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Essay on Health Economics

Consumers in the United States spend almost twice as much as their European counterparts on drugs. The disparity arises partly because of the higher drug prices in U.S. relative to the price controls in the European Union (EU). The lack of price controls in the U.S. pharmaceutical industry is increasingly becoming a contentious debate, given that the United States is the largest pharmaceutical market in the world. As of 2010, drug sales in the United States represented 42 percent of global sales compared to Europe, which accounted for 30 percent (Kesselheim, Avorn, and Sarpatwari, 2016). Stadhouders et al. (2019) believe that the gap is mainly because of the insurers’ aggressive price negotiation in the EU. Others have justified the absence of price controls in the U.S., claiming that the higher profits attained by the industry correlate with the country’s contribution toward global pharmaceutical innovation. However, the link between investment in research and development (R&D) and profits has been criticized within the scholarly community (Abbott, 2016). Regardless of the restrictions on access to more expensive and newer drugs in the U.S. market, the price difference seems unsustainable. The pharmaceutical revenues in the EU are significantly lower than in the U.S. This paper will discuss the implications of the absence of price controls in the U.Sin the US pharmaceutical market, as opposed to many EU markets.

There has been a sharp rise in the prices of prescription drugs in the United States that has led to skyrocketing healthcare costs. This trend has resulted in Americans paying disproportionately higher prices for prescription drugs than in the EU countries (Sarnak et al., 2017). While Europeans do not consume fewer drugs than their U.S. counterparts, they pay around 80 percent less. The higher drug prices have been sustained by the government’s monopoly granted to the pharmaceutical brands through patents and allowing the manufacturers to set prices for the essential commodity without considering the value derived from the product by the patients. The U.S. policymakers have permitted price differentiation for different markets. According to Kesselheim, Avorn, and Sarpatwari (2016), the U.S. pharmaceutical industry is the only industry among high-income countries where prices are currently unregulated. In the EU and other non-U.S. markets, governments control prices either directly or indirectly. Additionally, unlike public insurance programs in the EU, which negotiate for prices with manufacturers, Medicaid and Medicare are not in a position to negotiate for drug prices (Mossialos and Le Grand, 2019). Consequently, the high drug prices have resulted in non-adherence among low-income American patients who cannot afford the relatively over-priced prescription drugs.

Critics of the current price control policy in the United States have repeatedly argued that the permission to set prices for drugs at market prices and patent protection, as well as the ability to capitalize on inefficiencies in the current insurance system, encourage pharmaceutical companies to exploit consumers with overpriced drugs (Abbott, 2016). Nevertheless, many studies show that price controls would reduce the rate at which new drugs are introduced to the market because regulation would cut the firms’ returns after selling the drugs. Therefore, price controls would have short-run benefits for American consumers but adversely affect social welfare. The United States has been the center of global pharmaceutical innovation because of the higher returns in drug sales that are plowed back to fund research and development. Price control would therefore curtail innovation in this sector. The costs associated with R&D activities are unpredictable, while new drug development’s success rates are uncertain (Atella, Bhattacharya, and Carbonari, 2012). Furthermore, the financial return of newly released drugs fluctuates because of various factors. A recent study showed that reducing drug prices in the United States market by half would result in between 30 to 55 percent less investment in research and development, which is critical to developing new drugs (Chen, Yang, and Wang, 2019). However, modest price cuts, 10 percent, for example, would have relatively little impact on the R&D projects being undertaken (Stadhouders et al., 2019).

The above argument against price control for the sake of innovation has been anchored on the fact that almost 3 in every 10 of their new products generate net returns. Drug development is a sophisticated, rigorous, and heavily regulated process (Kigomo, 2015). Pharmaceutical firms should be compensated for the crucial technical risk to provide an incentive to innovate. For most of these manufacturers, just one of the tens of thousands of compounds explored gains the Food and Drug Administration’s approval. Many drugs these firms investigate fail because of a lack of commercial viability, safety, or efficacy. Moreover, the average period for developing drugs and gaining FDA approval is 15 years. All the costs for R and D projects that fail are compensated by charging extra for those that make it through (Mossialos and Le Grand, 2019).

Also, industry estimates show that the pre-tax cost of a new product is around $800 million, while the after-tax cost is about $482 million. The after-tax estimates are for firms with adequate revenues to capitalize on the tax benefits or sell them to another company. The discounted average net revenue for a new product is around $525. This means that during the launch of a new drug, the manufacturer can only predict a possible return on investment on their R and D of around $$45 million. For these reasons, price controls would tie down the manufacturers (Abbott, 2016). They have to decide whether to undertake an R and D project in the face of uncertainty. The proposed R and D projects given the go-ahead, do not necessarily move past clinical development. Only one out of ten R and D projects become commercially viable and introduced into the market. Introducing price controls in the United States pharmaceutical market will shift research and development focus to minor innovations which guarantee returns at the expense of revolutionary research that could yield more crucial health improvements but carries a relatively higher risk of failure (Lakdawalla, 2018).

Consumers in the American market would benefit from price controls due to reduced drug prices, but they would be affected in the long run because the innovation pace would be slowed (Sarnak et al., 2017). Therefore, it is a tradeoff between benefitting future generations with greater access to newer drugs and innovation in the pharmaceutical industry or benefiting the current consumers with lower prices. Relative to the EU countries, there is a strong link between revenues and innovation pace in the U.S. pharmaceutical market. Lower returns in the EU pharmaceutical market have made it lag behind the United States with respect to innovation. Newer drugs are released at a relatively higher rate to the U.S. market than in the European markets. Therefore, in analyzing this trade-off between future and current generations, it is vital to consider the impact of price controls on revenues. Sood et al. (2008) investigated this relationship across 19 developed countries that are members of the Organisation for Economic Co-operation and Development. The longitudinal study (1992 to 2004) showed that (1) price control increased during that period; (2) price controls significantly reduced revenues; (3) the impact of price controls in a market that was previously unregulated was greater than the effect on an already regulated market; and (4) the effect increased over time. These findings illustrate that implementing price controls in the U.S. prescription drugs market would offer a short-run benefit to the current consumers but pose substantial threats to future generations in terms of high healthcare costs and the lack of newer drugs.

However, reducing drug prices does not necessarily lead to slow-paced innovation. Instead, reducing consumer prices stimulateS research and development by increasing the utilization of the existing drugs. Pharmaceutical firms would generate more revenues through their existing products and use the extra profits to invest in innovation (Lakdawalla, 2018). Reports show that a significant number of American patients are not adhering to drug prescriptions because of the high prices. Raising the utilization of drugs will not only increase revenue for these companies but also magnify the positive effects of high-paced innovation. The increase in revenues due to increased utilization of released drugs should be compared to the revenue lost by the pharmaceutical firms due to reduced prices where copayment is not implemented. Thus price controls that do not directly affect the manufacturers’ revenues seem robust and crucial for benefiting both the current and future generations. According to Kesselheim, Avorn, and Sarpatwari (2016), U.S. policymakers should go for a copay-reduction approach, given the unpredictability of the pharmaceutical market.

Price regulation also has implications for competition, especially for generic drugs. The justification of price control in a pharmaceutical market based on the assumption of lack of competition appears weak when markets with drugs with unexpired patents are observed (Mossialos and Le Grand, 2019). Upon the patent expiry, the originator’s protection disappears, and other firms find it easier and cheaper to reproduce the drug. Generic drugs compete with the original drug despite the significant difference in the initial capital outlay in development and production. The original manufacturer’s market power diminishes with the creation of an oligopolistic market. This is because a generic drug has an equivalent quantitative and qualitative composition in active ingredients to the reference drug and has similar medicinal value. The EU countries have implemented price regulation strategies that seek to protect the innovator. To ease the competition in the generic market, countries such as the Netherlands, Sweden, and Germany, set the average price cap for generic drugs lower than the innovator’s price. In Austria, for instance, the first generic release must be priced at least 48% below that of the innovator, the second is required to price at 15 percent lower than the first generic release, and the third must set price at 10 percent below that of the second entry. Despite this intervention, originator brands in the United States would still face stiff competition from generic brands because the majority of American consumers would prefer generic products. In a country where drug prices are so high that some patients fail to adhere to doctors’ prescriptions, the innovator would be forced to lower their prices to the level of generic brands.

Another critical concern about price controls, as demonstrated in the EU pharmaceutical markets, is their impact on production. Manufacturers tend to cease production of price-controlled drugs, resulting in reduced competition and, in some cases, shortages (Mossialos and Le Grand, 2019). Generic manufacturers in Europe tend to shift from one medicinal product to another, depending on regulation. Further, firms are likely to abandon the production of products whose price ceiling has been set too low to make reasonable returns. Many European generic brands exit price-controlled markets at the expense of the consumer affected by the shortage. Mass exit from a particular price-controlled drug leads to less competition and less incentive to innovate (Abbott, 2016).

The absence of price controls in the United States pharmaceutical market has led to excessive pricing, which in the absence of cartelization and exclusionary conduct, is viewed primarily as either a self-correcting and temporary market failure or a problem that could be solved through industry-specific regulations. The economic theory outlines various factors that influence reference prices. One of those factors is the level of competition in the market (Atella, Bhattacharya, and Carbonari, 2012). When the market is relatively competitive, the expectation is that the prices will be set just above the cost. The prices in the U.S. pharmaceutical market tend to be farther from the cost the further the market shifts from the perfect competition (Abbott, 2016). Those firms with active patents have monopoly power, and the monopoly price seems to be excessive. Competition laws in the United States do not prohibit monopolies but instead the abuse of their dominant position (Sood et al., 2007). It is also argued that the prices set by American firms are unfair because they are way over their value. The value of a product, based on an economic standpoint, is usually defined as the maximum amount the consumer is willing to pay for it (Kyle, 2007). The value ascribed to a drug by the consumers seems to be lower than the price charged by the pharmaceutical companies.

Price controls in the U.S. pharmaceutical would negatively affect the cost and quality of care relative to the European Union. First, it is empirically proven that price controls directly affect the quality and cost through their implication on research and development. Firms in a price-controlled market will have lower cash flows and profits for innovation (Atella, Bhattacharya, and Carbonari, 2012). Lower returns mean a reduced supply of external capital, which leads to reduced investment. Lack of funds to reinvest in innovation translate to less innovative or fewer new drug releases. Consequently, reduced R and D projects will lead to higher care costs. The costs to society, which include higher morbidity, higher mortality, and expenditures on other forms of treatment, exceed the savings through reduction in R and D expenditures. Studies show that the use of new medical products and the discovery of innovative compounds significantly lead to better healthcare outcomes as well as cost-effective care. However, price control would lead to more cost-effective care if the associated costs are less than the savings in R and D expenditures. Market regulation can also affect the quality and cost of care because of the consumption of existing drugs and their prices. A price ceiling may lead to greater use by lowering the costs per use. This would lead to more cost-effective and higher-quality care. Nevertheless, quality and cost of care could be compromised by regulation, given the tendency of pharmaceutical manufacturers to withhold or delay the release of new drugs (Abbott, 2016). This has been evident in the EU, where some firms deliberately delay or suspend the launch of innovative drugs because they anticipate the price ceiling to change or because the current prices set by the government render the new product commercially unviable (Mossialos and Le Grand, 2019).

Price controls could be disastrous to market forces of the free market and negatively affect competition. Pricing is the most sensitive process of trade. Sellers price their goods such that they reap profit and that consumers attain value for money. Competition law supervises the pricing of products by market players as well as their conduct by ensuring that the market is as competitive as possible (Stadhouders et al., 2019). Government intervention in a free market is necessary when the market is unable to be competitive. The U.S. pharmaceutical market has been competitive because of the conduct of players in setting prices for drugs. Price controls would favor large firms that can use their economies of scale to make reasonable profits at the reference price. Additionally, some brands that depend on continuous innovation as a competitive advantage will face stiff competition from those that are price-oriented (Panteli et al., 2016). The innovation-oriented will find little incentive to introduce new products given the prevailing prices of existing products.

Implementing price control would give some parties market power which they could use to their advantage at the expense of other competitors. The EU regulation of the pharmaceutical industry is designed partly to protect domestic firms to the disadvantage of foreign competitors, regardless of the value of the marketed drugs (Mossialos and Le Grand, 2019). These arrangements hurt not only American pharmaceutical companies that serve European markets but also the consumers, especially in EU countries where innovative drugs for heart disease, cancer, and other illnesses are scarce or unavailable. The idea that price control could protect the local industry is counterproductive because regulation weakens domestic firms. Regulation distorts incentives and creates an environment hostile to companies undertaking risky investments in the search for revolutionary therapies.

The skyrocketing drug prices in the United States relative to the price-controlled EU pharmaceutical market could lead to increased importation of drugs which will negatively affect both American manufacturers and consumers (Abbott, 2016). Food and Drug Administration has raised concerns about drug importation. The agency, however, does allow the importation of certain drugs under exceptional circumstances. The FDA approval is rigorous and extensive for drugs developed and manufactured domestically but does not cover imported drugs. Most medicinal products sold overseas could be dangerous due to adulteration or varied formulations. American consumers who resort to imported drugs cannot establish whether the drug has an FDA-equivalent approval or is counterfeit. The FDA has limited ability to assess every foreign drug’s effectiveness, safety, and authenticity (Atella, Bhattacharya, and Carbonari, 2012). Additionally, the labeled country of origin of an imported drug could be wrong. Furthermore, using price control to protect American pharmaceutical firms from competition from EU firms within the U.S. market would be futile because it is unlikely that a foreign firm will export a larger proportion of its production of an innovative drug to the U.S. market at the expense of its local population (Mossialos and Le Grand, 2019). Also, companies exporting drugs to the United States are more likely to increase prices relative to those charged by local manufacturers.

Price controls have a significant influence on launch decisions in the global pharmaceutical market. It is a sophisticated industry where competition exists between different compounds used to treat the same condition or within the compound (originator-brand versus generic or prescription versus over-the-counter medicines) (Panteli et al., 2016). While the expiry of a patent typically leads to market expansion for the generic segment, but not all countries or therapeutic classes will attract new entries. Lakdawalla (2018) asserts that the revenue loss due to the entry of a newer drug by brands in the same therapeutic class is greater than that attributable to generic entry. With price controls, greater losses as a result of generic entry would be experienced in the U.S. market. Additionally, American pharmaceutical companies will likely launch products in non-EU countries with no price regulation. Equally, pharmaceutical companies from the EU market are increasingly launching their drugs in the United States, primarily through their subsidiaries and trade partners. Pharmaceutical manufacturers have the incentive to introduce new drugs first in a foreign market where there are no price ceilings. They use the freedom to set relatively higher prices depending on the prevailing market to influence the product’s price in a price-controlled market. This increases access to newer drugs among American consumers but intensifies competition at the expense of local manufacturers.

Nevertheless, research shows that drugs developed and launched by companies in markets with price regulations have relatively low success on the global market. Specifically, Panteli et al. (2016) argue that drugs invented by a manufacturer in a price-controlled country tend to have fewer markets. This means that price controls could diminish the competitive edge of American firms in the global market. One explanation for this is that the price controls create incentives that encourage companies in the EU market to launch new products that are slightly lower in innovation and with a minor variation in the form of the existing drugs because the prices of the launched products are regulated. A similar effect has been recorded in the United States because of Medicaid reimbursement. Typically, all firms (whether domestic or foreign) should be affected by these incentives if the price controls and entry regulations have the same effects on companies from different markets (Atella, Bhattacharya, and Carbonari, 2012). That is, an American firm should be able to gain the same returns from introducing a product on an EU market as an EU firm unless the American manufacturer expects lower profits due to lower prices or faces a higher cost of entry than the EU firm in a price-controlled market. Additionally, pharmaceutical firms in the EU are profitable in the face of price ceilings because of the nature of their population (Mossialos and Le Grand, 2019). Most EU populations have idiosyncratic needs, which are best addressed by domestic companies. The U.S. pharmaceutical industry has greater potential in the global market, and any form of price regulation would be a barrier (Abbott, 2016).

Existing research further implies that the U.S. market is less attractive for launch by foreign manufacturers. High-price markets have more barriers to entry than low-price markets. The underutilization of drugs in high-price markets like the United States discourages the introduction of new products by non-American pharmaceutical companies. Companies are assured that consumers will purchase the new product in price-controlled markets because they are not necessarily constrained by price (Panteli et al., 2016). These firms will generate higher sales in EU markets than in the U.S. The barriers to entry into the American market by foreign companies reduce access to newer drugs by American consumers. However, U.S. firms benefit from the price controls in the EU. Research shows that a product previously introduced in a high-price market has a significantly higher chance of entering additional markets than one launched in price-controlled markets (Lakdawalla, 2018). However, the low-price market is not attractive for American firms if they have to charge less than what Americans pay for the same product. Maintaining the status quo means that firms from EU markets will prefer to first launch their products in markets where they have the freedom to dictate the price, reap returns from high prices for the patent period, and then launch the drugs in the price-controlled market towards the expiry of the patent (Kigomo, 2015).

Numerous studies indicate that the greatest implication of price controls is reduced innovation (Sarnak et al., 2017). However, the direct effect of price controls and research and development is overestimated because the costs of developing new drugs are often inflated. Additionally, the research and development costs are directly proportional to the incremental value provided by new drugs. Also, developing new drugs is not entirely the responsibility of private manufacturers. Substantial amounts of taxpayers’ money are channeled toward financing the science behind the most innovative drugs (Atella, Bhattacharya, and Carbonari, 2012). To this end, the government should ensure that life-saving drugs are affordable to its citizen. However, the solution to the excessive pricing is not price controls because of the discussed negative implications, such as creating monopolies, but instead reforms in patenting. Some original brands take advantage of the monopoly granted by the patent to set prices beyond the justification of associated R and D costs. First, companies should not be allowed to apply for new patents on the same product. The duration should also be reduced to avoid patent abuse and overpatenting. Patent reforms and faster approval of biosimilar and generic drugs will enable the market forces to determine the most considerate price (Vincent Rajkumar, 2020).

In conclusion lack of price controls like in the European Union (EU) has made consumers in the United States spend almost twice as much as their European counterparts on drugs. While Europeans do not consume fewer drugs than their U.S. counterparts, they pay around 80 percent less. The higher drug prices have been sustained by the monopoly granted to the pharmaceutical brands by the government through patents and allowing the manufacturers set prices for the essential commodity without consideration of the value derived from the product by the patients. The pharmaceutical industry justifies the need for a self-regulating market because of the nature of the sector. Drug development is a sophisticated, rigorous, and heavily regulated process. Pharmaceutical firms should be compensated for the crucial technical risk to provide an incentive to innovate. Thus, price controls would reduce the rate at which new drugs are introduced to the market because regulation would cut the returns that the firms get after selling the drugs. Price controls would have short-run benefits for American consumers but adversely affect social welfare. Instead, patent reforms should be introduced such that firms cannot apply for multiple new patents on the same product. The duration should also be reduced to avoid patent abuse and over-patenting.


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