Politicians will never cease searching for a free lunch, or, of late, free drugs. Thankfully the D.C. Circuit Court of Appeals has told the District government no on price controls. Patients will be the biggest beneficiaries of the ruling.
That may sound counterintuitive. In the popular mind, drug prices are excessive. Why should you have to pay a few bucks for a pill that costs pennies to make?
The theory seems to be that new compounds arrive magically, like manna from heaven. If the drug makers were truly interested in the public, they would presumably give away their products.
Unfortunately, medicines do not just appear. They have to be created. That requires research and development spending, $55 billion worth by the research and biotech drug industry in 2006 alone (the last year for which figures are available). Moreover, few prospective compounds make it to market — 5,000 to 10,000 are tested for every final drug, and only 30 percent of the latter actually make money.
So the price of the few successful medicines has to pay for everything: research, dry holes, low demand drugs, administrative expenses, litigation, regulatory barriers, and defending against demagogic politicians seeking to seize one’s patents. Each successful medicine is estimated to cost $800 million on average to develop.
Industry critics complain about wasteful spending, such as advertising, but companies advertise to make people, doctors and patients, aware of their products. The goal is to increase demand, and thus revenues. As such, advertising is an investment intended to increase profits. Less advertising would mean less R&D.
IT’S NO SURPRISE that average people don’t understand pharmaceutical economics. But public officials have a responsibility to learn the facts. Unfortunately, the D.C. City Council has never paid much attention to economic reality.
Three years ago the Council came up with a bizarre system outlawing “excessive prices.” City courts were vested with responsibility for determining what was “excessive” based on several factors, including foreign prices. Violations were to be punished by fines, treble damages, a ban on future sales in the District, and “any other relief the court deems proper.”
The law also invited a deluge of private strike suits: groups claiming to represent “the public interest” and individuals claiming to be adversely affected could sue, seeking attorney’s fees and treble damages.
Drug makers would have to convince a judge that their prices were not “excessive,” a term left undefined. Excessiveness could be determined by considering “costs of invention, development and production of the prescription drug, global sales and profits to date, consideration of any government funded research that supported the development of the drug, and the impact of price on access to the prescription drug by residents and the government of the District of Columbia.” Imagine having to suffer through a trial for every new drug sold.
In fact, had the law been allowed to go into effect, pharmaceutical companies probably would have stopped marketing their products in the city. They could ill afford to subject themselves to an arbitrary price control regime in a small market that would ultimately reduce their revenues across the country.
IT WAS A monumentally stupid law, but not quite as stupid as the initial proposal advanced by city councilman David Catania. He originally wanted to make the sale of drugs at excessive prices an “illegal trade practice,” punishable by the seizure of company patents.
That proposal raised not only the issue of federal preemption, but also the Fifth Amendment’s requirement that government pay “just compensation” for taking property. What an idea: the incompetent, inefficient, and cash-strapped District could end up paying billions of dollars for pharmaceutical patents. The city council concluded that this was not a good idea, so it approved price controls instead.
The industry filed suit and in an expedited ruling the federal District Court judge voided the law less than three months after its passage. The city appealed — and ultimately lost again.
The Kidney Cancer Association and the 60 Plus Association, groups representing patients and seniors, respectively, joined the industry in claiming that federal patent law preempted D.C.’s price control regime.
The appellate court concluded that the legislation “directly targets and undermines [Congress’s] careful balance between innovation and drug costs” since price controls were “purposefully aimed at adjusting the scope and reward of the federal patent right.” In non-lawyerspeak: Washington grants patents to enable companies to earn the revenue necessary to fund research on new products, to encourage innovation.
Even the dissent in the appellate decision acknowledged that the city council was attempting to “establish patent policy” by investing city judges with the power “to determine what price is necessary to spur innovation.”
After losing last year, the city still would not give up. It asked the D.C. Circuit to hold an “en banc” hearing by several judges, compared to just three in a normal appeals panel. The judges again wisely said no.
UNFORTUNATELY, DISTRICT politicians are not alone in their search for the eternal free drug. States have come up with a variety of price and use controls. State and federal officials also have pushed the “reimportation” of American medicines from abroad. That effectively means imposing foreign price controls on U.S. medicines.
One reason prices vary among countries is their radically different economic circumstances. Most people in developing nations cannot afford to buy drugs at developed nation rates. Lowering the price increases sales and revenues. But if the drugs were sold at the lower price in the U.S., they would not have been developed in the first place. You can’t spend $55 billion on R&D if you collect only pennies for your products in your most important market.
Prices also vary internationally because of national price controls. The D.C. legislation presumptively treated as excessive prices 30 percent above those charged in “high-income” states, namely Australia, Canada, Germany, and the United Kingdom. But these countries have nationalized their health care systems and restrict drug prices.
In effect, these countries leech off of U.S. R&D. That’s not fair to American consumers, but punishing the pharmaceutical industry with price controls won’t solve the problem. If U.S. companies could overturn foreign restrictions, they would do so. Responding to this injustice by effectively subjecting them to the same controls in America would be even more unjust as well as economically perverse. Most important, doing so would reduce the availability of new pharmaceuticals.
What makes price controls so attractive politically is that the costs are invisible. People won’t suffer the worst consequences of price controls for years, given the long lead time in drug development. And it is impossible to say what products won’t be available since no one knows what cures otherwise would have been discovered. Cheaper drugs for voters today versus unrecognized deaths and hardship for the yet unborn in the future. What’s a politician to do? The answer is all too obvious — ask the D.C. city council.
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