(Bloomberg View) — Ezekiel Emanuel says drug prices are too high. Very expensive drugs, for rare conditions or cancer, can run well into six figures. What we need, he argues, is a national board that sets prices, or at least sets some caps, rather than letting the free market (and excessively generous Medicare reimbursements) drive costs into the stratosphere.
Well, maybe. But I'd like a bit more evidence before we leap in with red pencils blazing and start slashing away.
I understand Emanuel's frustration. The market for pharmaceuticals is characterized by a set of conditions that makes pricing difficult, and inevitably controversial:
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People who are dying are price insensitive; they would pay any amount to get a few more months of life. I don't think it's any accident that you see high prices clustered in diseases such as cystic fibrosis, cancer, and Hepatitis C — which historically had few good treatments.
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The tab for pharmaceuticals often is picked up by third-party payers. I may be willing to pay any amount to cure my cancer, but in practice, the amount I can pay is limited by my bank account, or the equity in my house. Third-party payers don't have the same hard limits. And though they do have incentives to hold the price down, law or public opinion often limit what they can refuse to pay for. The worse the condition, the harder it is to refuse treatment — companies probably can safely turn down a $300,000 a year treatment for athlete's foot, but cystic fibrosis is another story.
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Much of the cost of producing a drug is the up-front outlay required to develop a new pill, and get it approved by the Food and Drug Administration. Once that's done, the marginal cost of producing another dose is comparatively small. This process of drug discovery is insanely risky and expensive.
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Pharmaceuticals are protected by patents; a competitor can bring out an alternative cancer drug, but until the patent runs out, they can't produce yours.
All this adds up to prices that often seem arbitrary, excessively high, and ripe for trimming. And, in fact, it's true: if the U.S. mandated that prices for drugs had to be much lower, we would pay much less for drugs, and those pills would keep rolling off the assembly line.
But would do we get new drugs? Or rather, how many new drugs would we get? There's the rub: Those high profits provide strong incentive for pharmaceutical innovation.
Products with a high fixed cost and a low marginal cost always look as though they ought to cost a lot less. After all, it only costs a few cents a pill to roll it out! How dare they charge me so much? But over the long run, someone has to pay for the fixed cost — the research. If you don't pay for it, you don't get any more.
Emanuel acknowledges this, but suggests that pharma profits are so high that we could easily slash them by a huge fraction, and still get plenty of new drugs: "Regardless of the risks, many drug companies are making huge profits. Gilead, maker of Sovaldi, has profits of around 50 percent. Biogen, Amgen and other biotech firms have profits of around 30 percent. Merck and Pfizer are seeing profits of 18 percent or more. Even if profits were cut by a third or a half, there would be sufficient incentive to assume the risks of drug development."
These numbers are accurate, as far as they go. Unfortunately, that isn't very far. For starters, Merck and Pfizer are among the more profitable pharmaceutical firms. Eli Lilly's profit was 12 percent last year. Could we cut that in half, too? How about the profits of all the biotech firms that aren't making money just now?
More fundamentally, he seems to be thinking about this as a budget problem, rather than an investment problem. When your income is fixed, you start with the amount of money you have, and divvy it up to various uses. Could we cut the "profit" line and still make drugs? Sure. Would Eli Lilly still be a desirable stock? At some price, absolutely.
