Issue No. 36: The Right Way and the Wrong Way to End Disparity Between U.S. and European Drug Prices
In his State of the Union Address in January, President Trump said it was “very, very unfair” that people who live in other rich countries pay less for medicines than Americans do. As we noted in Issue No. 29 of this newsletter, there are two ways to address the disparity….
Option 1: We can try to convince the Europeans, through pressure and persuasion, to adopt our own market-based approach to set prices, which has produced a wealth of innovative, life-saving drugs and given nearly all Americans access to them.
Option 2: We can adopt the approach of the Europeans themselves, whose nationalized health-care systems use monopsony power – combined with cost-containment mechanisms such as health technology assessments, forced localization as a condition of market access, and various types of reference pricing – to constrain prices. The result has been to throttle drug development and limit timely access for patients.
Unfortunately, it appears the Administration is considering the second option for the Medicare program.
Importing Price Controls From Other Countries
In a speech on Oct. 25, President Trump said he was taking aim at the “global freeloading that forces American consumers to subsidize lower prices in foreign countries through higher prices in our country.” His answer is to set drug prices in this country based on an index of what 14 other countries, 12 in Europe plus Canada and Japan, are paying. In other words, he wants to import a key part of the European system of nationalized health care into the United States.
The new price controls would have some limits. The controls would apply only to single-source drugs and biologicals in Medicare Part B, which reimburses for physician-administered drugs, such as infusions of cancer medicines. According to a document also issued Oct. 25 by the Department of Health and Human Services (HHS), the new system “would be phased in over a five-year period [and] would apply to 50 percent of the country.”
It would, in effect, be an extremely large “pilot” program. But, if enacted, it would represent a significant change in the direction of U.S. health care policy: an emulation of foreign single-payer systems that Americans have previously rejected. But this pilot program could become the model for a wholesale change in health care – one that would put access to life-saving drugs in jeopardy for millions of Americans, negatively impacting global R&D spending and new drug introductions.
Details of the International Pricing Index Model
The HHS document says the department plans to implement what it calls an International Pricing Index (IPI) Model in the spring of 2020. Currently, Medicare payments for Part B drugs are typically based on the average sales price (ASP) in the U.S., plus a 6% add-on. The ASP is not simply a number mandated by drug companies. In the case of each drug, it is the result of intense negotiation between a manufacturer and powerful pharmacy benefit managers, several of which individually represent more patients than the entire Medicare system – not to mention entire countries proposed for the index.
Under the Administration’s proposal, Medicare “would pay for the drug based on a Target Price derived from [the] international price index and designed to draw down Part B drug prices toward international prices over the course of the model,” according to a release by the Centers for Medicare and Medicaid Services (CMS). Physicians and hospitals would receive a “drug add-on amount,” which presumably would provide them with roughly what they receive under the current system.
Many of the details of the add-on and the index are still unresolved, but a separate policy brief from HHS titled, “What You Need to Know About President Trump Cutting Down on Foreign Freeloading,” says that the IPI Model will set a target price of “126% of the average price other countries pay” for physician-administered drugs. Currently, according to a new HHS study, the U.S. pays an average of 180% of the prices for 27 Part B drugs that were compared to prices of those medicines in 15 European countries plus Japan. Including some of those countries in the comparison is questionable. Greece, the Czech Republic, and Slovakia, for example, have per-capita incomes that are about half that of the U.S., and, because per-capita income is a major factor in determining demand, it deeply influences the prices of all goods, including drugs.
Still, in its filing in the Federal Register, CMS says that, in constructing an International Price Index, “we are considering using pricing data from the following countries: Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, and the United Kingdom.”
The cherry-picking will clearly skew results. CMS, for example, proposes to leave off Switzerland, the country that ranks second to the U.S. in per-capita drug spending. In fact, the putative index leaves out seven of the nine other countries (in addition to the U.S.) among the top 10 nations for per-capita GDP.
A major means the other index countries use to hold prices down is to deny their citizens access to the best medicines. The Wall Street Journal pointed out Oct. 29 that of 74 cancer drugs launched between 2011 and 2018, some 95% are available in the United States. “Compare that to 74% in the U.K., 49% in Japan, and 8% in Greece
The U.S. Spends More on Drugs, But Also on Hospitals and Doctors
There is, however, no quibbling over the fact that the U.S. spends more on medicines. One reason is that we are richer and choose to spend our dollars that way; another is that our system is based mainly on free choices and free markets rather than on government fiat, which necessarily limits access. These factors do not merely affect pharmaceutical costs. For example, U.S. hospital costs are far higher than costs in other countries. As we pointed out in April:
An MRI in the U.S. costs an average of $1,119, according to another study. ; in Australia, $215. Appendix removal is $15,930 on average in the U.S. and $6,040 in Switzerland. In the U.S., heart bypass surgery is $78,318; in the U.K., $24,059. These differences are more significant than drug-price differences because hospitals represent about one-third of U.S. health spending while prescription drugs represent about one-tenth.
A JAMA study in March, by Irene Papanicolas and colleagues, found that physicians in the U.S. earn far more than in other countries – 63% more for general practitioners than in the average high-income country and 73% more for specialists; in the U.S. nurses earn 42% more.
There is no doubt that the rest of the world benefits from the fact that higher U.S. prices provide revenues that are then reinvested by pharmaceutical companies in the development of more drugs. The benefits of those innovative medicines to people beyond the U.S. are a positive externality, as economists would say, of the system. One of the hard truths of innovation is that it creates such externalities. An American company, Apple, invented the iPhone, but Afghans, Chinese, and Finns all benefit.
The Dubious Mechanism for Raising Prices in Europe
Let’s understand what the government is trying to do with its IPI Model. The idea, as we understand it, is that since an index composed of prices in 14 foreign countries will determine U.S. prices, pharmaceutical manufacturers will focus their efforts on raising prices in those countries – because higher prices in Germany and Greece will mean a higher IPI index and thus a higher price in the United States (though, obviously, not as high as currently). In other words, pharmaceutical companies themselves, hit by lower prices for Part B drugs in the United States, will try hard to raise prices in Europe to mitigate the damage.
This mechanism, President Trump and his advisers believe, will get the Europeans to stop “freeloading” on our innovation. The model posits that as Europeans pay more and Americans, at the IPI plus 26%, will pay less:
Overall savings for American taxpayers and patients projected to total $17.2 billion, with out-of-pocket savings potentially totaling $3.4 billion.
(By the way, the model does not account for the fact that price controls will also deter innovation, leading to higher rates of sickness and death and thus higher costs to society.)
Certainly, the U.S. government can try to issue an order setting prices in the United States (though the order may be illegal, and there are serious costs, which we will explain). But the notion that Europeans will pay more is based on a false premise, which is that drug manufacturers do not already try as hard as they can to get foreign governments, as sole purchasers, to pay as much as possible for their drugs. They have a huge incentive as it is.
Also, imagine the other side of the negotiation. How would a regulator in France respond to the argument from an American drug company that goes like this: “Please pay us more for our cancer medicine so that you will boost the index price and help us out in the United States.” Good luck.
The Costs of Price Controls on Drugs
Back in February, the President’s Council of Economic Advisers (CEA) issued a report titled, “Reforming Biopharmaceutical Pricing at Home and Abroad,” which explained:
The United States both conducts and finances much of the biopharmaceutical innovation that the world depends on, allowing foreign governments to enjoy bargain prices for such innovations…. Simply put, other nations are free-riding, or taking unfair advantage of the United States’ progress in this area.
It is hard to disagree with that sentiment, and, at the time, the CEA did not have a solution to the problem – or, if it did, kept that answer to itself. Now, we know that the putative solution is imported price controls. But if the U.S. did adopt European price controls at home, among the biggest losers would be Americans themselves, who would see drug innovation decline and with it their own health. Unless the IPI Model could somehow make up for all the lost revenues from price controls – clearly, an impossibility – then forcing price cuts in the U.S. would lead to fewer new medicines being developed, particularly the kind of high-value medicines for very sick patients covered by Medicare Part B.
The U.S., thus, faces an “innovation-access” tradeoff. If revenues are reduced by government command, then investment in research and development will fall as well. The result would be a sharp decline in new treatments – and in overall health – for Americans as well as foreigners.
A study by Thomas Abbott and John Vernon, published as a working paper by the National Bureau of Economic Research, found that “cutting prices by 40 to 50 percent in the United States will lead to between 30 and 60 percent fewer R and D projects being undertaken in the early stage of developing a new drug.” A full implementation of HHS’s plan would bring U.S. drug costs down from 1.8 times those of other rich countries to 1.26 times. That is a 30% reduction. Interpolating from the Abbott and Vernon calculations, we figure that R&D projects would drop between 20% and 40% -- a disaster for global health. So far this year, the Food & Drug Administration has approved 47 new drugs, fighting such diseases as lung cancer, leukemia, pneumonia, urinary infections, melanoma, and on and on. Imagine that 10 or 20 of those were never developed.
A Warning From 200 Economists
In 2004, a time when there was a flurry of interest in doing something about the European-U.S. price disparity, more than 200 American economists issued a warning. They signed a public letter that said in part:
The ideal solution would be for other wealthy nations to remove their price controls over pharmaceuticals. America is the last major market without these controls. Imposing price controls here would have a major impact on drug development worldwide, harming not only Americans but people all over the world. On the other hand, removing foreign price controls would bolster research incentives.
Among the signers were the late Nobel Prize winner Milton Friedman; the late Paul McCracken, CEA chairman under President Nixon; and President Trump’s own CEA chair, Kevin Hassett, who was then at the American Enterprise Institute.
What the economists were warning against – “imposing price controls here” in the U.S. – is precisely what the Trump Administration wants to do. The President rails against the Affordable Care Act, or Obamacare, but he wants to take a far more eventful step toward importing government-run health care from Europe – a system that will almost certainly mean restricted access for American patients.
Rather than competition, Europe, Canada, and Japan constrain their costs by delaying or even prohibiting the best medicines and procedures from getting to market. We reported in Issue No. 32 that restrictions on access to cancer drugs in the U.K. are one reason that…
five-year survival rates for cancer are higher in the U.S. than in the U.K. Based on American Cancer Society data, for cervical cancer, the rate is 67% in the U.S. and 59% in the U.K.; for breast cancer, 90% in the U.S. vs. 78%; for colorectal cancer, 65% in the U.S. vs. 51%.
Choosing Option 1: Pressure on the Europeans, Canada, and Japan
It does not have to be this way. The President could choose Option 1: pressuring other countries to remove their price controls. Donald Trump clearly believes that tough bargaining is his strong suit, so why not apply it here? Persuade, through carrots and sticks, other rich countries to relax, or end, their price controls. Those countries could still provide tax credits or direct subsidies to their citizens for drugs and other health services if their aim is to ease the burden of health-care costs.
There are precedents. In March, the Administration pressured South Korea into ensuring equal treatment for U.S. drug manufacturers in a renegotiated bilateral agreement; in the past, only Korean companies received the advantage of premium pricing. (The terms of this commitment are still under negotiation.) Foreign drug price controls distort trade, and the U.S. could challenge them under current agreements.
Meanwhile, the Administration could deploy the most effective means of constraining prices: facilitating competition through regulatory reforms. The FDA under Scott Gottlieb is taking many of the right steps – for example, easing generic approvals. But regulators need to do more to clear the path for biosimilar drugs to compete with many of the Part B biologics that HHS wants to target through price controls.
Our aim should be for other wealthy countries to significantly relax their price controls – not to import them to the U.S. A study published in January by Dana Goldman and Darius Lakdawalla of the USC Schaeffer Center study notes:
We estimate that if European prices were 20 percent higher, the resulting increased innovation would generate $10 trillion in welfare gains for Americans, and $7.5 trillion for Europeans over the next 50 years. Encouraging other wealthy countries to shoulder more of the burden of drug discovery — including higher prices for innovative treatments — would ultimately benefit patients in the United States and the rest of the world.
Option 1 benefits Americans far more than Option 2. Unfortunately, fixing the price disparity in this way that increases Americans’ health is not so simple as our government decreeing that Greece and the Finland determine what medicines should cost in America. But lives are in the balance. We should do this right.
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