At his first post-election press conference, Donald Trump declared that pharmaceutical companies are “getting away with murder” by pricing their drugs too high. “Pharma has a lot of lobbies, a lot of lobbyists, and a lot of power. And there’s very little bidding on drugs,” Trump said in January. “We’re the largest buyer of drugs in the world, and yet we don’t bid properly.” At a meeting with pharmaceutical company executives later in January, Trump stated, “The U.S. drug companies have produced extraordinary results for our country, but the pricing has been astronomical for our country.” He added, “For Medicare, for Medicaid, we have to get the prices way down.”
Trump was characteristically vague about just how he would lower pharmaceutical prices, but let’s assume that Medicare was legally mandated to negotiate prices with drug companies. In this case, “negotiate” amounts to creating price controls since pharmaceutical manufacturers would largely have to take whatever price the government wanted to offer, much like what already occurs in the case of the Veterans Affairs Department. Most companies would likely agree to the government price controls because they would still make money from their existing drugs because marginal costs of each additional pill are so low. What would happen? A new study in Forum for Health Economics & Policy by a team of researchers led by Jeffrey Sullivan at the consultancy Precision Health Economics finds that price controls would indeed reduce the cost of drugs to Medicare Part D participants.* But the unintended consequences to Americans’ lives and health in the future would be substantial and bad.
The researchers sought to analyze what would happen if Veterans Affairs drug pricing and formulary policies were applied to Medicare Part D—the federal program that subsidizes the costs of prescription drugs for senior citizens. More than 41 million Americans are enrolled in it, and estimated benefits will total $94 billion, representing 15.6 percent of net Medicare outlays in 2017.
Without going into great detail, the Veterans Affairs Department sets the federal ceiling price it will pay for drugs at 24 percent below the average price a pharmaceutical company gets from wholesalers. In addition, the VA keeps overall spending down by restricting the drugs to which veterans have access. For example, the Avalere consultancy reported in 2015 that the VA’s formulary does not offer access to nearly a fifth of the top 200 most commonly prescribed Medicare Part D drugs. So what would happen if Medicare adopted VA-style price controls?
Cutting prices would save Medicare money. The researchers cite a 2013 study by Dean Baker, co-director of the Center for Economic and Policy Research, that calculated that drug price controls could save Medicare between $24.8 and $58.3 billion annually. On the other hand, less revenue to pharmaceutical companies means less money devoted to research and development. A separate study, published in Managerial and Decision Economics in 2007, estimated that cutting prices by 40 to 50 percent in the U.S. will lead to between 30 and 60 percent fewer R&D projects being undertaken. Reduced investments in pharmaceutical R&D consequently results in reduced numbers of new drugs becoming available to patients. A 2009 study in Health Affairs calculated that as a result of fewer innovative pharmaceuticals being developed, average American life expectancy in 2060 would be around 2 years lower than it would otherwise have been.
Aiming to calculate the effect of drug price controls on future Medicare savings, Sullivan and his colleagues input these data and estimates into an econometric model that aims to track cohorts of people over the age of 50 and to project their health and economic outcomes. They estimate how both VA-style price controls and formulary restrictions would reduce Medicare drug expenditures, along with their effects on future drug development by pharmaceutical companies between 2010 and 2060. Keep in mind that what is being calculated here is the additional reduction in drug company revenues that the imposition of price controls would cause. Competition and its effects on future drug company revenues is assumed and taken into account in the econometric model being used by the researchers.
They devise a low-impact scenario in which price controls lower pharmaceutical company revenues by 7 percent and patient access to drugs by 7 percent, and a high-impact scenario in which revenues are reduced by 15 percent and access by 14 percent. In order to see how price controls will affect future lifetime spending and life expectancy, they assess cohorts of Americans born between 1971 and 1975, between 1981 and 1985, and between 1991 and 1995.
They learned that Medicare price controls do indeed reduce spending on drugs. In the low-impact scenario, the oldest and youngest cohorts respectively spend $100 billion and $300 billion less than they otherwise would have done. In the high-impact scenario, the lifetime expenditures for oldest cohort are reduced by $300 billion; for the youngest, it’s $500 billion. Meanwhile, as a result of reduced revenues, pharmaceutical companies develop and introduce fewer innovative drugs. The researchers calculate that 11 percent fewer drugs would be available in 2060 in the low-impact scenario; in the high-impact scenario, the decline is 25 percent.
Slowed drug development means shorter and sicker lives. The researchers estimate that the oldest cohort will lose between 0.4 and 1.2 years of life expectancy, depending on the scenario; the lives of the youngest will be cut short by 0.9 to 2 years. The “good” news is that shorter life expectancies mean that Medicare and its recipients will spend less money on other forms of medical care. In other words, dying younger saves money. Consequently, Medicare would spend $700 billion to $1.5 trillion less on both drugs and medical care than under the status quo.
People tend to value longer and healthier lives. To calculate the costs of lower life expectancies, Sullivan and his colleagues adopt a middle-of-the road estimate of $200,000 for each statistical life-year. (Roughly speaking, that is the amount of money people would be willing to pay for an extra year of life.) Once the calculations are cranked through their model, the researchers report, “price controls would reduce lifetime welfare by $5.7 to $13.3 trillion (US$2015) for the U.S. population born in 1949–2005.” In other words, the “benefits” of imposing drug price controls are almost nine times lower than their overall costs to the health of Medicare recipients.
These results, like all econometric model results, are illustrative only. Nevertheless, they are plausible. “Economists may not know much, but they do know how to produce a shortage or surplus,” explains the Rutgers economist Hugh Rockoff. “Price ceilings, which prevent prices from exceeding a certain maximum, cause shortages.” If President Trump and Congress seek to get Medicare “prices way down” by imposing price controls, Americans will save some money now, but at the long-run cost of living sicker and shorter lives.
*Given that this research was supported by the Pharmaceutical Research and Manufacturers of America, readers may want to ingest an additional helping of sodium chloride when evaluating its results.