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tzhenyang24

Singapore

​Should pharmaceutical drug prices be controlled?

March 24, 2016

Being crowned “the most hated man in America” is by no means an easy feat. But one man has done it. In September this year, Martin Shkreli, owner of Turing Pharmaceuticals, increased the price of the drug Daraprim by 5500%, from $13.50 a tablet to $750. He was immediately slammed online, harangued by presidential candidates and called names like “morally bankrupt sociopath”. Albeit a rather extreme case, this highlights the problems of “pharmaceutical greed”, a term Mr Shkreli has come to epitomise. This raises an interesting question: should drug prices be controlled by the government? Or should free market forces be allowed to determine the pricing?

A common method to evaluate the pricing of drugs is to utilise the Classical Economics Theory. According to Classical Economics, the price at which a company charges its customers for a product is the sum of the total investments and a profit. Critics of the pharmaceutical industry like Angell (2004) have argued that the prices charged are unfair because these profits far exceed what is deemed as “normal”. On the other hand, proponents of the Free Market Theory posit that there is nothing wrong as long as the laws of supply and demand in a laissez faire economy determine the selling price.

The latter argument might sound remarkably convincing but the economics of the pharmaceutical industry does not work this way. The laws of supply and demand are not universal. Unlike other commodities, demand for pharmaceutical drugs is inelastic and does not respond greatly to variations in pricing. Because of this characteristic, the price mechanisms of the drugs are vulnerable to abuse by the pharmaceutical industry, given their ability to increase drug prices without reducing demand. This problem is especially prominent in drugs protected by patents or solely manufactured by one company. Because of the monopoly this company has over the drug, they can price it levels that generate them the most profits.

In light of the potential abuse by the pharmaceutical industry, some governments have enacted laws that control the prices of drugs directly. These include direct price regulations which limit the prices of specific drugs and manufacturer specific budgets, which place a limit on the percentage growth of profits each pharmaceutical company can have per year. Both have seen widespread usage in many European countries such as Italy, Spain and France. Acting as social safeguards, they protect the citizens, ensuring that they do not get exploited by unreasonable prices for the benefit of pharmaceutical companies.

However, are legally enforced price controls without disadvantages? Unfortunately no. As Thomas and Vernon (2005) have argued, price controls, which reduce the revenue of pharmaceutical companies, would also reduce the number of innovative, potentially lifesaving drugs brought to the market. In every industry, investors take a risk when making an initial investment. The larger the risk, the larger the expected returns. In the pharmaceutical industry, this risk is defined by the investment in research and development (R&D) while the returns are defined by profit generated from the drugs. This risk is especially significant in the pharmaceutical industry because it is more “research intensive than any other industry, with over 18% of sales spent on R&D (Finkelstein & Temin, 2008). As at 2015, the estimated cost of producing a new drug is USD $820 million (Francis, 2015). Furthermore, drugs differ from other products in the industry because the probability in which a drug enters the market and generates profits is low (percentage of drugs passing from Phase 1 clinical trials to FDA approval is only 10% (Bio, 2014)). This percentage is even lower for innovative drugs which have the potential to greatly benefit humanity. As drugs usually take 15 years to reach the market, investors have to take substantial risks when putting money into R&D. Therefore, if aggressive price regulations are implemented, investors are likely to lose incentives to produce innovative drugs for fear that they may not be able to profit or even recoup their investments.

Ultimately, pharmaceutical companies cannot be looked upon as “charity organisations” (Selvaraj, 2011). While they play a pivotal role in safeguarding humanity, it would be incredibly naïve to think of them as anything more than profit-oriented companies. For long-term benefits to humanity, it is crucial for governments to preserve the incentives for innovative R&D that improve health. However, when short term benefits like cost of drugs are compromised at the expense of consumers, the government must step in. The responsibility of the government is thus to find a balance between short-term and long-term policies that protect both the current and future generations. To do so, the government cannot solely rely on direct price controls that reduce revenues of pharmaceutical companies but should instead actively seek a balance with alternatives like reducing copays for consumers (with governments absorbing a proportion of drug bills).  (800 Words)
 
References:
Angell, M. (2004). The Truth About the Drug Companies. New York: Random House.
Biotechnological Industry Organization. (2014). New Study Shows the Rate of Drug Approvals Lower than Previously Reported. Retrieved from: https://www.bio.org/media/press-release/new-study-shows-rate-drug-approvals-lower-previously-reported-0
Finkelstein, S. & Temin, P. (2008). Reasonable Rx. New Jersey: FT Press
Francis, D.R. (2015, November 3). The Effect of Price Controls on Pharmaceutical Research. Retrieved from: http://www.nber.org/digest/may05/w11114.html
Selvaraj, S. (2011, November 30). Should drug prices be regulated? Business Standard. Retrieved from: http://www.business-standard.com/article/opinion/should-drug-prices-be-regulated-111113000004_1.html
Thomas, A.A. & Vernon, J.A. (2007). The Cost of US Pharmaceutical Price Reductions: A Financial Simulation Model of R&D Decisions. Managerial and Decisions Economics, 28 (4-5), 293-306

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