Rarely are congressional hearings due to a problem coming full circle. But recently Senator Grassley dragged executives from seven top pharmaceutical companies before a Senate Finance Committee hearing. Ostensibly he was trying to clear the “secrecy” behind how companies set prices. Lawmakers frequently call for increased transparency and legislative oversight of healthcare and especially pharmaceuticals.
Legislative response to regulation run amuck
Some legislators propose solutions as radical as limiting price increases, capping prices, and fining drug companies for raising prices. But a case of wrongful conviction is at the root of all these regulatory proposals, dooming them to failure. The irony is, it isn’t greedy corporations, or a lack of regulations causing drug prices to spiral out of control. The culprit is the regulations that are in place. Those regulations are causing the harm.
Like handcuffs, regulations constrain regulated party’s movement. Proponents argue such rules are necessary to prevent bad behavior. The Laws of Supply and Demand tell us prices rise as you constrain supply. Cost Theory shows how prices are a function of a firm’s costs. Lawmakers forget to consider these basic principles when enabling regulators. It is even more rare when lawmakers or regulators balance the “benefits” of regulation against cost of undesired outcomes.
Pharmaceuticals are among the most regulated industries in the United States. There are over 10,000 individual rules and restrictions. Of course, each is in place to “protect patients and consumers.” Pharmaceutical companies add the cost of regulation to the price of their products to the tune of millions of dollars annually. They have to pay for the legal bureaucracy and required compliance manpower. Factoring in the Food and Drug Administration (FDA) rules on development, testing, efficacy, and certification of a new drug, costs reach the billions.
Cause & effect
Pharmaceutical companies spend among the highest percentage of revenues on research development of any industry. They spend an average of about 17% of revenue on R&D. It takes an average of 12 years and $4 billion to bring a new drug to market. Many cost more than $10 billion. Regulations and bureaucracy directly and significantly contribute to ballooning these costs. The costs are passed on to the consumer in the final market price of a drug. It is entirely unclear if any of these regulatory costs provide significant benefits to patient care or reduction of risk of a bad drug development.
The effect of regulations also creates perverse incentives in that they limit consumer choice and delay innovation. By raising the cost of developing a new drug, regulations incentivize manufacturers to focus on developing drugs that bring them the higher margins. Companies have little reason to focus on producing a drug that, while lifesaving or contributory to widespread wellbeing, has small margins. The sad irony is that the bulk of the proposals in D.C. are targeted at the consequences of previous regulations. Ayn Rand once said, “we can ignore reality, but we cannot ignore the consequences of reality.”
Example 2
We can actively watch this regulatory game play out in New York City. Their new $15 per hour minimum wage is forcing businesses into the laying off some workers to fund the higher wages for others. The New York Times reported fast food workers now face “unfair” firings. But, in truth, these firings aren’t unfair or arbitrary. They are the predictable consequence of government regulating minimum wage in a competitive labor market.
Now, rather than understanding the economics of their action in order to comprehend the outcomes, the city is compounding the regulatory error. It is reacting by pursuing new regulations to “protect” workers from being fired. The next step is probably to make it illegal for the business owner to go out of business.
Conclusion
Sadly, regulations beget more regulations. Regulators are unelected bureaucrats. They have no skin in the game. Their decision making can never be trusted to do the right thing. If lawmakers are truly concerned with out of control drug prices, it isn’t price controls or fines on businesses that will lower them. The answer is a fundamental reform of what we regulate and how we regulate pharmaceutical companies. There is a broader lesson here.
Ref:
Catalyst, Elliot Young, 3/7/19
