Drug affordability is rightly a top concern for Americans. President Trump recently launched an unprecedented effort to fix this problem with a proposal to tackle excessively high drug prices while still preserving incentives for medical innovation, which ensures better future health.
First, the president’s plan would cut domestic drug prices by dismantling the burdensome government approval and reimbursement policies that inhibit healthy competition. Second, the plan would combat foreign government policies that devalue intellectual property rights and create unfair pricing systems that force drug manufacturers to sell to foreign buyers at unreasonably low prices.
Ideally, prices should reflect the social value of treatments, regardless of who pays—patients or taxpayers. In essence, President Trump’s plan would stop overpricing of drugs at home and underpricing abroad.
Government policies that restrict competition are one of the main reasons that Americans end up shouldering the burden of high drug prices. For example, the lengthy drug approval process erects large entry barriers for both brand-name drugs and their cheaper generic counterparts. FDA’s work to facilitate timely generic entry is estimated to have saved Americans billions of dollars last year alone.
In addition, doctors are given precisely the wrong incentive when prescribing: the system reimburses them at higher rates when they prescribe more expensive drugs, ultimately funded by our tax dollars.
The president wants to prioritize patients over the special interests who benefit from the status quo. His plan injects competition into the system by dismantling current policies that prevent Americans from enjoying lower domestic drug prices.
Lowering drug prices while preserving innovation incentives is essential because innovation is what enables better health to be available in the future. After an innovative drug is discovered and commercialized, the price of the improved or prolonged health it buys falls to patented price levels, and later falls even further after the patent expires and generic or biosimilar drugs enter the market.
To fund such innovation, firms naturally focus on returns worldwide: a Swedish firm innovates for the global market, not its local market of 9 million Swedes. But the rewards for creating those treatments come disproportionately from American patients and taxpayers because foreign governments use the threat of barring access to the market to extort lower prices from drug makers.
A recent CEA report estimates that 46 percent of brand-name drug sales and more than 70 percent of profits in the richest countries are paid for by Americans, despite the United States constituting only about 34 percent of GDP among developed nations. In other words, foreigners have been enjoying medical innovation at Americans’ expense.
This free-riding on the United States’ back is due to foreign government monopsonies that push prices down below the value of the treatment; these single-payer systems do not allow market forces to determine a drug’s value to patients. In the United States, if a private insurance plan does not cover a drug, the patient can choose another plan.
Competing insurers thus make decisions in accordance with what patients—their customers—want. On the contrary, if the bureaucrats in a government-run system decide not to cover a drug, there is no risk of losing a customer: their patients cannot vote with their feet. And drug companies would rather sell drugs at artificially low prices than not at all.
Under the President’s plan, the U.S. Trade Representative will negotiate to end non-transparent, discriminatory, or unfair practices that artificially lower foreign prices. Our trading partners should contribute their fair share of the research and development costs for new cures and therapies.
Advocates of a single-payer system for the United States, or those who want Medicare to negotiate directly with manufacturers, often argue that our government should take advantage of its size to cut prices, just as big plans do in the private sector. But that’s a fundamental misunderstanding of how markets work: private plans only grow when employers or individuals like what they do in terms of balancing access to innovative drugs with the prices paid.
Government-run plans are large, inflexible, and lack innovation and choice, partly because they, unlike private plans, force people to fund the plans through mandatory taxation.
There is no free lunch. If neither Americans nor foreigners pay for the R&D to develop new drugs, then soon nobody will receive new treatments. The time has come to restore fairness in this system by ending the gouging of American patients.
Commentary by Tomas J. Philipson, a member of the White House Council of Economic Advisers and a professor at the University of Chicago on leave.
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