A half-hearted defence of the pharmaceutical industry

Depending on who you talk to, “Big Pharma” is responsible for withholding the cure to cancer, causing autism through vaccines, charging irresponsible amounts of money for drugs and, in general, being a sinister industry that only seeks to advance its own interests.

Let this be clear – the pharmaceutical industry has many, many issues and there are many valid areas of complaint. With a booming population and further access to health resources, the pharmaceutical industry has become increasingly essential to public health. It would then be fitting that their influence and power have increased accordingly, to the point where they have amassed monopolistic power, and have appeared to have begun to use it in nefarious ways.

Because the pharmaceutical industry is so large, this half-hearted defence will only address one facet – the cost of drugs paid by consumers. Fortunately, the issue is not as pronounced in Australia – the federal government subsidises the cost of most drugs to relatively affordable levels for most consumers, irrespective of the price charged by pharmaceutical firms. That said, the full cost of the drug is still picked up by the taxpayer.

As an example, a fluticasone and salmeterol inhaler is a treatment commonly used for asthma suffers. No matter how much the drug actually costs, the average person will pay a maximum of $38.80.[1] The inhaler actually costs around $62, so the government contributes around $23 towards the drug. Another drug called Adalimumab treats autoimmune diseases. However, this drug costs $3989,[2] with consumers only required to pay $38.80 of that amount.

While this works well for Australians, in other parts of the world such as the United States, where the government does not contribute to the cost of healthcare, or in areas where the average person cannot afford these drugs regardless, a serious ethical issue arises. It doesn’t seem morally acceptable that a person could die simply because they cannot afford expensive life-saving drugs. It’s then fairly easy to turn around and point the finger at pharmaceutical companies.

For most drugs, the company that develops them usually has a patent for around 20 years from their introduction.[3] During this period, the pharmaceutical companies have a monopoly on drug production and act as price setters, charging whatever they’d like. Only after the patent expires are other companies allowed to produce the drug as well, creating generics. Perhaps one of the most important considerations in this is that there are often no substitutes for drugs. A monopolist who raises the price of a non-essential good such as juice may find customers who are unable to afford juice purchasing soft drink instead. However, someone who is unable to afford the price of drugs and has no other safety net doesn’t have a substitute they can turn to. Knowing this, pharmaceutical companies tend to price new drugs fairly high, and experience little loss of demand from consumers.

A conclusion drawn here is that by making drugs unaffordable, pharmaceutical companies are behaving unethically. Here’s where the half-hearted defence comes in. The development of a new, effective drug can be an expensive, lengthy and arduous process. For example, AstraZeneca reported that on average, a drug costs around $11 billion to bring to market.[4] Considering all of the stages involved in bringing a drug to market, from discovering the drug, conducting clinical trials and starting all over again if the drug fails, it is (to some extent) understandable that pharmaceutical companies choose to charge high prices in order to recoup their R&D expenditure.

There are two options that governments may be able to implement if drug prices are unaffordable to consumers. They can choose to subsidise the drug, so that the pharmaceutical company still receives the full price they choose to charge, which is the approach taken by the vast majority of governments. Alternatively, a government could choose to implement a price cap on the cost of goods sold, which is never used, and for good reason.

When a price cap is imposed on any market, it creates large numbers of inefficiencies in the market. In the case of drugs, it would most likely lead to shortages. If a pharmaceutical company sold the previously mentioned autoimmune treatment for around $4,000, but the government were to force the company to bring it down to a ‘relatively’ affordable price, such as $40, there would be two unintended consequences.

It is likely to create shortages of the drug. In a market without subsidies, this means that suddenly much more people have access, and hence demand for the drug increases exponentially. Additionally, as the drug is now much less profitable, there is less incentive for the pharmaceutical company to increase production to match demand.

Price cap regulation also creates a ‘chilling effect’ on pharmaceutical companies, whereby they are no longer incentivised to create new drugs. After all, if a company sinks $11 billion into R&D costs, but for example, can only recoup $1 billion in costs, the obvious economic choice is to not enter the market for this drug, and not create it at all. This effect becomes even more pronounced for rarer diseases. A smaller addressable market base for rarer diseases means that while the costs of R&D remain fairly constant, the only way to bring the drug to market is to charge a high price for the drugs created. These are classified as “orphan drugs”, and for most countries, are often promoted by many government regulators by introducing incentives such as tax incentives, or relaxing regulations surrounding drug development.

In these circumstances, despite the good intentions of those supportive of a price cap, there would be a marked drop in welfare for all involved. There’s a really difficult balance to strike here in ensuring that life-saving drugs are accessible for those who need them, but also ensuring that pharmaceutical companies still have incentives to continue researching and developing drugs into the future.

[1] Department of Health. (2017, July 1). The Pharmaceutical Benefits Scheme: Fees, Patient Contributions and Safety Net Thresholds. Retrieved from http://www.pbs.gov.au/info/healthpro/explanatory-notes/front/fee

[2] Department of Health. (2017, July 1). The Pharmaceutical Benefits Scheme: Adalimumab. Retrieved from http://www.pbs.gov.au/medicine/item/10397F-10945C-11132X-8962Q-9187M

[3] US Food and Drug Administration. (2016, December 05). Frequently Asked Questions on Patents and Exclusivity. Retrieved from https://www.fda.gov/drugs/developmentapprovalprocess/ucm079031.htm

[4] Herper, M. (2012, February 10). The Truly Staggering Cost of Inventing New Drugs. Forbes. Retrieved from https://www.forbes.com/sites/matthewherper/2012/02/10/the-truly-staggering-cost-of-inventing-new-drugs/