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A bad plan for prescription drugs

Benjamin Zycher, Ph.D.
The San Diego Union-Tribune
August 28, 2006

Well, that didn't take long. I refer to Gov. Arnold Schwarzenegger's endorsement last week of “negotiated” prices—that is, price controls—on pharmaceuticals used by moderate–income Californians. Only last January, Schwarzenegger sent a letter to the congressional leadership of both parties, arguing against "efforts to impose price controls on prescription drugs because they will have a chilling effect on the research and development of life–saving medicines and harm California's critical biotech industry."

That was then; the looming election is now. And so Schwarzenegger's claim of profound respect early in his political career for the free–market philosophy of Milton Friedman has disappeared behind a fog of rhetorical sleight of hand and interest–group pandering. Instead, the pharmaceutical producers will be forced to negotiate with state bureaucrats over drug prices for people earning 300 percent of the federal poverty line—about $60,000 per year for a family of four—and for others with incomes over $70,000 who have medical expenses uncovered by insurance exceeding 10 percent of their incomes.

Officials in both the Legislature and the Governor's Office claim that the price discounts might be as much as 40 percent for brand–name drugs, and 60 percent for generics. And if the pharmaceutical producers refuse to offer such discounts? Their medicines might be taken off the formularies—lists of approved drugs—for MediCal drug programs for the poor.

Thus does the program endorsed by Schwarzenegger threaten to deny the newest and most effective medicines for the poor so as to subsidize much of the middle class. This is a violation of federal regulations; the federal government has made it clear it will not approve state programs that threaten the benefits of Medicaid (MediCal in California) patients in efforts to reduce drug prices for those not poor. That is why a program in Maine similar to that now endorsed by Schwarzenegger has never been implemented. Instead, after years of litigation, the state promised not to put drug access for poor patients at risk. And so the actual program implemented in Maine is voluntary, as is a similar successful program in Ohio.

Pharmaceutical negotiations with big government agencies are not analogous to negotiations between pharmaceutical producers and, say, large pharmacy chains. Wal–Mart and similar retailers must balance the demands of their customers for low prices and for greater inclusiveness of formularies; the retailers want to be able to offer their customers the medicines that they need. Therefore, they cannot drive too hard a bargain with the drug companies, who can refuse to accept too low a price. Government on the other hand does not have "customers." Instead, it has interest groups and voters; and if the drug that a given voter needs is unavailable in the formulary negotiated by the government, advice to "write a letter to your assemblyman" falls rather flat.

And that is why government by its very nature does not "negotiate" prices; it imposes them. That is the reality for drug prices under various current federal programs: Medicaid, Veterans Affairs drug programs, Medicare Part B, and the Public Health Service Act.

There is the further matter—as Schwarzenegger understood in January—that government price controls on medicines are inconsistent with the research and development process yielding new and improved drugs over time, that is, with the future alleviation of human suffering. The cost of bringing a new medicine to the market is over $1 billion; because the period of patent protection is limited, threats to remove given drugs from the MediCal formulary, apart from the adverse medical consequences for poor patients, threaten to wreak havoc with pricing strategies designed to recoup those huge costs. Pharmaceutical producers must satisfy investors seeking to do well rather than good. If price controls reduce profitability, as is inevitable, the flow of new medicines will be reduced or eliminated.

There is a far more straightforward solution for patients with moderate incomes. Drug companies should be allowed to offer discounts to those patients without being forced to offer the same discounts to federal and state programs. With such a change in policy, drug companies could offer those lower prices through their Patient Assistance Programs and make more money, because they would be able to sell more medicines without being forced to discount prices for a vastly larger part of the market.

For the permanent Sacramento political establishment, it's supposedly all about the children. Except when it isn't. The policy now endorsed by Schwarzenegger mortgages the future in favor of the present, and thus will do serious damage to the process by which patients both now and in the future derive the benefits of technological advance. Such are the fruits of government compassion.

Zycher is a senior fellow at the Manhattan Institute for Policy Research. He can be reached via e-mail at

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