Posted by on September 23, 2015

I was recently watching something on television about an “morally bankrupt sociopath” making large sums of money selling drugs to price-insensitive consumers after having eliminated much of his competition.  No, I am not referring to the Netflix series Narcos, which depicts the life of cocaine kingpin Pablo Escobar.  I am referring to a brief segment on CNN about the actions of Turing Pharmaceuticals in raising the price of the drug Daraprim from $13.50 to $750 per pill, having recently acquired the rights to the 62-year old drug for $55 million.  Daraprim is used to treat various infectious diseases, including malaria and HIV.  The news made the CEO of Turing, the former hedge-fund manager Martin Shkreli, “the most hated man in America.” The latest news is that the company has rescinded the price increase after the firestorm it unleased.

When asked by CNN to justify the price increase, Shkreli basically said (and here I paraphrase since I can’t find the original segment on the web) “We found a company that was selling a Ferrari for the price of a used Chevy, and we basically raised it to the price of a Toyota.”  He then went on to babble something about the profits being reinvested into new products and improvements in Daraprim, which elicited a “yeah, sure” look from the interviewer (and from me, across the television screen).  The basic translation of his statements is the punch-line from the old joke about why a male dog pays such scrupulous lingual attention to the hygiene of his private parts: Because he can.

But, as usual, the mainstream press got it all wrong.  The real question isn’t “why” Turing raised the price of Daraprim.  The real question is “how” it was able to get away with it.  But I will come back to this later.

This story follows on from several related ones that have emerged recently.  One appeared in the Financial Times and was entitled “Pricing of life-saving drugs is put under the microscope.”  The article focussed on the pricing of Solvadi, a new and apparently very effective treatment for Hepatitis C.  The only snag is that Gilead, the producer of Solvadi, has priced the required 12-week course of the drug at $84,000, which the company claims is very good value compared to the alternative of a liver transplant.  This “value-based” pricing has drawn outrage, including from Medicaid’s boss, Jeff Myers, who commented that “if Jonas Salk had priced the polio vaccine like Gilead, we’d still have polio.”  According to the article, Medicaid and Medicare dished out $6 billion for Solvadi treatments in 2014.  It also estimated that, if all Hep C sufferers in America were treated, the total bill would be almost $300 billion.  Similar comments, this time in reference to new drugs for reducing cholesterol, can be found in an op-ed piece from the New York Times entitled “The Price for Lowering Cholesterol.”

Now let’s turn to the interesting question of “how.”  Journalists love to comment about excessive profit margins and price gouging, but they are probably unaware of how pointless and atavistic this is.   In the Middle Ages, when they weren’t discussing how many angels could dance on the head of a pin, priests used to debate the “just price” of commodities such as bread.  The economic’s profession gave up on this line of reasoning a long time ago.  Economists know that the only things that determine prices are supply and demand, so when we see these type of anomalies, this is where we should look.  And we should always keep an eye out for the heavy hand of government, particularly in the field of health care.

Three factors make this pricing possible, all three of which can be traced to the government.  The first is that all of these medicines enjoy patent or other protections[1] which make it impossible for competitors to provide the drugs at lower prices.  The second is that demand is driven by the currency known as “OPM” – “other peoples’ money,” which means that the ultimate consumer doesn’t pay the bill, which is borne by a private or public insurance fund.  (Turing implicitly recognized this by promising to provide low-cost pricing for the uninsured; chivalrously, the company only wanted to gouge the insurers.)  The third is that government policy in Medicare and Medicaid, which has been largely aped in the private sector, is that there should be no “rationing” and that everyone is entitled to the best medical care possible.  There can be no “death panels.”

Put these things together and we get Martin Shkreli.  But it is very important to realize that this has nothing to do with free market capitalism, although it will certainly take the blame yet again.  As is so often the case, this type of deplorable behaviour exists only due to a big dose of help from the government.  And the solutions that will be proposed, including a promised one from Hillary Clinton, will doubtlessly be more of the same, probably involving some type of price controls.  But Megan McArdle over at BloombergView has already warned about the impact that this might have on the flow of new drugs.  And history is not kind to solutions based on further regulation.

This is a difficult issue, but my instinct is that much of the solution lies in enhancing market forces and not further regulation.  On the demand side, there certainly has to be a greater effort to control the “moral hazard” embedded in our insurance system.  For example, the new cholesterol drugs will very often be used to treat a problem that largely arises from a poor diet and a sedentary lifestyle.  The overwhelming cause of Hepatitis C, meanwhile, is intravenous drug use.  Should these high-risk behaviours really be underwritten by the rest of us?  Likewise, shouldn’t insurance companies, both public and private, be allowed to experiment with the scope of their coverage?  Should the insured who expect to benefit from the latest and greatest medications, irrespective of price, be required to pay premiums that reflect this policy?  If they were forced, a priori, to pay this cost, would they be willing to accept a degree of rationing instead?  What about a rationing that denies treatments to people who are responsible for their ailments, so that at least the disincentive to engage in high-risk behaviours is increased?  Finally, what about the notoriously difficult and expensive FDA process for approving drugs?  Streamlining this would go a long way towards increasing competition, including from smaller and foreign manufacturers who cannot afford to run the current hurdles.

Reform of the patent system may also be a very fruitful way to give greater scope to market forces.  The Economist has recently run a lengthy piece entitled “A question of utility – Patents are protected by governments because they are held to promote innovation. But there is plenty of evidence that they do not.”  The article lays out a strong case for reform of our entire intellectual property system, including patent protection for medicines.  At a minimum, there certainly is a case for eliminating the type of abuses described in this article and used to eliminate competition in the manufacture of otherwise “generic” drugs.  Reforms could take care of these abuses, along with others such as the “patent trolls” and “submarine patents” that stifle innovation in technology fields.

But there may be a case for a more root and branch reform of the patent system.  One striking observation from the Economist article:  In 2005, an economist at the Center for Economic and Policy Research in Washington, D.C., estimated that the consumers in the US paid $160 billion more for prescription drugs that year than would have been paid if all drugs were “generics.”  In return, the pharmaceutical industry spent $25 billion on R&D.  If the ultimate motivation for patents is to promote R&D and innovation, this certainly suggests that they may be a bad deal.  Perhaps we should experiment with alternative forms of rewarding innovation, such as prizes.   After all, the $135 billion difference between these two figures – which is probably even bigger now since the cost of prescription drugs has almost doubled since 2005 – gives plenty of room for experimentation.

One thing is for sure.  So long as we continue to combine protection from competition with price-insensitive demand, this problem isn’t going away.  Something has to give or we will have more cases of Daraprim.  And this can’t be good for anyone’s health.

Roger Barris, Weybridge

[1] Daraprim is out of patent protection but there are tricks of the trade that can be used by to extend or renew the period of government protection, such as re-formulations or the other tricks described here.

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