Contents I. Introduction II. Recent Developments in the Pharmaceutical Industry A. Demand-Side Developments: Generic Competition and Pharmacy Benefit Managers B. Supply-Side Developments: Increasing Costs and Biologic Drugs C. Changes in the Pharmaceutical Industry's Organizational Structure III. Price Controls in the Pharmaceutical Industry A. Existing Price Controls 1. Medicaid 2. 340B Program 3. Departments of Defense and Veterans Affairs Drug Programs 4. Medicare Part D 5. State Price-Control Initiatives B. Likely Consequences of Further Price Controls IV. Facilitating Competition in Pharmaceuticals A. Reduce Generic Approval Backlog at the FDA B. Expedite Biosimilars Approval C. Prohibit Anticompetitive Practices V. Conclusion I. Introduction
After years of modest growth, drug spending has increased dramatically. Spending in 2014 grew by over thirteen percent, the largest annual increase since 2001. (1) On average, the prices of traditional brand drugs grew by five to seven percent, (2) but prices on several high-profile drugs have increased by as much as 3000 percent. (3) Even some generic medications--the traditionally cheaper alternative to brand drugs--have experienced significant price increases. (4) This surge in drug spending has been driven by the increasing popularity of expensive specialty drugs such as biologics, higher prices on brand drugs, and fewer patent expirations that open the door for cheaper generics. (5)
In response to the sharp increase in spending and skyrocketing prices, consumers, insurance plans, medical groups, and politicians are looking for explanations and demanding change. (6) Reforms to curb further increases have engendered rare cross-party alliances in Congress and even rarer agreement among presidential candidates. (7) Proposed reforms include allowing more government intervention in the Medicare Part D drug program, (8) imposing direct price controls on drugs for lower-income Medicare patients, (9) capping consumers' out-of-pocket costs for drugs, (10) promoting generic competition, (11) and enhancing sanctions for anticompetitive practices. (12)
In this article, I explain why reforms promoting competition will produce better results and fewer negative consequences than reforms imposing new price controls. Price controls are government-mandated limits on prices or government-required discounts on prices. Basic economic principles, past experience, and empirical data indicate that new price controls will likely increase drug prices for some consumers, slow pharmaceutical innovation, curtail generic competition, and reduce patient access to certain medications. In contrast, reforms aimed at promoting competition or prohibiting anticompetitive practices will expand product offerings, lower drug prices for more patients, and incentivize innovation.
The article proceeds as follows: in Section II, I outline several demand-side and supply-side developments that have significantly impacted the pharmaceutical industry in recent decades. The nature of competition between brand drug companies and generic companies has changed dramatically as generics have increased their market share from nineteen percent to over eighty-eight percent of drugs sold in the United States. Brand companies now realize few sales after their patents expire and generics enter the market. At the same time that brand companies have lost market share and profits to generics, they have also seen increased power from pharmaceutical buyers--namely drug plans and pharmacy-benefit managers ("PBMs"). PBMs and drug plans now largely determine what consumers pay for drugs, what pharmacies they use, and what drugs they take, which has diminished drug companies' influence over prices.
Drug companies have also experienced significant increases in both the costs of drug development leading to approval by the Food and Drug Administration ("FDA") and the risks of product failures. The costs to bring a drug to market have increased from less than $200 million to over two billion dollars, (13) and only one in ten drugs that begin clinical trials is eventually approved by the FDA. (14) As the development costs for traditional drugs have increased, drug manufacturers have shifted much of their research and development efforts toward biologic products. (15) Although these complex drugs did not enter the market until the 1980s, they now comprise over a quarter of all drug spending in the United States. (16) Unfortunately, because of their high costs of development and production and lack of competitors to control prices, biologic drugs are prohibitively expensive for many consumers. (17)
In Section III, I describe existing government programs that impose price controls in the pharmaceutical industry and explain the likely consequences of further controls. As of 2005, over twenty percent of drugs sold in the U.S. were sold under government programs that mandate price controls, such as Medicaid, the 340B Program, the Department of Defense and Veterans Affairs programs, and spending in the coverage gap of Medicare Part D. (18) Some programs even require drugs to be sold for a penny. (19) Further price controls will create incentives for manufacturers to charge higher prices to non-covered patients to offset the discounted prices. If manufacturers are not able to offset discounts by increasing prices for non-covered consumers, all consumers may ultimately suffer. Empirical data suggest that price controls contribute to drug shortages, slow innovation, and curtail generic competition. (20) Ultimately, price controls meant to lower drug spending for some consumers could end up harming all consumers.
Rather than restraining prices through price controls, the government should promote competition to reduce drug prices. In Section IV, I discuss the many actions the government could take to increase competition in the pharmaceutical industry. Reducing the generic-approval backlog at the FDA will increase generic competition for drugs, expediting affordable biosimilar alternatives to biologics will lower prices for many specialty medications, and targeting anticompetitive behavior will promote competition throughout the industry. By increasing competition, these actions will expand product offerings to consumers, lower prices as suppliers compete to attain or protect valuable market share from rivals, and foster innovation as drug companies strive to create new products to stay ahead of competitors.
The recent surge in drug spending must be addressed to ensure that patients can continue to afford life-saving and life-enhancing medications. However, imposing new price controls on pharmaceuticals will produce negative consequences--less innovation, drug shortages, fewer product choices, and higher prices for some consumers--that could harm consumers rather than helping them. In contrast, promoting competition will lower pharmaceutical prices and drug spending without these deleterious effects.
Recent Developments in the Pharmaceutical Industry
The pharmaceutical industry has steadily expanded over the last several decades. Global revenue for the industry was approximately one trillion dollars in 2015, compared to approximately $340 billion in 1989. (21) The United States alone spent over $400 billion on pharmaceuticals in 2015. (22)
During this period of expansion, the pharmaceutical industry has undergone significant changes that have altered the nature of competition in the industry, shifted the relative bargaining power of drug sellers and drug buyers, and increased the costs of developing and selling drugs. In this section, I outline several demand-side and supply-side developments that have significantly impacted the pharmaceutical industry in recent decades.
Demand-Side Developments: Generic Competition and Pharmacy Benefit Managers
The nature of competition in the pharmaceutical industry has changed dramatically over the past several decades as brand companies have lost significant market share to generics. The generic industry exploded after the Hatch-Waxman Act in 1984 created an abbreviated regulatory process that encouraged companies to produce and market cheaper, generic drugs. (23) First, to spur the introduction of low-cost generics, Hatch-Waxman created the Abbreviated New Drug Application ("ANDA") process that allows a generic that demonstrates bioequivalence to rely on previously submitted brand-name safety and efficacy data. (24) This greatly truncated process enables generic manufacturers to quickly enter the market after the brand drug's patent expires. Moreover, Hatch-Waxman actively incentivizes generic companies to challenge brand patents' validity by creating a pathway for such challenges and by offering a lucrative incentive to the first generic manufacturer that files an ANDA claiming that the brand patent is either invalid or will not be infringed by the new generic. If the generic company wins or settles the patent litigation, it receives a 180-day exclusivity period during which the FDA will not approve any other generic versions of the drug, a period in which the first generic can earn substantial profits by shadow pricing the innovator's price. (25)
Generics have been further aided by drug substitution laws in every state that allow, or even require, pharmacists to automatically substitute a generic equivalent drug when a patient presents a prescription for a brand drug. (26) These regulatory changes have allowed generics to capture significant market share from brand companies. (27) As shown in Figure 1, whereas generics comprised only nineteen percent of all drugs dispensed prior to 1984, they now represent over eighty-eight percent of prescriptions filled.
The increased competition from generics puts downward pressure on prices, generating significant cost savings for consumers. After the patent expiry of a brand drug, generics enter the market at a significantly lower price. Data show...