After writing my article “Drug Price Gouging: Moral, Immoral, Amoral or Necessary?”, I felt that I had not properly addressed the question of what a fair price is. Who is to say that the price of drugs is too high?
In this article, I’d like to investigate the nuance of this question.
When considering the market for drugs, I think it is important to note that there are at least four core realities, or assumptions, that we should understand before further investigating the problem space (if there is a “problem” at all).
First, we must understand that people need many medications very, very much; life-saving drugs are especially necessary. This means that the demand for drugs will be pretty inelastic; this means that despite price hikes, people will still demand the product. What choice do you have but to pay?
Second, it’s important to note that the manufacturing of drugs requires plenty of science and technology. Science is very complicated, and very expensive; it’s a game of information, and you must have plenty of know-how and capital in order to enter these spaces.
Third, we can assume that we live under a fairly responsive government. This government responds both to public demands as well as lobbying, where there is plenty of value to be found for drug manufacturers. We must look at this at both that micro and macro levels. At the macro level, government might react to the general will of the people, for some sort of healthcare provision (perhaps Medicare, Medicaid, or subsidized insurance) and regulation for drug safety (the FDA). At the micro level, however, individual politicians might be very reactive to lobbyists who can help them secure reelection. This can lead to the so-called tragedy of the commons; a death by a thousand paper cuts.
For our last assumption, we can take it as a given that we are in a market system where firms are profit-driven. In the case of drugs, this means that medicine is basically another commodity; it’s a market system, and we shouldn’t expect firms to not go for profit maximization insofar as we wouldn’t expect firms in other industries to seek maximization.
The system created by these underlying core realities is a damaged one; it can be considered looking at least three factors.
First, there are massive barriers to entry for this market, both regulatory (think FDA) and financial (cost of research and development, cost of acquiring federal approval, etc.). This makes it very difficult for many firms to enter the market and places an inefficient upward pressure on prices.
Second, there is a lack of transparency that, while expected, creates plenty of ambiguity around the actual costs of production. This makes it easy for firms already in the market to defend their high price points to both the government and the people.
Third, patent laws are applied very loosely in this space (as they often are in the realm of technology), making it possible for large drug manufacturers to create new versions of generic drugs that utilize the same underlying science, with small modifications. This is often called “evergreening”, since generics can stay fresh over and over. That could mean combining two old drugs, or creating a new method of administration (think nasal vs. injection). These drugs lead to slightly better patient outcomes, since they’re more convenient, but they can be a lot more expensive.
All of these systems and actors interact in feedback loops that ultimately lead to lack of competition in many drug markets, which places an upward pressure on prices.
Thus, high prices.
Now, the question of a “fair price” has a moralizing feel; it’s making a normative claim about a market, which can become controversial (to say the least).
Why should we expect drug manufacturers to behave any differently than firms in other markets?
Well, for one thing, demand for life-saving drugs is very inelastic, as discussed above. Some might argue that it isn’t fair for firms to take advantage of this by keeping prices so high on items that can make the difference between life and death, comfort and suffering.
Additionally, it seems clear to me that drug manufacturers experience plenty of advantages that might not be defensible. For instance, the patent laws are applied without much restriction, which allows practices like “evergreening” that do not benefit society proportionally to the extra costs that they impose. Additionally, it is illegal to reimport drugs from other countries at lower prices, a policy that drug manufacturers lobby for heavily.
However, when considering the question of what a fair price is, we must be careful not to discount the contributions that manufacturers have made to the common good. Ponder a world without drug manufacturers that invest in further research and innovation: a bleak world indeed.
I hold the opinion that there is some sort of middle ground here, where profit-seeking firms can still see nice returns, while people (and government) can afford the drugs they need without extreme costs.
However, this is clearly ambiguous. It would be ideal for this market to be like any other, where the “fair price” is the price of the market, in which there are plenty of competitors who fight over your business.
Accordingly, one way to answer the question of what a fair price is might be by considering what the price of a healthy market, with that essential competition, would be. This is a question for economists, not a sophomore, but it seems to be an important question indeed.
Author’s note: I would like to thank Jackie Xu and Qiang Zhang for helping with the research and analysis of this issue. This is an adapted version of a forthcoming column in the Chronicle.