Price Controls by Another Name

The costs of medicines continue to dominate the headlines, attracting the attention of Congress and the Trump Administration. Reforms are necessary, but many of the reforms under consideration will make the situation worse. Indexing U.S. prices to the prices in other countries that use price controls, or using third-party arbitration to set the price of prescription drugs, exemplify these wrong-headed policies.

The Trump Administration’s proposal would set Medicare Part B prices (prices for drugs administered in a clinical setting) to the average prices charged in more than a dozen countries. Senator Rick Scott’s proposal (the Transparent Drug Act) would set U.S. prices equal to the lowest price in five countries. Regardless of the particulars, these price indices are government-created price controls; only the U.S. government is outsourcing these controls to foreign governments.

Third-party arbitration proposals are no better. Under arbitration, both the government and drug manufacturers would submit prices to a third-party arbitrator, who would then select the price based on these submissions. So, here again, the U.S. government is outsourcing the authority to set price controls; except instead of outsourcing this power to a foreign government, the government is empowering random arbitrators to set prices for the U.S. health care system.

These policies will have adverse consequences for patients and will lead to higher costs elsewhere in the health care system. However, the complexity of the pharmaceutical market often clouds the obvious costs these ill-considered policies will create. If policymakers were proposing to impose these regulations on workers instead of medicines, then perhaps the consequences would be easier to grasp.

Toward this end, imagine the following story.

One day your boss comes into your office complaining that he needs to cut the company’s unsustainably high costs. He understands that the company spends a lot of money maintaining the factory and purchasing new equipment, but he has decided that the company will reduce its expenditures by lowering its labor costs. He also has an ingenious way of doing this.

In the next town over, the government mandates a maximum wage. This maximum wage establishes an income ceiling or a salary threshold that no worker’s salary can exceed. This maximum threshold is below how much your company currently pays its employees.

While the purpose of this maximum wage is to make business costs more affordable, the actual effect is to discourage people from working in the town. In fact, the town is plagued with labor shortages.

Seeing these adverse impacts, no one in your town wants to pass such a bad law. But, your boss has a great way around it. Instead of imposing a maximum wage law, he offers you a choice between one of two options.

Under option one, your boss will set your wage equal to the wages of the people working your job in the neighboring town who are subject to the maximum wage law (e.g. the proposed drug price index proposal). Option two, you and your boss both submit a proposed new wage for you to an arbitrator, which could even include people working in your field from the neighboring town (e.g. the arbitration proposal).

After the initial shock, your first reaction would likely be, who cares between option one and two? The ultimate impact will be a reduction in your take-home pay. But, with respect to the actual proposals for pharmaceuticals, the more important question is: how would you react?

While you will continue working for this company in the short-term, since you have no other choice, over time you would clearly look for other opportunities. Everyone else at the company would feel the same. Soon, just like the neighboring town, the company would find it difficult to find qualified workers and might even face higher overall production costs as management searches for ways to alleviate its labor shortages.

While this scenario is ridiculous when applied to workers, it is exactly what policymakers are considering for the pharmaceutical industry. And, just like with workers, the consequences from these policies are clear: pharmaceutical price controls create access issues that worsen over time.

Precisely because there are no price controls in the U.S., Americans have access to nearly 90 percent of all of the new medicines that were introduced between 2011 and 2017. People living in Germany, the country with the next highest access rate, can only access around 70 percent; Australians only have access to one-third.

Policies that impose arbitrary price indices or mandate price arbitration are simply “price controls” by another name. If implemented, these policies will diminish medical vitality, discourage health care innovation, and jeopardize the creation of future cures. In short, they will make the health care system worse, not better.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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