The Economics of Medicine

The pharmaceutical (medicines) industry poses interesting questions for economists.

According to The Economist, a new drug war is looming. (Not the doomed war on drugs which looks finally, thankfully, to be winding down into a broader public health debate). This is the growing market for medicines: patients in rich countries are ageing and those in developing ones are getting richer, living far longer and so suffering from chronic diseases. But as demand for drugs rises, so does concern at their price. A record $1 trillion will be spent globally on medicines in 2014, and “the costs of many new medical products are becoming unsustainable for even the wealthiest countries in the world,” said the head of the World Health Organisation (WHO), recently.

Should drugs be cheap? Most people think so, because of the obvious impact on human health and wellbeing, and because of the numerous positive externalities associated with good health.

Pricing medicines is very difficult. One common model is to use price discrimination. One price for poor countries, and a higher price for richer ones. But this model tends to break down (as price discrimination often does) when markets cannot be effectively separated, with the cheaper medicines stockpiled in poorer countries to be resold in the richer ones. In October 2013, Maine became the first American state to allow drugs purchases from cheaper foreign online pharmacies. The drug makers’ have sued, charging that the policy is illegal.

The drugs companies - a good example of an oligopolistic industry - are testing new pricing models. “The starting point always is, what is the right price for a medicine?” says the chief executive of Roche, a Swiss pharmaceutical giant. “And there is no objective answer…At the end you are discussing, what is the price of life?”

Drug development is expensive, slow and chancy, so pharmaceutical firms charge a lot. But if drugs are too pricey, support for patents will collapse. The boss of Pfizer, an American giant, recently laid out the threat: “Unless we’re respected by society, unless we’re seen as good stewards of our resources, then we run the risk of both losing patents and losing the ability to price our medications.” The classic defence of supernormal profit in many industries is that those profits fund R+D, investment and innovation. At the height of the AIDS epidemic, protesters accused drugs companies of putting “profits before people”. The drugs backed down and dropped prices.

There’s much in the article to discuss, such as cost/benefit analysis. In the United States (in contrast to many other rich countries), treatments are chosen with little regard for cost. Britain’s National Institute for Health and Care Excellence (NICE), for example, works to a rough threshold of £20,000-30,000 for each additional year of good health when deciding which treatments should be available on the National Health Service. But in America any mention of cost-effectiveness generates fury. High American prices support research and subsidise lower prices elsewhere. Yet even Americans are starting to question the affordability of some treatments, one of which costs $11,000 a month and extends life by a median of six weeks.

Spending on drugs is a huge part of the health care debate as drugs must compete for new spending with many other health-care needs, including new hospitals, more staff and more surgery. In part because health budgets are small, drugs often already account for a bigger share of health spending in poorer countries than in rich ones. India spends 44% of its total on drugs and China 43%. America and Britain spend 12%.