I was glad to see Paul’s short post explaining some of the economics of the US government negotiating drug prices with the drug companies: the route Donald Trump rejected. I thought I would add a few more points.

First, the monopoly profits earned by the drug companies provide a powerful incentive for rent-seeking. This is the standard story that economists always complain about with trade protection, except instead of talking about a tariff that raises the price of the protected item by 10 or 25 percent above the free market price, we’re talking about a government-granted monopoly that typically raises the price of a factor of ten or even a hundred compared with the free market price. These markups are equivalent to tariffs of 1000 percent or 10,000 percent.

This not only encourages behavior like the payoff from Novartis to Trump lawyer Michael Cohen, it also gives drug companies an enormous incentive to misrepresent the safety and effectiveness of their drugs. We frequently hear stories of drug companies withholding evidence that their drugs are less effective than claimed or even harmful for some patients. Perhaps the most famous was the case where Merck allegedly withheld evidence that its arthritis drug, Vioxx, increases the risk of heart attack and strokes for people with heart disease. Needless to say, the costs from this sort behavior are enormous.  

A second point is that we are not talking about a typical consumer buying decision, like buying a car or a cell phone. People buy drugs because they are in bad health and possibly facing death. As Krugman notes, there is typically a third-party payer, either an insurer or the government. Apart from the possibility that this can lead to excessive payments that Krugman discusses, there is also the perverse dynamics this creates.

The price that companies end up getting for their drugs, and if they get it all, depends on the ability of patients to lobby their insurer or the government. Naturally, the drug companies are happy to help in this effort. There is a whole set of industry-funded disease groups that are largely aimed at forcing insurers and the government to buy expensive drugs, often of questionable value, from the drug companies.

This also raises the point that it is pretty crazy that we expect people when they are sick or dying to pay for research that has already been done. In almost all cases, the cost of manufacturing and delivering drugs is cheap, we make it expensive with government-granted patent monopolies. If we asked questions about paying for possibly life-saving drugs at their actual production costs, it would almost always be a no-brainer. But when we have a cancer drug, which may not even work, that a drug company sells for several hundred thousand dollars, it becomes a tough question as to whether the government should pick up the tab or force insurers to do so.

Finally, there is an absurd view in this debate that somehow patent monopolies are the only way to finance innovation. There is no argument that we have to pay for research; no one expects highly skilled researchers to work for free. But we can and do have other mechanisms for paying for this work.

The government already spends more than $30 billion a year on biomedical research, primarily through the National Institutes of Health. This research is incredibly productive by all accounts. There is no reason, in principle, that we can’t double or triple the amount we spend on directly supported research. This would allow all new drugs to be sold at generic prices, without patent monopolies or related protections. By my calculations, this would save close to $380 billion a year (around 2.0 percent of GDP or more than five times the annual budget for the food stamp program). We would also benefit from having all the research findings in the public domain so that doctors and other researchers would have access to it when making decisions for their patients or planning future research.

If this funding route sounds bizarre, think of the military. While there is plenty of waste in the military, we actually do develop very effective weapons systems through direct government funding. (This is not an endorsement of their use.) Furthermore, drug development has a big advantage over the military in that it would all be fully public as a requirement for funding. There is a real rationale for secrecy with military research, even if it is often over-played. There is no excuse for secrecy in publicly funded drug research.

It would be great if Trump’s servile response to the industry on negotiations led to pressure not only for lower prices but modernizing the way in which we finance drug development. Patent monopolies might have been great for the feudal guild system, they are not a good way to finance biomedical research in the twenty-first century.