Tuesday, June 28, 2011

The Costs of Prescription Drugs

One of the more infuriating aspects of the current discussion on how best to address the long-term U.S. fiscal situation is the focus on Medicare without addressing the out of control costs on healthcare in the U.S. In short, the healthcare situation in the U.S. is a mess and the Affordable Care Act does not address all its problems

One aspect of U.S. healthcare that has always amazed me is how willing the U.S. is willing to subsidize the cost of prescription drugs for the rest of the world. Other countries apply price controls to prescription drugs, but the U.S. does not. However, pharmaceutical companies are more than willing to sell brand name prescription drugs in other countries at lower prices. Why is that?

The reason is that prescription drugs have high research and development costs but are usually not that expensive to manufacture. In economic jargon, they have high fixed costs and low variable costs. What happens is that U.S. consumers pay a larger share of research and development costs than consumers in other countries. Since the costs of manufacturing a drug are usually relatively low, pharmaceutical companies can still make a profit by selling them at lower prices than in the U.S. in other countries, since the U.S. consumer has helped the companies cover their fixed costs.

In other words, in the name of the free market, the U.S. is subsidizing the rest of the world, where there is less of a free market for prescription drugs. Do we really want this system to continue, or should we work with other developed countries in order to negotiate a better cost sharing arrangement?

On the other hand, according to a report of the Center on Budget and Policy Priorities, expenditures for prescription drugs in the U.S. were 35 percent lower in 2010 than projected in 2003 and the costs of the new Medicare Part D is lower than the Congressional Budget Office ("CBO") estimated when Congress was considering the legislation creating this new program in 2003. (Ezra Klein has a post on this: "Does Medicare Part D make the case for Paul Ryan's plan?") However, this is not a reason to be sanguine about prescription drug costs. The Center's report says that the reasons for lower prescription drug expenditures in the U.S. than projected is the growing use of generic drugs combined with many major drugs going off-patent and fewer new major drugs with patent protection coming to market. As for Medicare Part D, costs were also lower according to the report because 6.5 million fewer Medicare beneficiaries enrolled in Part D than expected by the CBO.

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