Freeman

ARTICLE

Evaluating New Drugs: Remember the Bigger Picture

Prescription Drugs Have Unseen Benefits

OCTOBER 01, 2002 by LAWRENCE W. REED

“Don’t be penny-wise and pound-foolish” is an old adage that cautions us about false savings. Sometimes spending a little more now makes the best sense if it maximizes our savings in the long run. Failure to understand this lesson is at the root of many misjudgments and bad policies swirling around prescription drugs these days.

Critics of the pharmaceutical industry cite heavily promoted, expensive new drugs as the 800-pound gorilla in our nation’s costly health-care system. Lawmakers are debating ways to address this issue–including price controls and requiring more use of generics. As usual, government is part of the problem, and most of its attempts at a solution are almost sure to fail.

To begin with, it’s important to separate what media reports often confuse as one and the same: increases in total spending on drugs and increases in the prices of drugs. Drug spending rose 13.6 percent in 2000 while the average price of drugs went up by a rate comparable to price inflation, at 3.9 percent. There’s a big difference between 13.6 and 3.9.

Moreover, a core problem with America’s health-care costs afflicts drug prices like just about every other aspect of health care–third-party payments. Back during World War II, the U.S. government imposed wage controls. In an effort to compete for workers, employers began offering health-care benefits. Later, the IRS approved employer-provided health care and health insurance as deductible business expenses. Individuals, who previously took care of these things themselves, could not get a similar deduction when they purchased health insurance out of pocket. This bias in the tax code helped mightily to push America toward a third-party (employer-provided insurance) payment system. As a result, Americans spend more freely for health care without shopping around and asking tough questions.

“Nobody spends someone else’s money as carefully as he spends his own,” Nobel laureate Milton Friedman often says. That truism has been on brilliant display in our health-care system for half a century.

But now back to drugs specifically. A new body of research offers a compelling contradiction to the notion that we need a “cure” for high-priced drugs. It turns out that these “expensive” new drugs might just be the best weapon we have against rising health-care costs–food for thought for government programs and employers who help pay for our health insurance. Are we getting good value for our drug dollars? “Yes,” says researcher Frank Lichtenberg, an economics professor at Columbia University and author of a recent, incisive article in the journal Health Affairs.

Lichtenberg looked at newer drugs versus older drugs and found that people who are using newer ones may be paying more for their medicines, but they have lower overall health costs, due in part to reduced hospitalizations. In addition, they live longer and have fewer lost workdays. We’re spending more time at the pharmacy, but less time in the hospital or on the surgical table. That means we are managing our conditions better and spending less on more expensive types of care. That’s good news for consumers and patients, as well as employers and our health-care system as a whole.

A study by Lichtenberg for the National Bureau of Economic Research last fall demonstrated that replacing 1,000 old drug prescriptions with 1,000 newer and more expensive drug prescriptions would increase drug costs by $18,000 but would also cut hospitalization costs by $44,469.

Innovations in drugs are helping us treat many conditions with often dramatically better results than previous treatments. Stomach cancer used to be an ailment that was treated primarily by invasive surgery and long hospital stays but today, drugs are more commonly used. The newest drugs do the best job, and though they seem “expensive” up front, they’re doing more to save lives and reduce overall health-care costs than surgery.

What Is Unseen

This is the “bigger picture” that often gets lost in the rush to save a few bucks. As Lichtenberg writes, “Drug costs (and changes in drug costs) are visible to the naked eye; identification of drug benefits requires careful analysis of good data.” Sound policy requires that we take into account “the full range of effects, not just the costs, of newer drugs.”

For this reason, the case for generics (older drugs for which the patents have expired) is vastly overstated. And the advertising that pharmaceutical companies sponsor for new drugs, contrary to those who champion generics, serves a useful economic purpose of informing patients and encouraging them to ask about the newest innovations.

Meanwhile, a growing number of state governments are implementing sweeping prescription drug cost-control programs. In Michigan, for instance, a state-appointed panel now authorizes only certain discounted medications for the 1.6 million Michiganians who rely on state programs (like Medicaid). To the extent the program shifts people to older drugs, the state may end up in the long run spending more for health care while patients suffer through longer recoveries.

Profits aren’t the problem either. Throughout the industry, they’ve been steady over time and comparable to the profits in other industrial sectors. Moreover, a study by Harvard economist F.M. Scherer proved there is a close correlation between pharmaceutical profits and research and development (R&D). The more companies make, the more they pour into finding the next cure or treatment for what’s ailing us. Profits encourage innovations, while regulations of dubious benefit add millions to the cost and long lag times before a drug can be marketed.

Furthermore, making a profit on drugs is not easy or automatic. Pharmaceuticals have the same patent life as other innovations (20 years), but because of the need for early filing, pharmaceuticals have about 11 years on average to recoup R&D costs and make a profit. Only 30 percent of drugs that reach the marketplace ever earn enough to cover average R&D costs. Government efforts to reduce profits in the industry can only increase the risk, reduce the investment, and ultimately yield fewer new drugs–all of which spells higher prices and a less healthy people.

American pharmaceutical companies have produced a constant stream of new pharmaceuticals for your doctor’s toolbox when you get sick. Common sense dictates that we consider all costs and all benefits, long-term as well as short-run, lest we be penny-wise and pound-foolish.

ASSOCIATED ISSUE

October 2002

ABOUT

LAWRENCE W. REED

Lawrence W. (“Larry”) Reed became president of FEE in 2008 after serving as chairman of its board of trustees in the 1990s and both writing and speaking for FEE since the late 1970s. Prior to becoming FEE’s president, he served for 20 years as president of the Mackinac Center for Public Policy in Midland, Michigan. He also taught economics full-time from 1977 to 1984 at Northwood University in Michigan and chaired its department of economics from 1982 to 1984.

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