When regulating drug companies, note the two kinds: new producers and reproducers

During the presidential election, President Trump drew attention to something he did not like: increases in drug prices. After the election, his comments have become more strident: Drug companies get away with “murder.” Members of Congress are threatening an investigation of the upward movements, and demanding these firms justify their increases. There is much smoke here, but little fire.

 

As will be shown, regulating drug prices is fraught with known hazards sufficient to cause rational policy makers to reconsider their attempts, because while there could be some increase in the supply of old drugs (from the reproducers), the cost is a drastic reduction in the discovery of new drugs (from the new producers), including dramatic miracle findings, which help spell the continuance of our quality of life.

To get a better grip on this confusion, the consumer needs to understand there are basically two varieties of drug manufacturers. In one category are those that are essentially reproducing old, patented drugs. They are not engaged in research, nor are they assuming risks in investment for developing new drugs. Nevertheless they perform an important role in society. But if they are to be regulated, it probably would take some form of a cost-plus system – allowing a mark-up on the drug’s assigned costs, as in the regulation of many utilities.

The most important type of drug production, however, occurs among creative thinkers, innovators and visionaries. They have the incentives and the drive to make the personal sacrifices necessary to bring forth new drugs, the miracle drugs, the breakthrough products and the life-savers.

Some have the insight to convert an old drug into a new one. These are the real bell-ringers of a growth society even though they stand, to some extent, on the shoulders of many basic scientists struggling in university laboratories, often sponsored by the National Institutes of Health. Rather than placing mistaken regulatory obstacles in bell-ringer paths, we should be clearing channels for their trailblazing discoveries and continued growth. Applying cost-plus regulations to these firms would be the death knell of many new drugs. I would ask President Trump to proceed with caution.

How new drugs are developed and financed was the subject of one of my previous columns.

Basically, in one extreme scenario if a firm is to finance the creation, development and marketing of new drugs, cash flow from its current sales of drugs must be adequate to handle the task – bringing new drugs to market. In the other extreme scenario, the financing is external – from sale of debt or stock. To convince stubborn investors tomorrow that the firm can support future debt payments and/or the increase of dividends, financing through debt/stock sales requires adequate earnings today.

Therefore, and this is important, whether the firm chooses to finance growth with cash flow, or sale of debt/stock, it needs adequate earnings today, and this means access to the opportunity to increase current prices.

These two scenarios imply that allowing for freely chosen drug price increases can produce a flow of acutely needed drugs. In other words, making this means available, visionaries are aided in bringing new drugs to society. In sum, new drugs beget new drugs.

Public policy implications of this analysis are enormous. Policy makers should construct regulations so that firms producing new drugs have the option to raise prices. Dynamic, growth firms are to be encouraged not discouraged. Society may continue to provide deserved aid to so that hard-pressed consumers are not denied aid, but do not halt the flow of new drugs to our total citizenry.

Of course, some firms engage in the marketing of each type of product – the new and the old. Trying to apply cost-plus rules here would be a nightmare, involving the allocating, which is always controversial, of drug costs to new and old products. Knowledgeable people advise that it cannot be done rationally. Others agree but make an attempt anyway, praying that no harm is done. Since the consequences of a regulatory error here involve losing the flow of new drugs – our quality of life – this area is laden with serious hazards. Our admonition bears repeating – regulators may rigorously avoid price collusion among producers, but leave prices to the free markets.

As a step in controlling price increases, President Trump suggested introducing competitive bidding for the sale of drugs. For old drugs, this could be helpful but of minor price effect. For new drugs, a large step, however, in providing more competition is to heed the warning: do not to interfere with the incentive-price-increase model. After all, introducing new drugs per se tends to increase competition.

In the cost-plus area, lurking are potentially useful measures for enhancing price competition, but for the sake of improving the nation’s quality of life, policy makers should leave the new-drug growth area undisturbed.

(The writer is a professor emeritus of financial economics at the University of Georgia. He lives in Aiken, S.C.)

 

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