Can the US cut drug prices without sacrificing new cures?

Congress’s ambitious plans to expand health coverage are crashing up against one of the great questions in health policy: Can they force the pharmaceutical industry to hold down prescription drug prices without sacrificing the medical innovation that could lead to new treatments and cures in the future?

Democrats’ Build Back Better reconciliation bill sets a hard cap on the price Medicare would pay for some prescription drugs, ensuring that the program would pay no more than 20 percent more than other wealthy nations. Those prices would also be available to the commercial plans that cover most working Americans.

The policy is central to Democrats’ health care agenda: The $450 billion in estimated savings from the prescription drug reforms would pay for most of their other health care proposals.

The pharmaceutical industry warns the price controls that are contemplated in the Democratic bill would lead to fewer new medications and ultimately hurt patients. Progressives, Democratic leaders, and the Biden White House argue that the drug industry pumps up its profits in the US without much justifiable public benefit.

So who is right? It’s a question academics and analysts have been trying to answer for years. The US is the biggest pharmaceutical market in the world, representing 60 percent or more of the industry’s global profits. Nobody can say for sure what would happen if the world’s largest prescription drug market — by far — suddenly instituted government price controls. The Congressional Budget Office estimated in 2019 that international revenue from new drugs could drop by as much as 20 percent.

Many analysts agree this means that the industry would spend less on research and development, fewer drugs would be approved, and those losses would increase over time, although estimates range widely because there is so much uncertainty in the drug development process.

Stan Godlewski/Washington Post via Getty Images

The crucial question is not whether it would hamper new drugs, but how. Drugmakers develop lifesaving innovations, and also many treatments that don’t represent huge medical advances, but do help the companies’ bottom lines. Which kind of innovation would take the hit if profits dropped?

“It’s an unanswerable question,” Darius Lakdawalla, a health care economist at the University of Southern California, told me. “You’ve gotta take this for what it is, which is a risk-reward trade-off.”

Democratic leaders are gambling that drug companies would still develop true breakthroughs under their new pricing regimen. To a degree, it’s a bet they are taking to meet centrist Democrats’ demand to pay for their proposals: Congress usually uses savings from the health care industry to offset new federal health care spending.

But they are also trying to address a real flaw in the US health system: One in five Americans say they skip necessary medications because they can’t afford them. The US is locked in a situation where prescription drugs are unaffordable for many Americans — but any attempt to address the root cause of their high costs could backfire.

The exceptional — and expensive — US pharmaceutical market

There is nowhere like the United States of America for the pharmaceutical industry. Americans have unparalleled access to cutting-edge treatments — if they can afford them, because they also pay higher prices for prescription drugs.

The United States accounts for between 64 and 78 percent of the drug industry’s profits across the world. Americans pay about 3.5 times more money on average per dose of medication, brand-name and generic, than Europeans. Some of that is borne directly by patients, through out-of-pocket costs, and some of the cost is paid instead by insurers, who then pass on those costs in the form of higher premiums.

A lot of that money goes into research: About 25 percent of revenue goes to R&D, meaningfully higher than the amount in other “innovation industries,” such as telecoms, according to the CBO. (The total dollar amount has gone up as the industry’s revenue has grown, but the share invested has increased more modestly since the ’80s and ’90s.)

US pharmaceutical companies — and ultimately American consumers and insurers — subsidize drug research and development for much of the rest of the world, with at least 40 percent of the world’s pharma R&D originating in the United States.

Perhaps most importantly for American patients, they get the earliest access to the latest drugs: The US is where novel treatments debut, accounting for 65 percent of global sales for newly launched medications, according to data from IMS Health.

Research has consistently linked drug companies’ revenue to research and development spending and to new drug approvals.

“When the anticipation of future profits is higher, companies invest more in R&D and produce more new drugs,” the CBO said in an April 2021 report. “Similarly, if expectations about prices and profits were lower, companies would invest in less R&D, and fewer drugs would be developed.”

Two things help determine how much a pharmaceutical company makes from a drug: the size of the potential patient population and the price the company will be able to charge. And right now, companies have a lot of leeway to charge whatever they want in the United States. The US system grants patents lasting more than a decade to new drugs, delaying the introduction of cheaper generics that can drive down prices.

In other wealthy countries, it doesn’t work this way. The United Kingdom and Australia, for example, have boards of experts who assess the value a drug will provide in improving the health outcomes of patients, and the government pays a price based on that value. Such a system does have its trade-offs: Sometimes, expensive drugs are not available to everyone, and the drug may take longer to come on the market in that country or may never arrive at all.

But those are the trade-offs a country may have to make if it wants to control prices and focus on value — and those other systems provide the foundation of the Democratic plan to overhaul drug prices in the United States.

What would happen under US drug price controls?

Democrats’ proposal calls for drugmakers to negotiate on the prices Medicare will pay for certain prescription drugs. Medicare would pay no more than 120 percent of the average price paid by other wealthy nations, and the prices would also be available to commercial insurers. If pharma companies refused to negotiate, they would be subject to a punishing excise tax.

Saul Loeb/AFP via Getty Images

The plan does not come up with an American model for evaluating the value of drugs and paying for them accordingly. That work is outsourced to these other countries that already have such a system in place, raising questions about how the system would work if, for example, a new drug was debuting in the United States.

“I would ideally want us to do these assessments internally,” Stacie Dusetzina, who studies drug pricing at Vanderbilt and serves on the Medicare Payment Advisory Commission, told me.

The Congressional Budget Office projected in 2019 that the changes would cut the drug industry’s revenue by one-fifth unless they are able to make up lost profits elsewhere. As a result, the CBO estimated eight fewer drugs would be introduced in the US from 2020 to 2029 and about 30 fewer drugs over the following decade, under legislation similar to what Democrats are now proposing as part of their reconciliation bill. A more recent August 2021 CBO analysis found less of an immediate effect but projected a similar long-term impact on innovation.

That’s about a 10 percent drop in new drugs: We’d expect 300 drugs to be approved every 10 years at the current rate of approvals. The CBO estimate is generally considered the gold standard, but the analysts acknowledge a lot of uncertainty in those estimates, and several outside experts I spoke to thought the CBO estimate was too low.

Not all new drugs are the same, however. Some drugs are genuinely novel, new agents that had never been used before to treat disease. Other “new” drugs are actually combinations of existing drugs that are more effective or safer (or both) than their predecessors. Then there are imitators, called me-too drugs, that follow more established science.

After the first statin was approved in the late ’80s to treat heart disease, there was a flood of other statins that came on the market in the ’90s, using similar methods. Those me-too drugs arguably also provide value to consumers by introducing competition that reduces prices.

The CBO did not estimate what kind of drugs would be affected by the Democratic proposal. But other scholars have attempted to assess the relationship between market forces and drugmakers’ pursuit of new treatments.

When Medicare’s Part D prescription drug benefit was introduced in 2003, there were suddenly millions of Medicare beneficiaries with a prescription card who could afford medications. Researchers from Northwestern University concluded in a May 2020 study that most of the effect after Medicare Part D was introduced was seen in less novel drugs: As more patients had prescription drugs covered by insurance, drug companies resumed development for some of their less novel drug candidates in the hope of grabbing some of those new federal dollars. The effects on more novel treatments, on the other hand, were more muted and took longer to show up.

That could be encouraging news. Maybe less novel drugs are more susceptible to market pressure than true breakthroughs, and the latter would therefore be less affected by price controls. But Craig Garthwaite, a Northwestern health economist and one of the authors of the study, cautioned against too much optimism.

Win McNamee/Getty Images

Different drug companies spend their R&D money differently. Big companies tend to spend proportionally more on updating their current drugs to extend patents or conducting post-approval research to demonstrate better efficacy than similar drugs, which they can use to market against their competitors.

Smaller companies, defined by the CBO as those with less than $500 million in annual revenue, devote a bigger share of their resources to researching novel treatments, and they are driving the majority of new drug development. Those firms “now account for more than 70 percent of the nearly 3,000 drugs in phase 3 clinical trials,” according to the CBO.

Many of the smaller firms develop their drugs with the explicit goal of selling to a bigger pharma company, and the price at which they can sell is influenced by the prospective market, i.e., by the prices. Those companies also often depend on venture capital, which makes investments as bets: They look at the potential payoff and spread their money across a few different products, hoping one of them might pay off. But it’s hard to be sure which one will work.

Developing drugs is a long, expensive, and often frustrating process. It takes 12 years on average and costs between $1 billion and $2 billion, according to Congressional Budget Office estimates, to develop a successful drug. That accounts for the other drugs that failed over the same time, which is a lot of them, representing as much as 70 percent of the $1 billion cost, according to the CBO.

About 90 percent of prospective drugs are pulled in clinical trials, and the vast majority of the time that’s because they weren’t effective, as opposed to a commercial reason, a May 2021 paper by the University of Virginia’s Ekaterina Khmelnitskaya found.

But if the eventual market for these products is smaller because of price controls, venture capitalists may make fewer bets — and that could mean a product that could eventually be viable and valuable doesn’t actually get the financial backing necessary to get through the development process. They might also want to make safer bets, rather than taking the risk on a potential treatment that looks unlikely to work out.

Garthwaite described the venture capitalist’s mindset to me this way: “I can’t support as many early-stage bets because I won’t win as big in the late stage,” even if “one of those investments I don’t make could have been a successful product.”

The case for optimism would be that perhaps there would still be a sufficient reward for innovating new drugs, even in the more regulated market of a wealthy nation like the US. They can still make a lot of money. Drug companies continue searching for an effective Alzheimer’s drug, even though they have failed for decades, because of the potential payoff if they achieve a legitimate breakthrough.

Dusetzina told me she thought it was possible that drug companies would end up putting more of their resources into developing those truly novel treatments if there is less money to be made in the me-too market under price controls. So maybe the overall R&D pot would be smaller, but it might be spent more efficiently.

Under the foreign health systems that would serve as a basis for US price controls, those governments will still shell out a lot of money if the drug is actually valuable. The Democratic proposal does not create a direct value assessment made by the US government itself, but it does still provide an element of value-based payment by relying on those other countries.

“We will pay you more when you give us drugs with higher value, less with lower value, and we’ll pay you more than these other countries are paying, where you’re also making profits,” Dusetzina said. The plan’s opponents, she added, “frame it as ‘we will lose cures,’ and I don’t think that’s true.”

Some of those countries with price controls — the United Kingdom in particular — have managed to outperform their economy’s size in producing novel treatments, according to a 2010 study on international drug development.

Whether it’s novel or less novel treatments that are most affected by US price controls also has major implications for perhaps the most important question of all: How would this plan impact people’s well-being?

Saul Loeb/AFP via Getty Images

CBO explicitly said that it did not attempt to assess the influence of price controls on America’s health. But RAND analysts tried to do that in 2008 and found that with drug price controls, life expectancy would drop over 50 years unless innovation were somehow not tied to pharma revenue, which the authors considered unlikely. By 2060, that projected decline in life expectancy for both Americans and Europeans would reach approximately 0.7 years.

In other words, people would not live as long as they would without those price controls. That would be the worst-case scenario. Lakdawalla, who contributed to the 2008 analysis, told me he didn’t have any reason to think the results would be different if he ran the study again today, even with the evolutions in the pharmaceutical market over the last 10 years.

“I think it would be foolish to conclude we know how the market has evolved in the sense that we can predict whether revenue declines are going to wipe out helpful innovation or less helpful innovation,” he said. “No one knows what’s going to happen until it happens.”

What does all this mean for patients?

The backdrop of this debate over whether price controls would depress innovation at the expense of people’s health is a harsh reality: Many Americans already say they skip necessary medications because of the cost, likely with deleterious effects to their health. So what is Congress to do?

In 2008, the RAND researchers postulated capping out-of-pocket costs would be more effective at improving US life expectancy, without the deleterious effects they projected under direct price controls for pharma. That would mean regulating insurers and spending federal money to reduce patients’ cost (or both), rather than capping prices from drugmakers.

Democrats are actually trying that, too. Their legislation also proposes capping Medicare beneficiaries’ out-of-pocket costs for prescription drugs.

There are also other ideas for how to encourage drug development outside of pharma companies’ profits. Democrats are already proposing more federal funding be spent on basic medical research, though the CBO says it will take years for that investment to show up in new drug approvals.

Some scholars have argued for pushing through trade policies for other countries to pay more money for the drugs they buy. Garthwaite told me that he thought policies more narrowly targeted to introducing competition into the drug market, with less stringent patent protections, could yield cost savings without the same risk to genuine medical breakthroughs.

Sen. Bernie Sanders (I-VT) has called for awarding large one-time “prizes” instead of patents for new drugs, immediately allowing generic competitors to come on the market.

But those other ideas aren’t being proposed as part of the budget reconciliation. Instead, Democrats want to expand insurance to poor people and add new dental benefits to Medicare, both of which cost money — money that will come from the estimated $450 billion savings from these prescription drug price reforms.

Congress is in this predicament partly because centrist Democrats are balking at the reconciliation bill’s overall cost and demanding new spending in the bill be offset with savings.

The Democrats could, in theory, fund their health care expansions in all kinds of ways, without touching pharma’s profits. But there is a long-held practice of using savings from the health care industry to pay for new health care spending, so Democrats are looking to either cut spending for, or raise taxes on, health care firms.

They have settled on this plan for Medicare to negotiate drug prices, which they’ve been campaigning on for years and also happens to raise a lot of money. They also cite the data that shows how much more Americans spend on drugs than people in other countries, and other measures of how unaffordable drugs can be in the US, to justify the policy on its own terms.

The United States appears to have gotten stuck in a dilemma where medications are already unaffordable for many people, but the ideas being proposed to address that problem could end up dampening future innovation and possibly lead to worse health outcomes.

Democratic leaders in Congress and the White House sound willing to take the risk. The question now is whether centrists in the party will go along while pharma raises alarms about the potential fallout. Their decision won’t just determine the fate of the reconciliation bill’s health provisions — it has ramifications for the long-term future of US medicine.

David Paul Morris/Bloomberg via Getty Images

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