Fifty years ago, the populist Senator Estes Kefauver (D-TN) wrapped up a lengthy set of hearings into prescription drug prices and proposed a bill intended to create more direct competition among pharmaceutical firms and lower prices for consumers. Specifically, Kefauver sought additions to existing antitrust laws and the open compulsory licensing of drug patents after just three years of market exclusivity.[1]

In response, the pharmaceutical industry developed a three-part counter argument used repeatedly since then to help block price control legislation. First, pharmaceuticals cut down on hospital stays and return ill people to health faster, making them cost-effective for society. Second, the public needs to pay for the costs of developing not just FDA-approved drugs, but also of compounds that do not make through a lengthy testing and development process. Third, it would be a mistake for regulators to push the industry into competitive rounds of cost cutting given its public health responsibility to manufacture safe and high-quality medicines. Kefauver's original bill died on the Senate floor, though elements of it were revived in the wake of the thalidomide tragedy and rewritten into a consumer protection bill that, for the first time, gave the FDA the authority to require pre-market efficacy testing of new drugs.

Yet the issue of drug prices did not go away, particularly in Europe, as prescription use shifted from acute treatments (like antibiotics) to patients taking drugs for years or even decades to treat chronic conditions (like hypertension). Starting in the late 1980s, various price regulations were implemented, initially in northern Europe but soon mimicked elsewhere. These ranged from direct price controls in France, to indirect controls through overall pharmaceutical budgets and physician prescription quotas in Germany, to profit controls in the United Kingdom.

Over the past decade, reference pricing has become the norm across much of Europe. Countries typically either reimburse no higher than the median price across a therapeutic drug class, or compare specific drugs prices across a set of peer countries. Firms wishing to charge more for drugs can do so, but patients have to make up the price differential. In a significant change to policy in 2011, Germany (Europe's largest prescription drug market) has begun to implement a reference pricing approach that combines previous approaches and also implicates new drugs. After a one-year period of industry-determined prices, negotiations will set prices based on calculations of a drug's costs and benefits compared with other pharmaceuticals in the same class, but in any case below a reference price based on median prices across other EU countries. German policymakers are extending reference pricing to shortly after market entry in an effort to accelerate comparative cost-benefit analysis among drugs in the same class, although for many medicines it will prove impossible for firms to compile this data quickly enough to meet the regulatory requirement.[2]

Economists and industry leaders in Europe and the United States have raised two main concerns with price controls, especially reference pricing.[3]First, it undermines incentives for research and thus will reduce the number of new drugs reaching market, including for the many diseases for which no drugs are currently available. Second, by treating pharmaceutical prices in a "silo," policymakers miss the opportunity to integrate care and use relatively less-expensive drugs to reduce hospitalization and other forms of care down the road.

Europe's embrace of pharmaceutical price controls has helped to reshape global pharmaceutical markets. As reference price systems were implemented across Europe over the past two decades, firms were attracted even more strongly to the U.S. market, where drug coverage by private insurers and Medicare has expanded. With the exception of certain government programs (like Medicaid) the United States relies on market forces to set drug prices.

Annual government health research spending in excess of $30 billion, a wealthy single-language market, and access to scientific expertise also played important roles in the shift of the "pharmacy to the world" from Germany, Switzerland, and France to the United States:

• Seven of the top fifteen global pharmaceutical and biotechnology firms are headquartered in the United States, and all of the top twenty firms have research labs in the country.

• Of approximately 6,500 drugs in clinical development worldwide in 2007, over 40 percent were discovered in the United States.[4]

• Total industry R&D spending in the United States exceeded $45 billion in 2010[5]

• 1,552 pharmaceutical and biotechnology firms in the United States employed 832,000 workers in 2010, along with approximately 2.5 million jobs in supporting industries.

In 2010, total prescription drug sales in the U.S. exceeded $300 billion, some 35 percent of the global total of $850 billion.[6]Despite a larger population and nearly universal coverage, Europe's share of global pharmaceutical sales was ten percent less than that of the United States. The market share difference is largely explained by higher drug prices; for many top-selling drugs, the U.S. wholesale price is between two and three times as high as in Germany or the United Kingdom, and the retail price is between two and four times as high as in other countries.[7]Thus, even though the quantity of prescriptions filled annually in foreign countries with universal health coverage - the British buy 15 prescriptions annually - sometimes exceeds that of the United States at an average of 12 prescriptions per person, international pharmaceutical firms are drawn to the U.S. market.[8] In many instances, European-based pharmaceutical companies now seek market authorization first in the United States, despite the FDA's international reputation for rigorous and lengthy review.[9]

While beneficial to the U.S.'s comparative advantage in the pharmaceutical industry, drug spending also contributes to the high levels of overall healthcare spending that provided an impetus to the 2010 Affordable Care Act (ACA). In a recent white paper, we have developed calculations for the future U.S. pharmaceutical market based on projections for an increase in the number of insured, their demographic breakdown, shifts in spending on drugs per person that typically accompany getting coverage, and existing trends in total pharmaceutical use and prices. In 2015, we expect pharmaceutical spending between $435 and $440 billion (~12.5% of healthcare spending) and in 2020 it will near $700 billion (~14% of healthcare spending).[10]

This growth will bring new pressure for cost containment and price controls. Will previous arguments concerning the relationship of market pricing to industry R&D investments, pharmaceutical innovation, and the resulting public gains remain persuasive to policymakers in the United States facing sharp budget constraints? Congress and the Department of Health and Human Services will be hard pressed to explain increased drug spending to consumers, especially when compared to Europe, Japan, and other locations where reference pricing has become the norm.

The ACA, despite being pilloried on many fronts, actually holds out some hope for the United States to be the first country to break out of the silo framework that dominates health budgeting and to instead set budgets at the disease (or patient) level, linked to health outcomes.  Such a shift would likely benefit pharmaceutical manufacturers, given the proven ability of drugs to offset other health care costs.[11]

For this to happen, physicians, hospitals, and other providers will need to find it profitable to undertake greater disease prevention efforts while more tightly integrating dispersed care for the 20 percent of patients that account for 80 percent of healthcare spending, and to especially target the 5 percent that are responsible for 50 percent of U.S. health care spending.[12]

Ironically, such an approach has eluded the more nationalized (but not necessarily more coordinated) health systems in Europe, but may be possible under the accountable care organization model now emerging in the U.S.  To realize the cost savings potential of integrated care on a system-wide level, however, will require a step further than currently envisioned under new methods for calculating costs. Breaking down budget silos of prescription drugs versus hospitalization versus outpatient care for risk adjusted patients will be necessary to accurately weight the value of more innovative therapies or coordinated care platforms. Indeed, pharmaceutical firms will need to monitor prescription drug use in order to demonstrate long-term cost savings in relation to improved health outcomes from the use of pharmaceuticals. This may be the most effective way not only to control costs, but also to drive innovations with the most value for patients and society.

Endnotes

[1] At the time, patent terms ran 17 years in the United States; they were lengthened to 20 years in 1995. For pharmaceuticals, on-market patent life is generally considerably briefer since firms obtain patents prior to many years of clinical testing.

[2]D. Cassel, "Arzneimittel-Innovationen im Visier der Kostendämpfungspolitik," Gesundheit und Gesellschaft Wissenschaft 11 (February 2011), 15-24.

[3For two useful reviews of this literature, see: W. Comanor, "The Political Economy of the Pharmaceutical Industry," Journal of Economic Literature 24 (1986), 1178-1217; D. Kessler, "The Effects of Pharmaceutical Price Controls on the Cost and Quality of Medical Care: A Review of the Empirical Literature," white paper presented to the U.S. Department of Commerce and International Trade Administration (June 2004), www.ita.doc.gov.

[4]Wolters Kluwer Health, Adis R&D Insight Database, custom data run, August 2011.

[5]U.S. Department of Commerce, International Trade Association, "Pharmaceutical Industry Profile," (July, 2010), www.trade.gov.

[6] IMS Health, "Top-Line Industry Data 2010," www.imshealth.com, accessed August 2011.

[7] A. Daemmrich and E. Cameron, "U.S. Healthcare Reform: International Perspectives," Harvard Business School case 710-040 (2010), 21.

[8]Kaiser Family Foundation, "Health Costs and Budgets: United States," www.statehealthfacts.org; National Health Service, "Statistics and Data Collections," www.ic.nhs.uk/statistics-and-data-collections.

[9] P. Danzon, Y. Wang, and L. Wang, "The Impact of Price Regulation on the Launch Delay of New Drugs: Evidence from Twenty-Five Major Markets in the 1990s," Health Economics 14 (2005): 269-292.

[10] A. Daemmrich, "U.S. Healthcare Reform and the Pharmaceutical Industry," Harvard Business School Working Paper 12-015 (September 14, 2011), www.hbs.edu/research/pdf/12-015.pdf.

[11] F. Lichtenberg, "Have newer cardiovascular drugs reduced hospitalization?" Health Economics 18 (2009), 519-534.

[12] M. Stanton, "The High Concentration of U.S. Health Care Expenditures," Agency for Healthcare Research and Quality, Research in Action 19 (2006), www.ahrq.gov, accessed September 2011.