From the time we were toddlers, it has always been tempting to bang the square peg into the round hole. After all, there is always that one square peg that seems like it should just about fit into that round hole, and it would feel so satisfying if it did. Alas, square pegs don’t fit into round holes.
The analogy is apropos for Congress’ current approach to drug prices. In the latest iteration, the Senate Health, Education, Labor and Pensions (HELP) Committee has adopted a provision in its health care bill that will be banging square pegs into round holes.
The proposal would cap the growth in drug prices to the growth in the Consumer Price Index, the CPI-U specifically. Clearly, the cap is an attempt to lower the cost of drugs. In practice, the proposal introduces new inefficiencies into an already troubled system. Not only would such a proposal be difficult to implement, but it will also fail to effectively address the problems plaguing the health care system.
While it may not have been explicitly stated, presumably the rationale for the proposal is that the growth in drug prices should be no higher than the average growth prices in the economy. Such a supposition makes no economic sense.
There is no reason why the growth in drug prices should reflect the average growth in the CPI. While the CPI reflects the common influence from monetary policies on the prices of all goods and services, it also reflects the individual market trends of a huge basket of unrelated goods and services. Each one of these goods can, and often does, experience radically different market trends.
For instance, oil prices are subject to wild price swings caused by supply shocks, oil discoveries, and global geopolitical tensions. As another example, productivity growth in the computing industry is a pivotal factor decreasing the price for computing power.
Mandating that the growth in drug prices equals the average price growth for the entire basket of goods and services in the economy means, by definition, that the growth in drug prices should reflect the average of the market trends for all other goods and services, rather than the unique factors impacting the drug industry.
To see the damage this will cause, imagine if this policy were applied to either gas or computer prices. For computers, such a policy would end up artificially raising costs on consumers because the policy would disincentivize the current declining price environment, and would threaten the long-running productivity revolution in the computer industry. For gas prices, the policy would cause irreparable harm as prices were prevented from reflecting the changing economic realities of supply and demand in the global oil markets.
The same logic holds for pharmaceuticals. Prices should reflect the underlying realities of each market. A spike in the price of oil is no more an excuse to raise prices on drugs than the falling prices for computers is a justification for cutting prices. While there are all sorts of problems with the way in which drugs are currently priced and sold – and these need to be addressed – arbitrary price rules will only worsen the situation.
Another problem arises because the benchmarking proposal presumes we know which CPI index is the “right” one for benchmarking the changes in drug prices. The most oft-cited price index maintained by the Bureau of Labor Statistics (BLS) is the CPI-U price index, which is the index currently selected as the correct drug pricing benchmark. But, there are many other indices as well.
The BLS also maintains a CPI index that excludes energy prices, a CPI index that measures price changes in health care services, a CPI index that measures price changes for drug prices, and even regional CPI indices. The exact index chosen can meaningfully change what the allowable price changes would be, and fundamentally change the impact of the policy. The CPI-U was likely chosen as a matter of convenience or familiarity, rather than a thoughtful evaluation regarding which index made more sense.
Then there is the problem of which price should be subject to the cap? The legislation applies the cap to each drug’s list price. However, due to structural inefficiencies, the list price is only relevant for patient co-pays, not for the overall expenditures of the health care system. Perhaps it would make more sense to apply the cap to drugs’ net price, which are the prices that are relevant to the expenditures of the entire health care system? Perhaps some other price basis should be chosen. In practice, the actual impact from the CPI price cap will change dramatically depending upon which price is chosen.
Perhaps most important, without fixing the underlying structural inefficiencies inherent in the pharmaceutical supply chain, the arbitrary implementation of a price cap will create further complications and harm patient welfare.
Instead of embracing a new “big government” fix to the health care system, Congress should start addressing the underlying flaws leading to the undesired outcomes. These include enabling greater transparency in the pricing of drugs, improved efficiency in the supply chain, and broader payment reforms.
Sustainable fixes to the pharmaceutical market, as well as the broader health care system, require policies that diagnose the policies responsible for the adverse outcomes that are harming too many patients. Arbitrary price controls, of any form, are knee-jerk reactions that apply an inappropriate policy solution that will only worsen the quality of health care in the U.S.