By Michael LaBossiere
Martin Shkreli became the villain of drug pricing when he increased the price of a $13.50 pill to $750. While the practice of buying up smaller drug companies and increasing the prices of their products is a standard profit-making venture, the scale of the increase and Shkreli’s attitude drew attention to this incident. Unfortunately, while the Shkreli episode is the best known case, drug pricing is a sweeping problem. The August 2016 issue of Consumer Reports features an article on high drug prices in the United States and provides an excellent analysis of the matter—I am using it as the basis for the numbers I mention.
From the standpoint of consumers, the main problem is that drugs are priced extremely high—sometimes to a level that literally bankrupts patients. Faced with social pushback, drug companies do provide some attempts to justify the high prices. One standard reason is that the high prices are needed to pay the R&D costs of the drugs. While a company does have the right to pass on the cost of drug development, consideration of the facts tells another story about the pricing of drugs.
First, about 38% of the basic research science is actually funded by taxpayer money—so the public is paying twice: once in taxes and once again for the drugs resulting from the research. This, of course, leaves a significant legitimate area of expenses for companies, but hardly enough to warrant absurdly high prices.
Second, most large drug companies spend almost twice as much on promotion and marketing as they do on R&D. While these are legitimate business expenses, this fact does undercut using R&D expenses to justify excessive drug prices. Obviously, telling the public that pills are pricy because of the cost of marketing pills so people will buy them would not be an effective strategy. There is also the issue of the ethics of advertising drugs, which is another matter entirely.
Third, many “new” drugs are actually slightly tweaked old drugs. Common examples including combining two older drugs to create a “new” drug, changing the delivery method (from an injectable to a pill, for example) or altering the release time. In many cases, the government will grant a new patent for these minor tweaks and this will grant the company up to a 20-year monopoly on the product, preventing competition. This practice, though obviously legal, is certainly sketchy. To use an analogy, imagine a company held the patent on a wheel and an axle. Then, when those patents expired, they patented wheel + axle as a “new” invention. That would obviously be absurd.
Companies also try other approaches to justify the high cost, such as arguing that the drugs treat serious conditions or can save money by avoiding a more expensive treatment. While these arguments do have some appeal, it seems morally problematic to argue that the price of a drug can be legitimately based on the seriousness of the condition it treats. This smells of a protection scheme or coercion: “pay what we want…or you die.” The money saving argument is less odious, but is still problematic. By this logic, car companies should be able to charge vast sums for safety features since they protect people from very expensive injuries. It is, of course, reasonable to make a profit on products that provide significant benefits—but there need to be moral limits to the profits.
The obvious counter to my approach is to argue that drug prices should be set by the free-market: if people are willing to pay large sums for drugs, then the drug companies should be free to charge those prices. After all, companies like Apple and Porsche sell expensive products without (generally) being demonized for making profits.
The easy response is that luxury cars and iWatches are optional luxuries that a person can easily do without and there are many cheaper (and better) alternatives. However, drug companies sell drugs that are necessary for a person’s health and even survival—they are generally not optional products. There is also the fact that drug companies enjoy patent protection that precludes effective competition. While Apple does hold patents on its devices, there are many competitors. For example, since I would rather not shell out $350 for an iWatch, I use a Pebble Watch. I could also have opted to go with a $10 watch. But, if I had hepatitis C and wanted to be cured, I would be stuck with only one drug option.
While defenders of drug prices laud the free market and decry “government interference”, their ability to charge high prices depends on the interference of the state. As noted above, the United States and other governments issue patents to drug companies that grant them exclusive ownership. Without this protection, a company that wanted to charge $750 for a $13.50 pill would find competitors rushing to sell the pill for far less. After all, it would be easy enough for competing drug company to analyze a drug and produce it. By accepting the patent system, the drug companies accept that the state has a right to engage in legal regulation in the drug industry—that is, to replace the invisible hand with a very visible hand of the state. Once this is accepted, the door is opened to allowing additional regulation on the grounds that the state will provide protection for the company’s property using taxpayer money in return for the company agreeing not to engage in harmful pricing of drugs. Roughly put, if the drug companies expect people to obey the social contract with the state, they also need to operate within the social contract, Companies could, of course, push for a truly free market: they would be free to charge whatever they want for drugs without state interference, but there would be no state interference into the free market activities of their competitors when they duplicate the high price drugs and start undercutting the prices.
In closing, if the drug companies want to keep the patent protection they need for high drug prices, they must be willing to operate within the social contract. After all, citizens should not be imposed upon to fund the protection of the people who are, some might claim, robbing them.