April 23, 2024
World Economy

Why drug monopolies are bad medicine – Twin Cities

Edward Lotterman portrait
Edward Lotterman

After being ignored for a quarter-century, monopoly power, and how it can harm both customers who buy products or workers who sell their labor, is drawing the attention of the Federal Trade Commission.

Groceries are a case in the news. The FTC is challenging Kroger’s proposed purchase of Albertsons. These are “the No. 1 and No. 2 traditional supermarket chains in the United States” according to the FTC challenge.

Some of the issues would not have popped up 50 years ago. For example, in assessing competition, the FTC had to include the phrase “traditional” because Target, Walmart, Costco and Sam’s Club all sell a lot of groceries, as do stores with a narrower range of products like Aldi.

All of that will get ironed out in legal challenges and an eventual case in federal court. The important thing is that the federal government is once again challenging monopoly power — and that is easier to do before the fact than after.

If only it were so with the pharmaceutical industry. Monopoly power in this exemplifies the difficulties of dealing with an empty stall after the horse disappears. For decades, U.S. administrations were both complacent and complicit as mergers and buyouts sharply reduced the number of drug manufacturers and assorted distribution industries.

There always were collusive acts in the industry, such as fixing the price of the antibiotic Tetracycline in the 1950s, but these were parried by FTC actions. Worldwide, the industry was distributed across several countries with large sectors in Switzerland, Germany, France and Japan in addition to the U.S. There were not great differences between countries in terms of patent and licensing laws.

All this began to change in the 1980s. The Reagan administration had little interest in antitrust. A new thought in jurisprudence attacked government regulation. And pharma lobbies persuaded Congress to change patent laws and enforcement to favor existing firms.

Thus, between 1995 and 2015, the number of major pharma firms shrank from 60 to 10. With the U.S. indifferent to anti-competitive practices, our patent laws more favorable than anywhere else and our government willing to carry water for pharma companies in international trade negotiations, the consolidation often meant U.S. companies absorbing ones from elsewhere. U.S. global market share grew; that of Europe generally declined.

Conservative donors such as the Koch brothers funded organizations supporting a new generation of legal conservatives, such as Supreme court justices John Roberts, Samuel Alito, Neil Gorsuch and Brent Kavanaugh. With GOP administrations naming judges over 20 of the 28 years from 1980 to 2008, federal courts grew more conservative and lost interest in supporting government-enforced competition when challenged.

Democratic President Barack Obama wanted the Affordable Care Act but could only secure passage by giving in to GOP demands for a ban on Medicare bargaining with suppliers over drug prices.

Over the same years, the sharp reduction in health care competition generally included the emergence of “pharmacy benefit managers,” often soon absorbed by insurance firms such as United Healthcare and Cigna. There was a matching consolidation in drug retailing with CVS and Walgreens emerging dominant.

All of this contributed to the high cost of health care in our country with its percentage of GDP well above that in other industrialized market economies. This is an implicit tax on the economy as a whole.

Moreover, the system is mindlessly complex with, for example, Medicare beneficiaries having to choose between a bewildering array of drug plans. Some people, like me, pay almost nothing for the large numbers of meds I take, while others, often poorer than me, are out of pocket hundreds of dollars.

To use a Biblical phrase, “this ought not so to be.”

But once we get ourselves in a mess, it isn’t easy to get back out. Early antitrust actions broke up both Standard Oil and International Harvester. However, doing something similar today in health care would be difficult.

Reform would be easier if Congress understood the economics of drug issues better. Leftist independent Sen. Bernie Sanders of Vermont is an impassioned critic of pharma companies and loves to grill its executives in hearings. On YouTube and other sites one can find multiple video clips of him and other members of Congress doing this.

Their attacks usually start with the same questions: “What do you charge in the U.S. for one patient’s course of drug X? What does it cost you to manufacture that quantity of drug X? What do you get for that same quantity of drug X in Canada or Argentina or South Africa?”

The executive always answers with a high sale price in the U.S., a much lower manufacturing cost and a lower price in other countries than here. This is not irrelevant information, but it is incomplete and misleading.

First, Sanders or other questioners don’t specify what they mean by “cost to manufacture.” Is this just the variable costs of ingredient chemicals, labor and utilities? Is it just the marginal cost, the increase in total costs from turning out one more unit? Or does it include amortizing the fixed costs of the buildings and machines needed for production? What about the labor and research costs that went into developing the products and getting them approved? Drug companies can always argue that if costs are artificially lowered, R&D would suffer, and, by extension, so would sick people.

Those questions would be addressed in an Econ 101 class. But drugs are a industry in which labor, raw materials and utilities often are a small fraction of the company’s total costs. It is, in fact, the research and development of new drugs and all the trials needed to get regulatory approval that dominate costs. And these are largely ”fixed costs” in the economic sense — they don’t change if 10,000 doses are sold each year or 10 million.

Over anything but the very short run, fixed costs must be paid for any firm to stay in business. But pharma is complex. Sen. Sanders could ask, “What did it cost you to develop drug X and get it approved?” But that would only get us a little farther. Only a small minority of new experimental drugs ever get approved or sold. So the discrete number of market successes have to pay the “sunk costs” of all the failures.

Moreover, one does not know beforehand how long any drug will sell. A new one may be a cash cow for decades. Another may be eclipsed by a competitor after a few years. Glitches may arise. The non-sedating antihistamine Seldane was a boon for its manufacturer in the late 1980s, with 100 million patients taking it. But it caused heart problems for some and was off the market almost overnight.

So a drug company has to have a floating set of profitable drugs to bear the costs of all, including the many busts. And it has to price discriminate to maximize revenues. That means charging different prices in different markets to groups with different sensitivities of quantity wanted versus price.

Because of our health care system, demand for drugs in the U.S. is “inelastic;” raise price and you do not cut demand much. It is more “elastic” in Canada for a variety of reasons and so prices are lower there. Demand is even more sensitive to price in poorer countries and hence prices are lower.

Forcing U.S. companies to charge exactly the same price in all countries would, in most cases, raise them sharply in the rest of the world more than lowering them here. It would be devastating to patients in poor countries and would probably lead to a revolt that would overturn the international system of patent protection. That would harm the world economy as a whole and ours in particular.

We have let pharma gain abusive market power. There are ways in which we can, over time, unwind this. But lawmakers need to understand the economics of what they want to change.

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