Drug price controls...coming to the Bay State?


Markets span the gamut from monopoly (one supplier, many buyers), to competitive markets (many buyers and sellers), to monopsony (one buyer, many suppliers). Competitive markets are the most efficient: price signals in competitive markets promote competition and innovation, and provide products at a variety of prices and levels of quality to consumers.

Some markets may naturally tend to monopsony (the Pentagon for national defense) or monopoly (typically markets with very high capital costs and barriers to entry, like electric utilities).

But monopoly and monopsony are considered sub-optimal outcomes. Monopolists have the power to depress competition and charge higher prices than there would be in a competitive market. Monopsonists, on the other hand, have the power to depress prices sub-optimal levels. Both have a tendency to underprovide resources, leaving unmet demand - the "deadweight loss" of consumer and producer surplus from goods that aren't produced or consumed.

What relevance does this have for health care? Lots, actually. The increasing socialization of health care costs through government programs (Medicare, Medicaid, Obamacare) give government monopsony power, allowing it to depress prices.

From the government's perspective, this is a good thing since scarce tax dollars can be used to buy large quantities of health care at below market prices. From a political perspective, it's also easier to ask for concessions from (for instance) drugmakers than to increase patient copays, reduce coverage, or ask voters to pay more in taxes.

But monopsony power is a double edged sword. If you drive prices too low, you sharply reduce incentives to invest in R&D. You get cheaper drugs today, at the price of many fewer new (and better) medicines tomorrow. Grandpa gets cheaper drugs today, but his grandchildren get fewer new medicines, and more old ones.

European nations have used their monopsony power to control drug pricing through a variety of mechanisms (from outright price controls to reference pricing), but at the cost of driving drug R&D out of Europe and (generally) delaying European patients access to new drugs.

The U.S. hasn't used this approach - yet - but one state, Massachusetts, is at least seriously considering it. Under Section 273 of new health care legislation signed into law this week, the Bay State created a pharmaceutical cost containment commission "to study methods to reduce the cost of prescription drugs for both public and private payers." In particular,

The commission shall examine and report on the following: (i) the ability of the commonwealth to enter into bulk purchasing agreements, including agreements that would require the secretary of elder affairs, the executive director of the group insurance commission, the director of the state office of pharmacy services, the commissioners of the departments of public health, mental health and mental retardation, and any other state agencies involved in the purchase or distribution of prescription pharmaceuticals, to renegotiate current contracts; (ii) aggregate purchasing methodologies designed to lower prescription pharmaceutical costs for state and non-state providers; (iii) the ability of the commonwealth to operate as a single payer prescription pharmaceutical provider; and (iv) the feasibility of creating a program to provide all citizens access to prescription pharmaceuticals at prices negotiated by the commonwealth.

Why stop here? If it's such a good idea for the government to buy drugs in bulk, why not buy MRIs, ultrasounds, hospital beds, and bedpans?

For that matter, why bother shopping at Wal-Mart when the state can use it's purchasing power to buy your food, your clothing, and your housing at ultra-cheap prices?

The reason that we don't let the government buy these things (except for the very poor) is that it produces an economic disaster. Price controls destroy incentives to bring new products to market. The irony is that we keep trying to figure out new ways to make price controls work.

There's a much, much better way to lower costs while also improving quality.

For instance, the MA bill puts a lot of emphasis on building Accountable Care Organizations to coordinate care pay based on capitated payment rates. Whether or not ACOs are a silver bullet for fixing health care, ACOs or other health systems (and insurers) are still much better situated to negotiate with drug companies on the best bundle of old and new medicines needed to optimize health outcomes.

A central purchasing agent (in this case, the state) can't possibly account for all of the myriad ways that drugs fit into the totality of the health care system. Indeed, some ACOs/health systems might opt to increase their overall pharmaceutical spending or spending on select new drugs because it offsets other health care costs - like expensive doctors and hospital beds.

Ideally, consumers would pick from competitive bundles of care with their own cash (or vouchers, for low-income Americans). This would give providers even more powerful incentives to create innovative bundles of health care products and services.

Medicare Part D operates like this: allowing seniors to pick from a wide range of competing private insurance options at a range of prices. Plans that manage to offer the most effective drug formularies at the most attractive prices gain market share. And competition also produces robust negotiations between drug companies and insurers, helping to keep prices low for consumers. To date, Medicare Part D has come in over 40% below initial cost estimates, thanks to robust competition between insurers and drug companies.

One of the bright spots in the Massachusetts legislation appears to be an effort to collect better data on health care prices and outcomes - and this information could empower consumers to seek out the best, and most efficient providers.

We need more competition and consumer choice in health care, not less, and certainly not a single payer (for drugs or anything else). We'll have to wait and see what the Bay State commission recommends, but we'll go out on a limb right now and venture that it'll be a bad idea.

Here's hoping we're wrong.

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