Making a Lot of Profit with a Drug ≠ Making a Lot of Health with a Drug

The New York Times has a healthcare blog called The Upshot, and Austin Frakt of The Incidental Economist is a regular contributor. He recently wrote an article about drug prices, which is what got me thinking a little more about drug prices and prompted my post last week.

Sidenote: He has not been blogging very regularly anymore on The Incidental Economist, and it feels like a great hole has opened up in the health policy blogosphere. He has a great way of getting interested in a topic and finding all the useful evidence on the subject and then synthesizing it all, and through that process thousands of followers get carried along that journey of learning about an important health policy topic.

I think the topics Dr. Frakt covers in his most recent Upshot article are important, so I want to highlight some of them.

First, there is a link between higher prices and more innovation. Drug company executives aren’t dumb–if there’s a lot of money to be had in a certain drug market, they will put their R&D investments into those areas.

But the potential to make a lot of money with a drug doesn’t always line up with the potential to make a lot of health with a drug. We try to help those two things line up by manually setting patent lengths longer for drugs that will have a greater impact on health, but American politics is messy, so it doesn’t always work out that way. Another way to try to help those two things line up is by using administrative pricing. For example, New York Medicaid, similar to many countries, establishes prices based on a drug’s “therapeutic value.” If there is a high therapeutic value, the drug will be priced higher, and therefore the drug company will make more money if they focus their R&D on areas that are the most likely to increase health.

There is a whole independent nonprofit group dedicated to helping figure out the therapeutic value of drugs, and it’s called the Institute for Clinical and Economic Review (ICER). Some have proposed Medicare use the recommendations from ICER, but these days the trending proposal (which essentially accomplishes the same thing but is more politically palatable) is to instead look at the prices other countries set for drugs (presumably based on therapeutic value assessments) and then set our prices similarly. This is referred to as international reference pricing.

And while I think these proposals make a lot of sense because I, too, want more medications available to help my patients better, from a market perspective, I still have huge reservations to these sorts of administrative pricing proposals. It’s the same argument I end up at every time an administrative pricing proposal comes up: Taking the pricing power away from the collective knowledge of the market and putting it in the hands of a group of experts will never be accurate enough to allow the most efficient use of resources. And, in impossible-to-predict ways, it may create barriers to innovation.

I will talk more about the specific downsides of administrative pricing next week. And, by the way, my purpose here is not to say that administrative pricing is always wrong; rather, my purpose is to say that there are significant unpredictable costs associated with such a policy, and those short- and long-term costs need to be taken into account when deciding which policy would be best.

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