Frequent comparisons are made between health care costs in the United States and in other wealthy countries. The focus of these comparisons is nearly always pharmaceutical prices. The latest example is a report, issued by the House Ways and Means Committee staff, titled, “A Painful Pill to Swallow.” The report compared drug prices in the United States with those in Canada, Australia, Japan, and a group of Europeans countries. It concluded, “The analysis presented in this report clearly illustrates that, across the board, the U.S. spends more on drugs than other comparable developed countries.”
That’s hardly a surprise. The U.S. health care system is utterly different from that of other countries, where the government is in charge and, as a monopsony buyer, can demand the prices it wants from drug manufacturers. These nationalized health systems may have the benefit of lower prices, but they create significant drawbacks.
What About Innovation?
The Ways and Means report sheds little new light – while casting considerable shade – on a complex subject. The researchers, for example, give short shrift to what is probably the most important issue that faces serious policy makers tackling drug-cost question: the impact of prices on innovation. The U.S. set a new record last year for drug approvals, and the number of new sophisticated biological products jumped from 10 in 2014 to 24 in 2018. Many of these approved medicines target the worst diseases, especially cancer.
The Ways and Means report is clearly meant to provide ammunition for those in Congress (and even in the Administration) who want to force foreign price controls onto the U.S. system. But if that happens, how will innovation be funded? Who will provide the capital to develop the pill that cures Alzheimer’s or AIDS or that extends the life of cancer patients?
As we pointed out in Newsletter No. 52, after examining health spending in the U.S. and other rich countries last year, three Harvard researchers, including Ashish Jha, the dean for Global Strategy at the Harvard T.H. Chan School of Public Health, concluded: “Although the United States’ high prices of pharmaceuticals are controversial, these prices have been viewed as critical to innovation, including U.S. production of chemical entities.”
The effect of price controls is predictable. They will deprive drug manufacturers of the revenues needed to fund research and development and harm the U.S. pharmaceutical industry in the same way they have depleted its European counterpart. As recently as 1990, Europe was spending more than the U.S. on R&D. Today, it’s no contest. Henry Grabowski and Y. Richard Yang wrote in Health Affairs that “U.S. firms overtook their European counterparts in innovative performance or the introduction of first-in-class, biotech, and orphan products. The United States also became the leading market for first launch.”
In a report titled, “The Opportunity Costs of Socialism,” the U.S. President’s Council of Economic Advisers looked at the effects of adopting European-style price controls:
Take the case of pharmaceutical innovation to improve patient health. Empirical research in this industry and others has shown that R&D investments are positively related to market size. For the case of medical innovation, evidence suggests that a 1 percent reduction in market size reduces innovation—defined as the number of new drugs launched—by as much as 4 percent (Acemoglu and Linn 2004).
Given that future profitability drives investment in this way, Lakdawalla and others (2009) examined the impact on medical innovation of the U.S. adopting European-style price controls. The study examined patients over the age of 55 and considered the reduction in R&D and new drugs approved that these price controls would cause. The paper examined increases in mortality for the heart disease, hypertension, diabetes, cancer, lung disease, stroke, and mental illness.
The study’s major finding is summarized in a chart on page 48 of the CEA report. Life expectancy for Americans aged 50-55 would quickly fall by a half-year in the U.S. and keep falling to seven-tenths of a year by 2060. And, because the U.S. develops so many new drugs, life expectancy would drop in Europe as well, by four-tenths of a year by 2040 and seven-tenths by 2060. The conclusion: “Given that innovations are financed by world returns mostly earned in the U.S., the mortality effects on health were substantial both in the U.S. and in Europe.”
R&D Projects Estimated to Fall 30% to 60%
Many U.S. companies now plough one-fifth of their revenues or more into R&D; indeed, R&D spending often exceeds net earnings. A study by Thomas Abbott and John Vernon, published as a working paper by the prestigious 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.” David R. Francis revisited the Abbott-Vernon paper on Oct. in the NBER Digest and wrote:
Numerous economic studies indicate that price controls, by cutting the return that pharmaceutical companies receive on the sale of their drugs, also would reduce the number of new drugs being brought to the market. So, a short-run benefit for consumers could lead to a long-run negative impact on social welfare. And, this damage wouldn't be fully felt for several decades because it takes so long to develop new drugs.
Against considerable research, the Ways and Means paper quotes the February congressional testimony of Rachel Sachs, an associate law professor at Washington University of St. Louis, who claims that pharmaceutical companies have “other opportunities to obtain savings” within their current business models. In other words, revenues may fall, but the drug companies can cut expenses to make up for the losses and still maintain R&D levels. Any economist would find this an odd claim. If businesses can save money and thus boost earnings, they would already be doing it. They have a huge incentive: their stock prices.
The Matter of Rebates
Rebates are a way of life in complicated pricing schemes for pharmaceuticals. As HHS explains in a Fact Sheet:
Drug companies pay rebates and other payments to PBMs [pharmacy benefit managers, who work for insurance plans], but these payments are not reflected in patient out-of-pocket drug costs. The average difference between the list price of a drug and the net price after a rebate is 26 to 30 percent. These rebates, negotiated in Medicare Part D and private plans, are typically not used to reduce patients’ cost sharing for a particular drug.
Unfortunately, it is difficult to calculate rebates. According to a study by the research firm Milliman:
Rebate contract terms are trade secrets and vary widely among brands, pharmaceutical manufacturers, and health insurers, but tend to be highest for brands in therapeutic classes with competing products. This secrecy makes cost comparisons of competing brands on the basis of price alone very difficult (if not impossible) to estimate.
What we do know is that rebates are huge, and rising. The IQVIA Institute for Human Data Science found that the difference between invoice spending (that is, the amount paid by drug distributors, or roughly the list price) and net spending (accounting for all price concessions) increased from $74 billion in 2013 to $130 billion in 2017 for retail drugs. HHS found a similar trend of growing differences between list and net prices. Manufacturer rebates were only 10% of gross prescription drug costs in 2008. Today, according to HHS, they represent between 26% and 30% of list prices and in many cases far more.
The Ways and Means study uses 22% -- a figure for the year 2015, as reported this year by the Congressional Budget Office. Why such an old number when the Centers for Medicare and Medicaid Services has more up-to-date figures?
In a table, the Ways and Means report lists average drug prices for different countries and then states what the U.S. rebate would have to be in order to match it. On average, 61 drugs were examined per country -- with a range from 37 drugs from Portugal to 78 for the U.K., so, obviously we are not talking about direct comparisons here. Again, on average, the U.S. rebate to match foreign prices would have to be 73% -- with a range from 61% for Denmark to 82% for Japan.
The actual average rebate, as we noted, is probably around 28% -- but we can’t tell what the figure would be for the 37-78 drugs examined in the Ways and Means report. That report, to the committee staff’s credit, also looked at GDP per capita in the comparison countries. Clearly, richer countries, with more demand for medicines, should naturally have higher prices. Much of the price disparity can be explained by adjusting for GDP per-capita differences and subtracting rebates. For example, Canada’s GDP per capita is 27% lower than that of the U.S., and we can assume a 28% percent rebate.
Putting Drug Prices in Perspective
While prescription drug prices seem to be the obsession of the day, they represent only 10% of total health care costs, according to official National Health Expenditures data. An additional 4% of health care costs are attributed to drugs that are administered in hospitals and doctors’ offices. By contrast, hospitals account for 33% of U.S health costs, and physician and clinical services for 20%.
The truth is that the prices of nearly all health care services are higher in the United States. According to the Peterson-Kaiser Health System Tracker, an overnight hospital stay in the U.S. costs $5,220 versus $765 in Australia. The average price of an angioplasty in a U.S. hospital is $31,620, compared with $7,264 in the U.K., and a Caesarean delivery is $16,106 in the U.S. versus $9,965 in Switzerland. An MRI in the U.S. costs an average of $1,119; in Australia, $215. And an appendectomy costs twice as much in the U.S. as in the U.K.
Physician compensation in the United States is higher as well: an average $313,000 a year, according to an international compensation survey published this year in Medscape. That compares with $163,000 in Germany; $138,000 in the U.K., and $108,000 in France. Part of that difference is owed, as mentioned above, to disparity in GDP per capita, which is roughly 50% higher in the U.S. than, for instance, in France.
In addition, U.S. doctors have a heavier burden of medical malpractice insurance in a litigious society plus higher administrative costs that they must absorb themselves. A 2014 study published in BMC Health Services Research by Aliya Jiwani and colleagues found that billing and insurance-related activities added an additional $70 billion to physician-practice expenses, or about $80,000 per doctor in 2012, which would be about $100,000 today.
Remember, as well, that Americans have won or shared the Nobel Prize in Physiology or Medicine in 29 of the past 40 years. Not only our pharmaceuticals but our physicians are the best in the world.
Lack of Access in Other Countries
But health care is useless without access. The CEA report provides a comparison that shows, for different nations, the proportion of seniors who waited “at least four weeks to see a specialist in the past two years.” Of the 12 countries studied, the U.S. did best, with only 21% of seniors waiting that long. A sampling of the others: France, 42%; U.K., 51%; Canada (worst of the 12), at 59%.
Lung cancer is the number-one killer of cancers world-wide. While treatment for non-small-cell lung cancer (NSCLC) has improved considerably because of new drugs, in many rich countries access is limited. A study by HIS Markit for PhRMA found that, for five countries studied (Canada, South Korea, France, the U.K., and Australia), the average delay between regulatory approval of a drug to treat the disease and the first actual reimbursement of a patient was 589 days, or more than a year and a half. In the U.S., the delay is just 30 days.
The long delays in the other countries mean that many patients don’t survive to benefit from the effects of the drugs. By contrast, says the study, “American patients who were diagnosed with locally advanced and metastatic NSCLC between 2006-2017 are estimated to have gained 201,700 life years in total due to innovative medicines.”
An analysis by the U.S. Department of Health and Human Services found that only 11 of the 27 advanced medicines available under Medicare Part B in the United States were available in all 16 of the rich countries examined by HHS.
Rather than the U.S. importing European-style price controls, other wealthy countries should relax the tight grip of government, pay market prices, and give their citizens access to the best medicines. A study published last year 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.
We have entered a Golden Age for new medicines. Shouldn’t it benefit us all?
Online newsletter dedicated to helping you understand the costs and benefits that sometimes lie obscured in our complicated health care system