had estimated economic theory says that they should reduce their price accordingly. This is what is taught in advance price theory classes even though it contradicts what is taught in intro economics. Since the firm sets the price they can set the lower price at a point that leads to greater volumes so that total profits actually increase. I realize this is an over simplification and that frequently the firms are price setters not price takers. But this applies much more to oil and hardly at all to drugs.

    What amazes me is not that many readers of economic have never learned this theory but that so many writers of economic blogs seem to not know about it either.

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