The Public Policy

Terminating the Free Market

The national implications of Arnold's Drug Plan.

By 11.5.06

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Gov. Arnold Schwarzenegger earlier this fall signed a bill requiring prescription drug companies to offer huge discounts on medications to low-and middle-income Californians. The Golden State's plan has garnered wide praise -- and many are seeing it as a model for the nation.

If other states follow California's lead, however, the future of America's health care is at stake.

The California Prescription Drug Initiative forces manufacturers to lower their prices by up to 40 percent on brand-name medicine and a whopping 60 percent on generics.

Specifically, the "price-controlled" drugs will be available to uninsured Californians with incomes below $29,400, or about $60,000 for a family of four. Certain Californians -- like a family earning less than $70,626 -- with significant un-reimbursed medical expenses would also qualify. It costs enrollees virtually nothing -- only $10 a year -- to join this program.

To enforce compliance, pharmaceutical companies that fail to sell their drugs at the government-imposed discounts within three years could be kicked out of Medi-Cal, the multibillion-dollar health coverage system for low-income Californians. Thus, even though Gov. Schwarzenegger has touted his plan as "voluntary," the measure is better described as a shakedown. Before invoking the hammer on the drug companies, the federal government's CMS would have to grant approval to California. It is hard to see CMS signing off on this plan.

In addition to Arnold's strong-arm tactics, there are plenty of sensible reasons to resist replicating this initiative on a national level. For starters, his plan might make sense if government price controls actually worked, but they almost always have the exact opposite of their intended effect.

Of all people, Gov. Schwarzenegger should know this. He saw communism with his own eyes as a child, and witnessed consequences of state-managed markets.

In the case of the Prescription Drug Initiative, pharmaceutical companies would need to compensate for the forced discounts by raising prices on people who don't qualify.

For example, a family of four with a household income of $70,000 and a child with cancer might see its drug bills increase to offset discounts on hyperactivity medicines available to a family making $68,000.

The bill would also have an even more pernicious side effect. It would actually grow the ranks of the uninsured by encouraging people not to purchase drug coverage, even if they could afford it. After all, why would any rational person pay a private insurer when, for just $10 a year, the state would extort a deep discount from the nation's drug firms.

If other states follow Gov. Schwarzenegger's price-fixing scheme, the law of "unintended consequences" would have far more severe repercussions. It would result in less investment, less innovation, and fewer new medicines for the entire country.

Today, it costs between $800 million and $1 billion to bring a new drug to market. Cancer patients have hope precisely because companies are willing to risk that money in developing drugs like Avastin, Erbitux, Gleevec, Herceptin, Nexavar, Sutent, and many others.

Ironically, if Governor Schwarzenegger's plan had been implemented across the country 25 years ago, very few of these drugs would have been invented in the first place because it wouldn't have been profitable, so there would be no life-saving medicines to discount.

If state governments make breakthrough drugs unprofitable, companies will simply stop trying to invent them. In my home country of Canada, for example, the government's intervention in drug pricing has affected the behavior of the industry to the point where Canadian pharmaceutical companies now invent drugs at half the rate of the United States.

And even in the United States, researchers at the University of Connecticut's Center for Healthcare and Insurance Studies found that, since 1960, government interference in drug pricing caused $188 billion in lost spending on research and development.

The "lost" medicines that might have been developed with that money could have saved 140 million life years.

What a wonderful example Arnold is setting. Let's hope other states don't follow his lead.

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About the Author

Sally C. Pipes is president & CEO of the Pacific Research Institute and author of Miracle Cure: How to Solve America's Health-Care Crisis and Why Canada Isn't the Answer with a foreword by Milton Friedman.