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Commentary

What's Good for Pharma is Good for America
Richard A. Epstein, The Boston Globe, 12-3-06

Epstein, a law professor at the University of Chicago and author of the new book Overdose: How Excessive Government Regulations Stifles Pharmaceutical Innovation, discusses the effect that drug price controls would have on the pharmaceutical industry in the U.S.

Perhaps the biggest threat on the horizon for the drug industry is mounting pressure to submit to price controls. One possibility is that the government will set uniform prices for all drugs. Another is that it would require a company to sell to all customers at the lowest price charged to any customer within the past year. But no matter how such controls are calculated, they could devastate the business. What's more, they're just not necessary.

Traditionally, patent holders could decide how much to charge for their wares. Public protection against excessive profits for drug companies came from three sources. First, the patent period is limited to 20 years, with about half that time used to shepherd a new drug through the FDA approval process. Once the patent expires, the entry of low–cost generics sharply reduces the cost of proven drugs. Second, the rapid pace of invention means that consumers frequently can choose between two or more patented drugs in the same class (Lipitor, Crestor, and Zocor, for example, are three statins used to lower cholesterol), effectively blunting the monopoly power of all patent holders. Third, antitrust laws make it illegal for any makers of the same or similar drugs to conspire to raise prices or reduce output.

Within these constraints, of course, the research pharmaceutical firms still must recover their huge front–end costs, which can run over $1 billion for a new drug, over an ever shorter useful patent life. In addition, their successful drugs must generate additional revenues to cover the predictable flops. Yet companies need to charge someone for the initial costs of production, not just for the small cost of producing additional pills.

One common argument for price controls is that drug companies should only spend money for research but not for lavish marketing. Yet that short–sighted argument assumes that pharmaceutical companies could sell the same quantities of drugs without advertising them. Of course, the cost of marketing raises the total cost of production, but by expanding the consumer base, it lowers the average costs consumers pay per unit. Any system of direct price controls would thus play havoc with both research and marketing, drying up the capital needed for innovation.

The overall picture today shows a research drug industry under constant pressure from all sides. Industry critics greatly fear letting bad drugs on the market, while simultaneously underestimating the real costs (in the form of forgone health benefits) of keeping good drugs off the market. In reality any sound risk assessment, whether by regulation or litigation, should take into account both kinds of error.

Critics also naively assume that investors and firms will continue to make huge investments in new products without any assurance of recouping their costs in the marketplace. But the drug business is too vast and complex to depend on individual altruism or government bureaucrats to fuel medical advances. As Adam Smith recognized long ago, the profit motive is the only constant and reliable spur to making the major investments on which the prosperity (and health) of any nation depends. Today's pharmaceutical industry is not exempt from that enduring insight.



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