Pharmaceutical innovation has been responsible for many “miracles of modern medicine.” Reliance on the “invisible hand” of Adam Smith to allocate resources in the market for prescription drugs, however, has had a number of adverse consequences.
Prescription drugs in the US are not only high in price relative to international price benchmarks, but their use often diverges from objective efficacy and cost-effectiveness. Examples include US Food & Drug Administration (FDA) approval of costly drugs like Aduhelm based on biomarkers with limited or no information on clinical and cost-effectiveness; pricing of drugs like insulin and enzalutamide (sold as Xtandi) in the US at several multiples of the price in other countries; FDA approval of a variety of highly priced “me-too” drugs like anti-programmed cell death protein 1 (PD-1) monoclonal antibodies with a low percentage of therapeutic advantage and no reduction in price as more drugs enter the market; significant evergreening of drug patents based on slight modifications that have limited therapeutic advantage but which may be more convenient; and markedly increased utilization of drugs due to physician marketing and direct-to-consumer advertising. Moreover, the high profitability of drugs for the treatment of cancer and rare diseases has led to a relative underemphasis of drug development for general medical conditions affecting larger patient populations. The Inflation Reduction Act (IRA) contains provisions that should favorably impact some aspects of drug pricing, but the intended effects may be blunted. The objectives of this Commentary are to explain how these intertwined problems are rooted in market imperfections and propose solutions that would improve the match of utilization with efficacy and cost, while fostering continued innovation.
This depiction of how Adam Smith’s invisible hand guides the price and utilization of prescription drugs under a free market is so far from reality as to be fantastical. This is because none of the assumptions of a well-functioning market applies to prescription drugs:
- At a time of significant illness, the emotional state of patients and their families and their lack of knowledge and expertise limit their ability to make rational, informed choices about potential drug treatments. Instead, patients generally rely on their physicians.
- Patients do not make purchasing decisions based on the true price of a drug because their out-of-pocket cost is usually only a small fraction of the price paid to the manufacturer.
- Physicians often cannot draw on comparative-effectiveness data in counseling patients because of gaps in the literature.
- Physicians’ recommendations may be influenced by drug company marketing and their own income objectives.
- When a safe and effective drug is commercialized by a pharmaceutical company, entry of other manufacturers is constrained by patent protection. Patents serve an important societal purpose—a quid pro quo in which a time-limited monopoly is awarded for new drugs to encourage research and development, balanced in the long-term by postpatent societal benefits. However, drug companies have fostered regulations through lobbying and litigation that are favorable to patent evergreening and high prices that, in practice, are not subject to reduction by competition with other manufacturers of similar drugs.
- Supply and demand are not independent. Producers can create demand through physician marketing and direct-to-consumer advertising.
These deviations from the underlying assumptions of a competitive market produce imperfections in the production, consumption, and price of prescription drugs. Moreover, when public and private health insurance covers more than 90% of the population, as is now the case in the US, insurance benefits take on characteristics of public goods.
That is, once a prescription drug becomes a covered benefit for everyone in a plan, individuals cannot effectively be excluded from the use of the benefit, and one individual’s use of the benefit does not reduce its availability to others.
In the US, federal policy paralysis regarding comparative effectiveness and CUA of prescription drugs has adversely impacted the quality of care, price, and utilization.
Quality is compromised by limitations in the funding of comparative effectiveness studies that are needed by physicians to make optimal treatment decisions. Indeed, efficacy determination by the FDA is almost always based on a randomized controlled trial that compares the drug being evaluated with placebo but not with a standard-of-care drug, should one exist. Prices of drugs are elevated because once the FDA grants approval, drug companies can set high launch prices; this will not change under the IRA. When patents are granted for drugs similar to ones that already exist, there usually is little in the way of price reduction relative to the competition because the industry follows a price leadership model.
Manufacturers net a high percentage of their list price after being filtered through a complex system of wholesalers, pharmacy benefit managers, pharmacies, insurers, and patient rebates.
The incentives in this byzantine structure motivate continued high launch prices for new drugs and subsequent price increases, although the latter is a less important consideration than the launch price.
Utilization of drugs is enhanced by low out-of-pocket patient cost and by supplier-induced demand in a setting wherein cost-effectiveness and cost-utility information on alternative treatments is limited.
