Managerial Application 164

Global Price Controls for Pharmaceutical Drugs

In the United States, Medicare, Medicaid, and state-run health-care cost reimbursement plans funnel federal and state dollars to help share the burden of exploding healthcare costs. What is not generally understood is that such programs in the United States and abroad can contribute to higher health-care prices.

Consider the market for pharmaceuticals. If the market for prescription drugs was a typical free market, demand would be limited by the extent to which consumers are willing to pay for innovative therapies. However, if each dollar of consumer demand is matched by federal or state funds, the demand for prescription drugs skyrockets. Suppose a given prescription costs $15, but that 80 percent of this cost is borne by the government. Most consumers focus on the $3 cost that they must pay, rather than the overall cost of $15. As government health-care benefits rise, it is the matching share paid by consumers that constrains industry demand. Rather than cut the cost to consumers of high-priced drugs, government matching schemes allow drug companies and other health-care providers to raise prices. In the United States, the eruption in prescription drug prices and other healthcare costs coincides with the growth of government-sponsored cost-sharing plans. It is perhaps ironic that government-sponsored plans designed to help consumers with sky-high drug prices actually contribute to higher drug prices.

Now, global governments are getting tight-fisted. In the United States, cost containment measures are sure to pinch profit margins for prescription drugs. European governments go one step further and demand stiff discounts from drug prices prevalent in the United States. For example, French price controls set prices at only 42 percent of the U.S. average for prescription drugs. In Japan, allowed prices are based upon a weighted average of prices in other markets. Clearly, global governments are using their buying power to reduce the industry's pricing flexibility. Stay tuned. It looks like price controls might give the industry a headache.

See: Stephen Pollard, "Big Pharmaceuticals Take the Gloves Off," The Wall Street Journal Online, December 17, 2001 (http://online.wsj.com).

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