The wrong way to reduce drug prices

Recent reports of pharmaceutical companies sharply increasing their prices for existing drugs highlight the issue of drug pricing. Unsurprisingly, public outrage over price hikes led to increasing calls for European-style price controls. Less-stringent proposals would require pharmaceutical companies to disclose and justify price hikes. While attractive, these measures are misguided, as they do not address the underlying causes of high drug prices: the high cost of drug development.

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Two high-profile cases brought this issue to national spotlight. Last year, pharma bad boy Martin Shkreli outraged lawmakers and the general public when, as CEO of Turing Pharmaceuticals, he hiked the price of Daraprim, a lifesaving drug used by AIDS and cancer patients, by 5,000 percent overnight. More recently, Michael Pearson, the now outgoing CEO of drug maker Valeant Pharmaceuticals, found himself in the hot seat over his company's aggressive pricing strategy. But the problem is not limited to only a few actors. Other pharmaceutical companies may not be as aggressive, but a recent report revealed drug price increases over a range of widely used drugs.

Exorbitant drug prices are clearly a problem; however, price controls are unlikely to solve it. While price controls may provide immediate financial relief to some patients, they will also reduce future research and development spending and lead to fewer drugs being developed. They will also make investment in drugs that treat less common diseases unprofitable. Thus, the policy may provide some short-term benefit, but it would impose substantial future costs.

A better way to address the issue is to foster greater competition and innovation in the pharmaceutical industry. The ultimate culprit behind the exorbitant prices charged by some pharmaceutical companies is the high cost of drug development, which is mostly driven by overly precautionary Food and Drug Administration (FDA) regulation. The most recent estimate put the cost of new drug development at $2.6 billion, which is more than double the estimated cost only 13 years ago. Most of this increase is driven by higher clinical trial costs and lower success rates. This means that the FDA is asking pharmaceutical companies for more and more data and yet approving new drugs at a much lower rate than it did only a decade ago.

The high costs of drug development leads to higher prices in two ways. First, pharmaceutical companies pass on the development cost to consumers in the form of higher prices. Second, high development costs act as barriers to entry, making it harder for entrepreneurs to start new biotech companies and compete against incumbents. This reduces competition in the industry and allows existing pharmaceutical companies to charge monopolistic prices. Reducing development costs would allow the forces of market competition to keep prices in check naturally. It would also increase the number lifesaving drugs becoming available to patients.

One key point that is often overlooked in debates over drug spending is that drugs are, in fact, cost-saving tools. A few bad actors aside, most drugs actually reduce overall healthcare costs. To understand how, consider the case of statins, which are cholesterol-reducing drugs. Patients with high cholesterol are at higher risk for stroke or heart attack. By reducing patients' cholesterol levels, statins reduce their chances of cardiovascular diseases. Since treating these diseases requires expensive hospitalization and surgery, statins effectively save patients and health insurance companies money by preventing the need for costly treatments — not to mention the fact that invasive surgeries take a far higher toll on patients' bodies than a simple drug regimen.

In fact, it is medication non-adherence — patients' failure to take prescribed medication — that is the major problem facing our healthcare system. It costs the healthcare system almost $300 billion in preventable healthcare expenditures annually.

Having a vibrant and innovative pharmaceutical sector developing new and better drugs is crucial to both improving the quality and keeping down the costs of healthcare. And for that, we need to reduce the costs of new drug development.

Abdukadirov is a research fellow in the Regulatory Studies Program at the Mercatus Center at George Mason University.