Stump speech fodder.

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Clinton's Plan to Mess Up Prescription Economics

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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Hillary Clinton thinks drug development should be riskier, and less profitable. Also, your health insurance premiums should be higher. And there should be fewer drugs available.

This is not, of course, how the Clinton campaign would put it. The official line is that Americans are just paying too darn much for drugs, and she has a plan to stop that:

  • Regulate direct-to-consumer advertising more heavily, and strip its tax deductibility
  • Require drug companies to spend a certain percentage of revenue on research and development, or face penalty payments and the loss of their R&D tax credit (I am inferring that this is what she is talking about, since the actual language of the proposal is long on paeans to the importance of federal research funding and short on details)
  • Cap out-of-pocket costs for drugs
  • Reduce the exclusivity period for biologic drugs
  • Prohibit companies from making side payments to generic manufacturers to keep generic competition off the market
  • Allow drug reimportation
  • Require that new treatments be proved to be a substantial improvement over existing treatments -- i.e., eliminate the dreaded “me too” drugs
  • Allow Medicare to “negotiate” drug prices

Eliminating the side payments seems eminently sensible. (Yes, yes, you can strip my libertarian card, but market-rigging contracts shouldn’t be enforced.) It also seems reasonable to require some sort of comparative effectiveness research. Other provisions will certainly drive down drug prices, at the risk of also driving down innovation.

Still other provisions, however, are simply bad economics. In what other market do we worry about having a second product available that’s merely just as good as the first? Should we really only have one antidepressant, one statin, one blood pressure medication, and so forth? Might there be variation among patients so that drugs that are statistically about equally effective in large groups are nonetheless individually more or less effective for different people? Might one drug's side effects be better tolerated by some patients than another's? Might having two drugs in the category help keep prices down?

Then there is notion that we should force pharmaceutical companies to spend a set percentage of their revenues on R&D.  This seems to me to be … what’s the word I am looking for? Ah, I’ve got it: “insane.”

For one thing, compared to virtually any other industry, pharmaceutical companies already spend an enormous fraction of their revenues on R&D. Why assume that it ought to be higher? Or even more risibly, exactly the same at every company?

For another, as far as I am able to determine from the campaign’s somewhat sketchy outline, this metric could potentially create an utterly bizarre result: a company that buys a smaller firm, or a drug invented at a smaller firm, and then takes that drug to market, would be forced to charge lower prices than a company that invents and markets its own drugs.

Why is this crazy? Well, consider what the acquiring company might pay for the drug. If you had a valuable drug under patent, what price would be needed to induce you to part with it? That price would probably be pretty close to . . . the profits you’d expect to get if you marketed the drug yourself, less any money you’d have to lay out to get the drug approved and produced, and maybe some discount because you get a guaranteed sum right now, and don’t have to wait, or take the risk that the market won’t be interested in your new drug.

In other words, as a way of funding the invention and production of new drugs, these two things are exactly economically equivalent; it’s irrelevant whether the drug was invented in-house, or acquired from another firm, because from the perspective of the folks investing in the research and development (which is what those profits are supposed to encourage), the expected return is roughly the same either way.

Yet the government would be treating these situations as if they were completely different. Effectively, they’d be penalizing companies for buying drugs invented somewhere else. That’s bad for a number of reasons, starting with the fact that biotech startups often don’t have the necessary capacity to take a drug through trials and production and to market. It would also reduce the value of patents, because a patent sold to another company suddenly loses much of its value. And what normally happens when the government artificially sets the price of something at well below the current level? That’s right, boys and girls: You get less of it.

As Harvard’s Amitabh Chandra told the New York Times, this is “an astonishingly naïve approach,” that wouldn’t necessarily do much to control prescription prices, while potentially encouraging wasteful spending on low-value R&D projects in order to hit an arbitrary federal target. That’s obvious to anyone who knows anything about drug research and/or thinks about it for more than three seconds. But most voters don’t know anything about drug research and won’t think about it for more than three seconds.

The larger question is why Clinton is so focused on pharmaceutical prices. They’re not the bulk of health-care spending. In fact, drugs often help patients avoid a much more expensive alternative. Years of pricey new statins are still cheaper than a coronary bypass.

I think there are a few answers to this. First, the pharmaceutical companies' story is hard to tell. We think they’re selling us pills. But as I once heard it explained, they’re not really selling the pills, because pills are trivially cheap to make. What they’re actually charging for is the little white piece of paper you get with the pill: the one that tells you how much to take, and what the side effects and possible drug interactions are. That’s what cost a billion dollars they’d like to get back. But since most of us don’t even look at the little piece of paper, this is a mite hard to explain to your average voter.

Second, consumers often pay a higher percentage of their drug costs than they do of their other health-care services, and if they’ve got a chronic condition, they pay those costs every month. So they’re more outraged about the bite this takes out of their wallet than doctor’s visits and hospital stays that are more rare and more covered.

And third, there’s a hospital and a doctor’s office in every district. Voters know health-care workers. They like those people. They don’t want their politicians bad-mouthing them. On the other hand, pharmaceutical research is concentrated in a few areas, and most people have never met anyone in the industry. That makes it much easier to think of them as faceless, terrible people who are robbing us.

Economically, large parts of this plan make little sense. Politically, many of these items would be very difficult to pass, not least because the Congressional Budget Office would assess the likely effects and would make it sound much less appealing than it does in a gauzy stump speech. But away from those harsh realities, purely as campaign rhetoric, it probably works very well.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor responsible for this story:
Philip Gray at philipgray@bloomberg.net