Drug prices are distorted by state intervention.
The pricing of prescription drugs is often the subject of debate. Many forget that pharmaceuticals and drug development form a market like any other, but circumstances and the human condition make it admittedly more complicated. Medicine is unique in that it grapples with human life amid unavoidable scarcity. Scarcity forces tough trade-offs and costs, and when lives of our loved ones hang in the balance, emotions can overwhelm rational judgment. Politicians eagerly exploit these situations.
Politicians pose populist solutions that appeal to our emotions. But these policies are deeply flawed when they fail to understand pricing, information, and risk, thereby missing the etiology of the issues that plague the pharma and healthcare industry.
Economics is the science of managing scarcity. This principle holds true in pharmacoeconomics, as well, where drugs are developed in response to a need or demand and then must be managed accordingly. Pricing serves to transmit information and direct resources.
President Trump has launched TrumpRx and Most-Favored Nation pricing for pharmaceuticals, in response to what he deems excessive costs for American buyers for certain medications. The Trump administration is now allowing the American consumer to buy pharmaceutical drugs at costs comparative to those of foreign buyers, who purchase these at lower costs.
But this raises the question: Why are Americans paying so much more for drugs than consumers in Europe or Canada?
US prices are roughly 2.78 times higher than those in other high-income nations, but the picture is incomplete and manipulated to drive narrative. In the United States, bench-to-bedside is costly. According to a study out of Tufts University, the average drug costs billions of dollars to take from R&D to commercial. In addition, the drug approval process is a risky endeavor. Of the thousands of drugs that are submitted each year for approval, only about 9.6% from Phase I make it all the way through the FDA gauntlet. Only once approved and in the commercial sphere companies can they make a profit. It is now that countries like Europe and Canada, with socialized healthcare systems, come to the negotiating table. These countries like to buy our drugs but at near manufacturing costs. Manufacturing costs that come nowhere near R&D costs. Pharmaceutical firms now face a dilemma. As Thomas Sowell points out in Applied Economics, R&D costs are sunk costs. To quote Sowell, “Once these costs have been sunk, the price at which the product will be sold is determined by what the market will bear at that point forward, regardless of what the sunk costs were.”
Companies can either take the low-price deal and try to recoup as much as possible in volume, or they can turn down the deal and lose money entirely. But this leaves Americans to pick up the bill.
There is a silver lining: America is the world’s leader in R&D, spending $102 billion annually. Because Europe and Canada participate in socialized systems and price-fixing, they have little funding for R&D and innovation, relying on breakthroughs from the US. However, if America follows their lead, engaging in price caps and big government fixes, it will hamstring R&D and stymie our position as global leaders. Therefore, the increased costs on our end are necessary.
Critics might argue that US R&D is not solely funded by high domestic prices, pointing to global sales or subsidies. Yet data shows that the US accounts for about half of global pharma profits, which directly fuels innovation that benefits the world.
Regulatory burden has inflated the cost of drug development astronomically. Since the expansion of bureaucracy in healthcare and pharmaceuticals in the 1930s with the New Deal, then with the 1938 Food, Drug, and Cosmetic Act, and finally with the 1962 Kefauver–Harris Amendments (a massive increase in regulations and a shift in focus on safety to both efficacy and safety), prices have skyrocketed. Not to mention that these changes extended timelines on drugs—time is money—and caused a lag time with drugs making it to market before those of competitors in other countries. For reference, drug costs in the 1950s and ’60s were tens of millions of dollars in inflation-adjusted terms, compared to billions now. That is a massive increase in cost. This is primarily due to bureaucratic expansion into the process.
Furthermore, the centralized drug approval process spearheaded by the FDA distorts market information and drives up prices. For instance, it inserts a third party to assume risks on behalf of patients, when this really should be determined via individual trade-offs between safety, efficacy, and preference. The FDA has become increasingly risk-averse. As Milton Friedman decried in Free to Choose, the organization creates asymmetric incentives where there is no reward for expediency, but excessive costs for perceived errors. Unlike pharmaceutical companies, which face market feedback through profits, losses, and competition, the FDA incurs no direct costs for missing deadlines or stifling innovation. This encourages bureaucratic expansion, where enforcing ever-stricter regulations justifies larger budgets and broader authority, further inflating development costs and shrinking the pipeline of new drugs.
The centralized model assumes that a small group of individuals can make superior decisions on behalf of millions of people. It presumes that a small group of bureaucrats can process vast amounts of information more effectively than can markets. It deprives patients of a dispersed system in which the individual, doctors, drug developers, and firms make decisions, not a disconnected government-based third party. Without the FDA’s monopoly, accountability would not vanish; instead, we’d see more drugs reaching consumers, increased competition (with exponentially lower costs for biotech and pharma startups), and information flows for informed decisions by doctors, patients, and companies. In the most nefarious cases, courts and lawyers could enforce accountability.
The high price of pharmaceuticals serves as a signal to the buyer. It can indicate scarcity or surplus, or, as in this case, information that is being distorted somewhere upstream. If the Trump administration genuinely wants to address the high cost of pharmaceuticals, it must do so through aggressive regulatory reform. Price-fixing is a moot solution that will only exacerbate and further obscure the underlying crisis.
In a free market, voluntary exchanges drive efficiency; mandates only stifle.