Negotiated drug prices in Medicare: from the right and the left

In the last post I talked generally about government "negotiation" of health care prices. This time, I'd like to look at a specific area in which price controls are being debated: the Medicare drug benefit. The drug benefit results from a 2003 Bush-era law that, among other things, extended Medicare benefits to cover prescription drugs in certain complex ways. Conservatives indicated they would not support the bill if its 10-year cost exceeded $400 billion, so it was announced as a $400B bill, though evidence later emerged that the Bush administration had higher cost estimates in its possession and suppressed them. So the cost estimates for the bill jumped, to over $500B about a month after it passed, and to about $1.2 trillion two years later.

Clearly, a prescription drug benefit is expensive. Not really very surprising.

The bill contains many provisions designed to appease various constituencies, as any large bill sort of has to. One of the provisions is that the government is forbidden from "negotiating" drug prices. Rather, a network of private plans actually provide the benefit, and these plans negotiate prices with the pharma firms.

Now, some find the non-negotiation provision odious. And "some" seem to be mostly on the left.

(Important aside: I really hope, in this blog, to be able to find a middle ground. I don't have a hidden "conservative" or "liberal" agenda. Part of the point of this exercise, in fact, at least for me, is deciding what I really think. In some cases, such as this issue of "negotiation", I may seem to take a right-leaning viewpoint. On others, I imagine I'll seem to lean left. If my views on "negotiation" have led you to either write me off or embrace me, depending on your bent, as somehow conservative, I urge you to instead set those labels aside, and just come along with me as we try to figure this stuff out.)

At this point, rather than offer you my own untutored views, I'm going to cite two position papers on the concrete issue of whether the non-negotiation provision is a good or bad thing. The goal is for you to look these papers over, if you care to, or read my attempts at summary, and see which arguments you think make the most sense.

The first paper is a piece titled "The Human Cost of Federal Price Negotiations: the Medicare prescription drug benefit and pharmaceutical innovation", put out by the Manhattan Institute for Policy Research. The MIPR appears to be your classic neo-con think tank, founded by William Casey who went on to direct the CIA under Reagan, and funded inter alia by Bristol-Meyers and the Scaife family (see articles on Wikipedia and SourceWatch). The second piece is titled "The Savings from an Efficient Medicare Prescription Drug Plan", put out by the Center for Economic and Policy Research, a left-leaning think tank focusing on economics issues (see the Wikipedia and Sourcewatch articles).

One thing you could do, of course, is just go browse the papers yourself and see what you think. But if you're pressed for time, I'll do my best to summarize them.

MIPR paper: this paper makes the claim that if the government uses its power to drive Medicare prescription drug prices down, pharma R&D budgets will suffer, fewer new drugs will be introduced, and people will live less long as a result. The paper argues that price controls will save $21B annually, but that the lost life-years have a value of $500B annually. The paper goes on to predict that government price controls on prescription drugs would lead to a reduction of pharma R&D expenditures of between $300 and $600 billion between 2005 and 2025. The paper also argues that, by analogy with the Veterans Administration, which imposes significant price controls in the form of steep mandatory discounts, a price-controlled Medicare drug program would have an incentive to reduce the formulary, i.e. the number of drugs available in the program, leading to a narrow range of drug choices for Medicare beneficiaries.

CEPR paper: this paper takes the position that the lower prices paid in other countries for drugs that cost substantially more in the US is proof that those lower prices are economically sustainable for the drug firms, and would remain so even if extended to the US. "The pharmaceutical industry must at least cover its production costs and make a normal profit on even the lowest price drug sales to other
countries or agencies, otherwise it would not make them," the paper states. The paper goes further than this, in fact, as it goes on to use the market price of generic drugs as a floor to which Medicare drug costs could be driven, since, again, generic drug manufacturers sell at these prices and still somehow prosper.

By all means read these papers yourself, compare, decide what you think make sense. I was surprised to find, by the way, that I turned up many more position papers on this topic from the right than from the left. The left-leaning paper I found, I have to say, does not impress me. I wish I'd found a better one.

If you read my last post on "negotiation," you can probably guess which of these papers I think makes more sense. I don't set much store by the $500B MIPR estimate of the value of "lost life-years." There are far too many assumptions in the chain there. Likewise, R&D reductions projected out 20 years don't impress me too much. But the notion that Medicare price controls will drive down pharma R&D to some extent, all other things being equal (and that's a big if, to which I'll return), seems obvious. One other, I think potentially quite potent point, is the claim that price controls would lead to narrower formularies, as it's alleged they have in the case of the Veterans Administration. The VA's national formulary, for example, does not include Lipitor, though it includes a number of other drugs in that class. But this is a complex issue that apparently even senior program administrators for the VA and Medicare can't quite agree on.

The CEPR paper, on the other hand, is downright puzzling in its naiveté about market pricing. Its author, Dean Baker, is said to be an economist, has written numerous books, and apparently correctly called the housing bubble and its aftereffects. How is it possible that he doesn't seem to understand differential pricing, or grasp the argument I advanced in my last post, that sufficiently low pricing in some market sectors guarantees that price in others will rise (all else again being equal)? If you assume that a company can successfully offer, across its entire market, the lowest price it offers to any segment, you are assuming that it has a great deal of unnecessary or unfair profit built into its overall pricing scheme. The CEPR paper takes this view almost explicitly. The paper does acknowledge, in a footnote, that "There is an important issue about whether the industry  would still have enough money to finance research into the development of new drugs if its profit margins were substantially reduced in the United States." But the note goes on to conclude that the question is not germane to the paper, which is simply try to calculate how far costs could be reduced. Can pharma companies still prosper under such circumstances? Not my problem!

So I'm afraid I find the CEPR paper, in favor of Medicare price controls, very weak due to the author's apparent ignorance of or disregard for the true nature of differential pricing. But in the end I think both papers fail. In their focus on negotiating price (which is after all their topic), the papers take differing but equally shallow views of cost, specifically, how much pharma companies are paying to develop new drugs. The MIPR paper effectively takes the view that the pharma cost structure is essentially sane, reasonable and efficient. It takes the view that there's not a ton of "fat" in the pharma cost structure, so that lowered prices must inevitably hit R&D to some degree. The MIPR paper takes a dramatically different view, namely that even the lowest drug prices in the market contain provision for a "normal" profit, so that US prices could come down 30%-50% without any adverse effects.

As we can see, the difference between these two papers comes down to the difference in unexamined assumptions about the cost and profit structure of the pharmaceuticals industry. The interesting question is in fact a root cause question: is research into new drugs structured in a sane and efficient way? That's why I think this focus on price control is so misguided. We need cost control, not price control, and in that sense, both of these papers, though I find their merits somewhat unequal, ultimately miss the point.