President Trump and senior advisor Jared Kushner claim that the most favored nation executive order signed by the President over the weekend is necessary for drug pricing because “the U.S. shouldn’t pay more than other European countries for the same treatments.” This policy will make things worse, not better.
If the president and his son-in-law applied their flawed logic consistently, then there is an even greater economic disparity that requires fixing. People living in Manhattan or San Francisco are paying more than other Americans for the same “housing services”. Based on the Trump logic, New Yorkers and San Franciscans shouldn’t pay more than residents of other U.S. cities for the same housing services. But, they do.
According to rentcafe.com, the average apartment in Manhattan, which is 703 sq. ft., rents for $4,208. In San Francisco, a renter must pay $3,629 for a 747 sq. ft. apartment. These prices are outrageous compared to Columbus, Ohio, rated as one of the 10 cheapest cities to rent in the U.S., which is only $959 for an 885 sq. ft. apartment.
Shelter is a fundamental human need, so if the most favored nation logic fixes pricing affordability issues, shouldn’t the government use a most favored city criteria to set the prices of rent? Surely, families in San Francisco and Manhattan would rejoice if their rents were cut to a sq. ft. adjusted $762 in Manhattan and $809 in San Francisco. Of course, this is not a fair comparison because average incomes are so much higher in Manhattan and San Francisco. Adjusting for these income disparities, the most favored city rent should be $1,217 in Manhattan and $1,640 in San Francisco.
If the Trump/Kushner logic works for drugs, then clearly the President should issue an executive order that the U.S. imposes a most favored city criteria on rents across the U.S. This policy makes no sense, of course, and perhaps the President’s real estate background explains why he is not suggesting such a policy for rents across the U.S.
A most favored city rent policy would make things worse, not better, because it fails to account for local policies that are artificially skewing prices, and the local supply and demand trends. Take San Francisco as the example. While fundamentals appear to be changing, historically high housing demand coupled with slow growth in housing supply (due to government-imposed rent control policies, strict zoning laws, and costly regulations) have created a supply-demand imbalance that have driven prices to astronomical levels.
Artificially imposing a price cap on the San Francisco market will only make this bad situation worse. A most favored city mandate that cuts rents in half will make it even less profitable for home-builders to build more housing. Housing shortages will become worse. Just as troubling, the reduction in rental income will make it difficult for current landlords to invest in maintenance, so the quality of housing will decline as well. The confluence of these trends would create an even larger housing problem over time for the residents of San Francisco.
Instead of adding additional regulations that worsen the problems, the best way to address the high costs of rent in places like Manhattan and San Francisco is to remove the government policies – such as rent control and overly burdensome zoning regulations – that are limiting supply and driving prices higher.
There is a direct parallel between rental markets and the U.S. market for medicines.
The most favored nation executive order connects the prices that Medicare will pay for drugs to the prices charged in select countries. However, unlike the rental example, the drug price comparisons for many non-infusion drugs are not on an apples-to-apples basis.
Prices in the EU typically include the concessions paid by manufacturers, or if they have not been considered, the concessions are small in monetary terms. The prices typically discussed in the U.S. do not include the value of any of the concessions, which are incredibly large in monetary terms. Consequently, the Trump executive order will often be setting prices based on the wrong benchmark.
Beyond this definitional problem, prices in these other markets reflect the price controls that these countries have imposed on the sales of biopharmaceuticals. Price controls come with a high cost because patients in these countries do not have access to many innovative medicines that patients in the U.S. take for granted.
As I noted in an earlier editorial, patients in the U.S. currently have access to nearly 90% of all of the new medicines that have been launched since 2011 – more access than any other country in the world. Patients in Germany, the country with the next highest drug availability rate, could only access a bit more than 60%. Canadians have access to less than half. This lack of access harms patient outcomes in these price-controlled countries.
The access problem also creates a pragmatic obstacle to the President’s executive order. After all, how do you benchmark to a price that doesn’t exist?
Perhaps most troubling of all, the same ill-effects that would impact the rental market will occur in the drug market if this executive order is ultimately implemented. Due to the price controls, there will be fewer resources devoted toward the development of new medicines, and the availability of the medicines that already exist will slowly become scarcer. Both drug innovation and access to drugs will suffer, harming patient health as well.
The best way to address any problem is to diagnose the causes, and then implement solutions that efficiently address them. In the case of drug affordability in the U.S., the source of the problem is the nonsensical drug pricing system. Trump’s most favored nation executive order does not improve the efficiency of the drug pricing system, but it does add additional inefficiencies and harms patients by creating new access issues. It is, consequently, a wrongheaded policy reform that the Administration should jettison before it is too late.
I am a Senior Fellow in Business and Economics at the Pacific Research Institute and the Director of PRI’s Center for Medical Economics and Innovation. My research explores the connection between macroeconomic policies and economic outcomes, with a focus on the health care and energy industries. I have over 25 years of experience advising Fortune 500 companies, medium and small businesses, and trade associations. I received my Ph.D. in economics from George Mason University.