Making Big Pharma an Offer It Can’t Refuse

As part of the Inflation Reduction Act of 2022, the Centers for Medicare & Medicaid Services (CMS) gained the authority to negotiate the price the government pays for prescription drugs. Recently, the CMS released a target list of 10 drugs that will be subject to the first round of government-mandated price negotiation. The list includes drugs to treat chronic conditions like diabetes, arthritis, and heart failure and accounts for nearly 20 percent of total spending in the Medicare prescription-drug program, according to CMS data. This process isn’t a negotiation, however, but an arbitrary, one-sided effort at price controls. Ultimately, this form of negotiation will stifle new drug discovery, reduce generic competition, and create longer-term impacts to the commercial health care market. But it’s an offer big pharma may not be able to refuse.

Over the past three decades, advocates of government-run health care have taken aim at the pharmaceutical industry, often pointing to drug pricing as an example of corporate greed at the expense of patients. Admittedly, some drug companies make themselves easy targets through questionable or illegal practices, but the industry has also been responsible for developing drug therapies that have extended the lifespan of and increased quality of life for millions of people. For example, according to the American Cancer Society, the number of people in the United States who have lived five or more years after their cancer diagnosis has grown consistently and is projected to increase approximately 30 percent over the next decade, due in large part to innovative drug therapies.

In addition, newer and more effective drugs to treat Type II diabetes, including Jardiance, one of the drugs targeted by the CMS, have been developed to combat the increased prevalence of the disease. According to a report by the Congressional Budget Office (CBO), the number of new drugs approved each year has grown over the past decade, reaching a peak in 2018. Drug development does not come cheap, however. In the same report, the CBO noted that the pharmaceutical industry spent $83 billion on R&D in 2019, equal to approximately 25 percent of revenues. Even with that level of spending on new drug development, 85 percent of drugs do not make it past the earliest phase of testing.

Lowering pharmaceutical revenues through price controls will lead to less new drug development. Based on a University of Chicago study, the impact of the CMS price negotiation could result in 135 fewer new drug approvals through 2039. One should hope that a yet undiscovered drug to treat Alzheimer’s, heart disease, or cancer is not among them. Without being able to recoup R&D costs, drug companies will reduce drug discovery projects and reallocate resources, thus limiting the potential to make a significant impact on the lives of patients. In addition to the impact on new drug discoveries, government price-setting will also reduce the discovery of new uses for existing products. Many drugs gain additional use indications after the accumulation of efficacy and safety data that follows years on the market. Government price-setting begins in as little as nine years post approval, thereby shortening the timeframe for conducting the additional research necessary for new indications. Even if a new indication is gained in a different therapeutic area, the drug is still subject to the government-mandated price for its original use.

Generic equivalents have made a significant impact on reducing drug costs. They have done this by attracting market share through a deeply discounted price and by realizing the financial incentives associated with entering a given market. Establishing a government-mandated price on branded drugs, however, could also lower the price any generic firm would charge. In that case, the generic drug would no longer enjoy the deep discount compared to the branded product nor be able to generate the type of profit margin that makes the venture viable — the unintended consequence being a lack of financial incentive for generic manufacturers to enter the market, thereby reducing the quantity and quality of generic competition. (READ MORE: America’s Drug Supply Depends on India and China. You Should Fix That, FDA)

Unfortunately, drug-pricing mandates may only be the beginning. In addition to other drugs, it is likely that the CMS will explore a similar approach in other high-cost areas. For example, medical providers are already required to bill Medicare at a rate lower than the commercial market — why not apply additional mandates to high-cost provider specialties, like cardiology or surgery? Certain high-cost procedures like cardiac catheterization or outpatient surgeries might also be targets for price negotiation, as would in-patient hospital charges. These scenarios would negatively impact the commercial health care market, as patients outside of Medicare would ultimately bear the burden of having to subsidize the lower drug and provider costs crammed down by Medicare. 

Coming to the table to negotiate usually entails the pursuit of a win-win scenario for both parties. In this case, drugmakers are required to submit to the government’s demands or face significant consequences, like excise taxes, financial penalties, or loss of access to patients in the Medicare market. This approach to negotiation mirrors that of Don Corleone in The Godfather: “I’ll make him an offer he can’t refuse.” Unfortunately for the pharmaceutical industry, this “offer it can’t refuse” will have consequences that demonstrate, yet again, that government involvement in the U.S. health care system is bad medicine. 

Richard D. Kocur is an associate professor of management and marketing at Grove City College. He has written extensively on U.S. health care policy and, most recently, on the changing role of corporations in society.

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