Strangling Generic Drugs is the Wrong Path to Lower Prices

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Lowering drug prices is a public policy objective that everyone can agree on. About 18 million patients can't afford their prescribed medications, according to a recent poll, including nearly 1 in 5 members of the poorest households. Unfortunately, Congress’ plan to control pharmaceutical prices consists of half-baked proposals that would do serious harm to consumers.

The legislation’s central feature is an elaborate set of price controls — simply put, government-imposed ceilings on what drug makers can charge for their products. Although price controls are a tempting remedy to make medicines more affordable, their historical record is dismal. From 3rd-century Rome to modern-day Venezuela, artificial constraints on prices invariably lead to shortages in the short-run and decreased innovation in the long-run as private companies abandon the market or rein in their investment.

A study from the National Bureau of Economic Research, for example, estimated that cutting pharmaceutical prices by 40-45 percent by government fiat — roughly the reduction being proposed for some drugs — would cause pharmaceutical makers to significantly cut back on research and development, resulting in a 50-60 percent decrease in the number of compounds getting to human trials. That means fewer cutting-edge treatment options for patients.

Innovation in the brand-name pharmaceutical industry wouldn’t be the only casualty of Congress’ plan. The market for generic and biosimilar drugs — low-cost copies of a brand-name product — would be significantly disrupted, too. Makers of generics and biosimilars tend to compete against the costliest brand-name drugs, hoping to attract customers by undercutting their rival’s price. As more manufacturers enter the market and competition intensifies, prices fall rapidly.

For example, products with a single generic maker are about 35 percent cheaper than those with no generic competition, and prices drop by 95 percent when six or more generics are offered, according to FDA data. That explains why 92 percent of generic prescriptions in the U.S. are filled for $20 or less, delivering more than $315 billion in consumer savings every year.

But by forcing down the price of brand-name drugs, Congress’ plan would weaken the enticement for generic and biosimilar competitors to enter the market. Though not as costly as developing a novel drug, creating generic or biosimilar medicines can be expensive. A 2013 paper estimated that it takes 7 to 8 years to develop a biosimilar, at a cost of up to $250 million. Investors will be less likely to view the expense as worthwhile if the government can intervene to impose arbitrary caps on drug prices. The result will be fewer generics and less competition for brand-name products, undermining the price reductions that Congress hopes to achieve. Lawmakers should be seeking to make it easier for generics and biosimilars to thrive, not more difficult.

Another provision of the bill punishes certain drug makers for raising their prices faster than inflation. Though matching pharmaceutical price increases with consumers’ cost of living is intuitively appealing, this measure could easily backfire. Generic manufacturers generally price their products just above production cost, counting on the volume of sales — not revenue per unit — to turn a profit. While consumers benefit from rock-bottom prices, the viability of this pricing strategy hinges on drug makers’ ability to modify the price as underlying production costs fluctuate. Given the complexity of the global pharmaceutical supply chain, it’s impossible to foresee when the price of a raw input — potentially located in a foreign country — may spike, forcing the drug maker to rapidly increase its sale price in order to stay afloat. If penalized for doing so by an inflation cap, the manufacturer would curtail its production or withdraw from the market. Why would a generic drug manufacture enter the market and take this risk?

The design of the inflation penalty is especially problematic, since it is based on the percentage that a price increase exceeds inflation. That means a generic drug maker may face a penalty for increasing its price by a penny from $0.25 to $0.26 (a 4 percent increase), but a brand-name drug manufacturer could increase its price by 20 cents from $10.00 to $10.20 (a 2 percent increase) may avoid the penalty. Once again, this tilts the playing field against lower-cost medicines.

There are better ways to tackle drug costs. Accelerating FDA reviews of generics and biosimilars promises to lower prices and expand consumer choice without disrupting competition. Reining in the excessive power of pharmacy benefit managers (PBMs), which often exploit their position as middlemen in pharmaceutical transactions to extract exorbitant profits, should also be a priority for Congress.

Millions of patients need relief from spiraling pharmaceutical prices. Lawmakers should be focusing on real solutions, not miracle-cures that do more harm than good.

Steve Pociask is president and CEO of the American Consumer Institute, a nonprofit education and research organization. For more information on the Institute, visit www.TheAmericanConsumer.Org or follow us on Twitter @ConsumerPal.

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