Americans pay prices for prescription drugs that are two to six times the rest of the world, despite having personal incomes that are on par with many developed countries. For instance, the average price for Humira — a top-selling drug to treat rheumatoid arthritis — is nearly $2,700 per administration in the U.S., more than twice the price in the U.K. American salaries are not twice as high as British salaries.
It’s not surprising that in countries with different per capita incomes (e.g., U.S. vs India), the prices of drugs are different. But why is it that in countries with similar per capita income as the U.S., drug prices are so much lower than in the U.S.?
This answer provides a good explanation for how some countries achieve lower drug prices but not why drug prices are higher in the U.S.
Perhaps the most common explanation for why drug prices are high in the U.S. is what economists call “free riding.” The argument goes like this: because the U.S. is willing to pay higher prices for drugs, other countries don’t feel the ‘need’ to do so and therefore don’t.
This explanation is overly simplistic and misses the two key economic issues at stake.
First, pharmaceutical companies are concerned with global profits, not the profits from any single country.
Second, expectations of future profits drive pharmaceutical investments, which means that reducing profits will negatively affect research and development (more on this point below, which is more controversial than it should be). This creates an innovation-access trade-off. All patients would prefer lower drug prices; in fact, the efficient way to increase access today would be to charge prices for drugs that equal their marginal cost, which is sometimes pennies.
But, doing so would lower the expected profits of companies who take on uncertain R&D investments (only 1 out of every 12.5 potential drugs ever reach patients, the average drug takes 11-14 years to develop, and the costs of bringing a drug to market range from $1 to $2.6 billion).
Multiple economic studies suggest that lower profits will lead future patients to have fewer new therapies. These studies typically examine how the number of new FDA-approved drugs change when policies make drugs more or less profitable (e.g., Medicare Part D, which expanded drug insurance coverage for the elderly and raised expected profits to drug manufacturers, was associated with increases in R&D for drug classes with high Medicare market-share).
The key economic consideration is not whether this empirical fact is true, but whether reducing drug company profits and the prices of medications today will outweigh the societal benefits of those innovations just at the cusp of not being discovered.
Although this question is difficult to answer, several studies suggest that the benefit of lower prices today is offset by the forgone value created by drugs that never reach the market. According to one estimate, if the U.S. were to adopt European-level price controls, the reductions in U.S. prices today would result in 0.7 years lower longevity for future cohorts of Americans and Europeans due to fewer new drugs. This would cost Americans more than $50,000 per person when the value of foregone health is valued.
These points lead to an important economic conclusion. Because the U.S. accounts for the plurality of global pharmaceutical revenues — in 2016 the U.S. comprised 42 percent of global pharmaceutical revenues — it faces an “innovation-access” tradeoff that other countries do not.
If the U.S. were to adopt price regulations like other countries, the impact on global pharmaceutical revenues would be substantial because the U.S. comprises a large share of global revenue. A 20 percent reduction in U.S. pharmaceutical prices would directly impact global pharmaceutical revenues, whereas an identical policy by any single European nation would have a small impact.
If reductions in global profits ultimately lower innovation, it could therefore be in the long-term self-interest of Americans to pay higher prices for drugs than citizens of other developed countries.
Problematically, policies designed to lower the prices that Americans pay for drugs and increase the prices that other countries pay may be difficult to enact. The core challenge is that individual countries behave, well, individually.
Although many European countries have economic agendas that are unified through the E.U., and the E.U. is, as a whole, comparable in size to the U.S., there exists no mechanism for cross-E.U.-country harmonized pricing that balances the innovation-access tradeoff that the U.S. currently privately faces.
Recognizing that countries have different incomes per capita, pricing policies could flexibly allow for higher prices in nations with greater income per capita. Ultimately, collective incentives across countries of similar income per capita are needed to support medical innovation. In addition to harmonized pricing, this could be achieved through bilateral trade agreements, but those negotiations, too, would be difficult to negotiate.
The discrepancy in drug pricing between the U.S. and other countries continues to draw attention, both from those that view price controls as a much-needed way to lower U.S. pharmaceutical spending, as well as those who believe that price controls may adversely impact innovation.
Answers to this debate depend on recognizing the importance of collective action across countries of similar wealth to balance affordability of medications today with access to new medications in the future. At present, the way to achieve this balance isn’t clear. While a single-payer approach to paying for drugs in the U.S. will lower drug prices today, the ‘price of health’ will rise as the future availability of health-improving technologies falls. Whether this is a price society is willing to pay remains the critical question.
Anupam B. Jena is the Ruth L. Newhouse associate professor of health care policy a Harvard Medical School, an internist at Massachusetts General Hospital, and a faculty research fellow at the National Bureau of Economic Research.