I finally got around to watching a Cato Institute forum from May in which Cato health economist Michael Cannon discusses with health economist Luca Maini of Harvard Medical School and health economist Pragya Kakani of Cornell Medical School the effects of Medicare price negotiation on drugs. The forum is “At What Price: Determining Pharmaceutical Prices in Medicare,” May 22, 2024. (You can listen at 1.25 speed.)
The bottom line is that the negotiation will only slightly reduce the present value of the revenue stream that goes to pharmaceutical companies and, therefore, will only slightly reduce the discovery and introduction of new drugs.
The person who lays this out most clearly is Professor Kakani. Her presentation is third, and goes from 41:30 to 55:40.
Notice the requirements for a drug to be subject to Medicare negotiation. Kakani shows an interesting slide on that at the 46:49 point. The drug must be a brand-name drug, it must give rise to more than $200 million in annual Medicare expenditures, it must be on the market for at least 9 years (for small molecules) or 13 years (for biologics), and must face no competition from generics or biosimilars. She also lays out 3 other categories that are exempt from price negotiation.
Kakani shows that in steady state, only $43 billion of Pharma’s $1.1 trillion (in 2022) would be on drugs subject to Medicare negotiation. (She assumes that the price negotiation has been in place for years and thus gets to a steady state.) That’s only a 4% hit.
If the Inflation Reduction Act (which introduced price negotiation) cut the relevant drug prices by 50%, global revenues would fall by 2% (50% times 4%.)
She then takes an extreme case: a drug with high Medicare exposure (2/3 of revenue from the US vs. the actual average of 30 to 40%) and a 67% reduction in prices due to negotiation (rather than the Congressional Budget Office’s estimate of 50%.)
She then estimates that in present value terms, there would be an 11% drop in revenue. One reason is that the price negotiation comes after the drug has been around for a long time; the further out in time, the lower the loss to Pharma in present value terms. (She doesn’t state what interest rate she uses.) All the heavy lifting happens by the 54:40 point.
At 1:07:00, Michael Cannon points out that Sam Peltzman found in the early 1970s that the 1962 law that required proof of efficacy reduced the stream of new drugs by 60%. That suggests an idea: repeal the 1962 law and have the FDA certify safety, not efficacy, as it did pre-1962 and then we would have way more innovation on net, even with the Medicare price negotiation.
[Editor’s note: Readers may also be interested in this episode of The Great Antidote podcast, Michael Cannon on Prices and Health.]
READER COMMENTS
steve
Sep 18 2024 at 9:56am
They seem to assume that pharma will be unable to increase prices for the rest of the world to compensate. I think everyone, well maybe not Bernie Sanders, seems to understand that pharma needs profits to pay for research and innovation. However, it’s not clear why the US must uniquely bear so much of that burden. Just so it’s clear Rand recently put out a paper comparing international drug costs. The US pays over 400% of what the rest of the world, OECD, pays for brand drugs. Of note, we only pay 67% of what they pay for generics. Competition works!
https://www.ncbi.nlm.nih.gov/pmc/articles/PMC11147645/#:~:text=The%20gap%20between%20U.S.%20prices,States%20than%20in%20other%20countries.
“The gap between U.S. prices and prices in other countries was larger for brand-name originator drugs. U.S. prices were 422 percent of prices of non-U.S. countries for these drugs. However, prices for unbranded generic drugs were generally lower in the United States than in other countries. U.S. prices were 67 percent of prices of non-U.S. countries for unbranded generics.”
Steve
robc
Sep 18 2024 at 2:23pm
I have wondered why the Pharmas dont just put out a price list and refuse to sell to countries who wont pay the list price?
Is it that countries would refuse to pay and let their citizens suffer with less effective drugs? Or would they threaten to withhold patent protection?
I have always assumed the latter. But wouldnt there be some type of treaty in place to prevent that?
steve
Sep 18 2024 at 2:50pm
My assumption, I have asked and not gotten great answers from people in industry, is that to some extent they have not needed those higher prices from the rest of the world. They are still making profit (meaning more than covering production and distribution costs) from those places and their rules probably do make it harder to negotiate with them. However, they have made such massive profits in the US that they have not needed to try very hard so no need to play hardball. Note that in the video they say they dont even consider the possibility of higher prices in the rest fo the world. That should not be off the table.
Steve
Craig
Sep 18 2024 at 4:07pm
“I have wondered why the Pharmas dont just put out a price list and refuse to sell to countries who wont pay the list price?”
Fear of compulsory licensing.
robc
Sep 18 2024 at 5:06pm
So, my assumption was right, as, in my mind, compulsory licensing is a form of not protecting the patents.
What good is a patent if you can’t refuse to sell the product?
And that brings it back to my treaty question.
Jim Glass
Sep 19 2024 at 8:52pm
Price discrimination is optimal for the seller.
Sellers want to charge not just what the market will bear, but what each slice of the market will bear. When you refuse to sell you get zero revenue, zero profit.
Imagine if publishers refused to sell books to persons not paying the first-edition hardcover price, so no paperbacks, no audio or e-books … movie studios refused to show films to persons not paying first-run theater ticket prices, no TV or online showings … airlines refused to sell seats to anyone who didn’t pay full business-class price … and on and on and on…
Why do retailers have all kinds of “special sales” right here in their home market, instead of making everyone always pay full price?
They seek to segregate the market into parts, then charge each part what it is willing to pay, thus: senior discounts, weekend fares, business class, tourist class, student discounts, Black Friday sales, post-holiday sales, etc.
Foreign markets are part of the total market in which people can afford to pay only less for pharma than we can afford here in the USA, so pharma charges them what they can pay instead of nothing.
BTW, right here in the USA pharma practices price discrimination on a massive scale. Few actually pay full published list price for the most costly drugs.
MarkW
Sep 24 2024 at 6:37am
Of note, we only pay 67% of what they pay for generics.
Yes, and most prescriptions are for off-patent drugs for which generics are available. So we get low cost drugs for most uses but still incentivize innovation in new drugs. So maybe let’s not screw with a market that, despite all the teeth gnashing, seems to be working reasonably well?
Craig
Sep 18 2024 at 10:04am
“Notice the requirements for a drug to be subject to Medicare negotiation.”
Whoever responsible for that, I’d fire them.
“The drug must be a brand-name drug”
“it must give rise to more than $200 million in annual Medicare expenditures”
Why not $10 million?
“it must be on the market for at least 9 years (for small molecules) or 13 years (for biologics),”
Oh boy
“and must face no competition from generics or biosimilars”
OMG
Its almost like they have no idea how to do purchasing at all. Its an institution spending other people’s money to procure things for an institution that has no profit/loss incentive.
“only $43 billion of Pharma’s $1.1 trillion (in 2022) would be on drugs subject to Medicare negotiation.”
That’s using a really really really big number to try to trivialize a very big number actually. Only $43bn? Is that all? And of course that number is limited by these purchasing criteria that only a government $35tn in debt would conjure up.
“That’s only a 4% hit.”
Quick google of CVS’s net margin and I am seeing a number under 2%, I wonder if they say, “Well that is only 4% of our cost of goods sold” Of course not they have a most favored nation clause for 100% of their drug purchases. FYI Medicaid does this at the state level as well. I don’t see why they shouldn’t be buying along the lines of, particularly given the information systems in place now, “Hey, you charge CVS $X, you charge Walgreens $Y, you charge Medical $Z” and have it be the average of or lowest price of the three?
Why wouldn’t Medicare do something LIKE THAT. The only rational explanation to me is institutional incompetence. There’s an inertia behind the process and nobody cares because its not for profit.
steve
Sep 18 2024 at 1:11pm
I think you are being the effects of all that money pharma puts into lobbying. Mind you that money is just the tip of the iceberg. The drug companies make sure they hire lots of the children and friends of people in Congress.
Steve
Craig
Sep 19 2024 at 10:43am
Sounds like you might be onto something, Steve!
Grant Gould
Sep 18 2024 at 10:54am
I’m not sure what “safety” means in the absence of efficacy: the tolerable level of risk for anything — whether a drug, a procedure, an industrial process, or a children’s toy — is inextricably linked to what it does and what it is used for, since we regularly tolerate immense risks for e.g. chemotherapy drugs that we wouldn’t tolerate for an athlete’s foot cream or an asthma inhaler. What would it even mean for an ineffective drug to be safe?
David Henderson
Sep 18 2024 at 1:51pm
You write:
It’s a reasonable concern but somehow the FDA managed to judge safety and not efficacy between 1938 and 1962.
You write:
It would mean that the drug didn’t do what it was supposed to do but also didn’t do harm.
Jim Glass
Sep 21 2024 at 2:24am
Why did they change? (I’m not arguing or trying to make a point or anything.) What was the thinking? Just asking.
David Henderson
Sep 25 2024 at 12:07pm
I just saw this. Sorry for the delay. I was at a memorial service for a friend who mentored me in college. I’ll be sharing some of it on my Substack.
You asked:
Interesting that you ask that because Charley Hooper and I are working on a long article on that very issue. The reason was thalidomide. Senator Estes Kefauver of Tennessee was looking for a way to regulate drug companies and the thalidomide tragedy gave him his excuse. The irony, of course, is that thalidomide was effective; it was just unsafe.
Kevin Dick
Sep 18 2024 at 2:18pm
I imagine that this study actually _over_-estimates the effect on drug R&D.
The law only ex-post regulates blockbuster and near-blockbuster drugs later in their lifecycle.
Having a blockbuster or near-blockbuster drug has benefits to the maker beyond the stream of profits from that particular offering. At the very least, it increases “brad equity”. But I think a strong case can be made that the long term opportunities to accumulate knowledge capital from the technical, manufacturing, and marketing of a very successful product are also significant.
robc
Sep 18 2024 at 5:10pm
And before David Henderson (appropriately) calls me out on it, I oppose both patents and copyrights as contrary to natural law.
Mark Brady
Sep 25 2024 at 9:31pm
“The bottom line is that the negotiation will only slightly reduce the present value of the revenue stream that goes to pharmaceutical companies and, therefore, will only slightly reduce the discovery and introduction of new drugs.”
Therefore? Not necessarily. The statement above assumes that the greater the monopoly profits from patented medicines, the more pharmaceutical research. Plausible, but that’s not the whole story.