Code Red: Two Economists Examine the U.S. Healthcare System

March 23, 2011

What’s Behind the Drug Price Spike?

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 1:41 pm

The news that branded drug prices skyrocketed last year is alarming. Net prices negotiated with insurers seem to have increased by 15 percent or more. In past years, increases have been considerably smaller. Alarming, but also puzzling. One might chalk this up to “greedy” drug makers but doing so raises some hard questions: Did they only just now become greedy? If not, why didn’t they raise prices this much last year? If drug makers think they can get away with exorbitant price increases today, surely they would have thought the same a year ago.

I don’t know for sure what is going on but I can offer a plausible explanation. Let’s suppose that drug makers are actually raising prices higher than is optimal in the short run. (Supposing otherwise returns us to the “why are they only greedy now?” dilemma.) One reason they might do so is if they believe there is some chance there will be drug price controls in the future. If future prices are regulated, then charging prices that are “too high” today would result in prices that are just right in the future.

The problem with this explanation is that I am unaware of any new pressure to regulate drug prices, just the same vague complaints that Washington always emits. So I am at a loss.

I know that lots of my readers are in the drug sector. The rest are drug users, in a manner of speaking. What do you think is going on?

4 Comments

  1. I agree with you. You mentioned two plausible explanations, sudden greed & frontrunning regulation, but there is actually a third worth exploring.

    A steepening of the elasticity of demand for drugs caused by brand loyalty and a decrease in the availability of substitutes could also explain the rise in the price of drugs. Pharmaceutical companies have made tremendous strides in advertising directly to consumers, especially via cable and digital TV. The result has been patients asking doctors for a specific brand, before the prescription is written. In some cases, the commercials allow consumers to self diagnose and then ask “this drug is right for you.” But brand loyalty isn’t the only factor. The recession has had an adverse side effect* on the financial health of non-diversified manufacturers. Earlier this week, Peptimmune, which markets an alternative to Teva Pharmaceuticals’ Copaxone, filed for Chapter 7 liquidation after failing to secure a venture capital injection*. The impact for those who suffer from multiple sclerosis will be spasmodic as the availability of lower cost substitutes decreases.

    I, too, discount the sudden greed argument and I can make a case for a shift in elasticity. However, I strongly believe the front-running regulation to be the strongest argument. Health care is likely to be a hot topic during the run-up to the 2012 national election. As conservatives continue to strip away labor rights, progressives are likely to counter with stricter regulation of free-markets deemed essential to working class Americans. This having been said, I still believe recent price increases to have been fueled by the drug industry wanting to get ahead of anticipated regulation, whether the President’s plans have been made public or not.

    —–
    “Don’t be a raft in the sea of uncertainty. Be a battleship!”

    Comment by Hermann Mazard — March 28, 2011 @ 8:46 am

    • I agree with you but tend to think of this as more of a long term trend. It started when PBMs began asserting themselves two decades ago and the drug makers could no longer rely on the strength of their relationships with prescribing doctors. But something has happened in just the past year and I can’t quite put my finger on it. Having thought more about this over the weekend, I wonder how the political winds are shifting. Do drug makers expect a new round of regulations, perhaps weakening some of the features of the Affordable Care Act while tightening the screws on drug pricing?

      Comment by dranove — March 28, 2011 @ 8:50 am

  2. I believe there are two causes that need to be articulated:

    1 – Drug company profits and prospects are suffering. We hear constantly about the “patent cliff” because it is already reducing profitability or will very shortly for the big pharma companies that have significant products on the market. J&J is suffering due to manufacturing issues primarilly with their OTC products. Other companies are facing a variety of additional problems. In this environment companies will “push the envelope” on those things that can improve their performance in the short term such as raising prices. As one pharma president told me once years ago related to a price increase that was proposed, “that amount of margin contibution is worth the PR push back.”

    and 2. The number of generic products has increased so substantially over recent years that the remaining products that still have patent protection, and thus increased ability to raise prices, are in more difficult disease states and more differentiated from their competitors. These benefits are easily translated into pricing power and more importantly price increases (especially for companies suffering through performance challenges).

    Comment by john — April 7, 2011 @ 7:46 pm

    • Point #2 is especially interesting and a reminder that we often talk about aggregated statistics as if “all else is equal” when all else may be changing in important ways.

      Comment by dranove — April 7, 2011 @ 9:42 pm


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