Why Is Medicine So Expensive?

The prominence of high drug prices among current American grievances derives from three recent episodes. In 2014 Gilead Sciences brought out Sovaldi, a drug that cures hepatitis C within twelve weeks but costs $1,000 a pill, making the price of a full course of treatment $84,000. In 2015 Turing Pharmaceuticals, a new company headed by Martin Shkreli, a hedge-fund manager, acquired Daraprim, the sole treatment available in the United States for a life-threatening parasitic infection, and raised the price per tablet from $13.50 to $750. (Shkreli is now serving a prison sentence for fraud unrelated to drug prices.) And in 2016 Mylan Pharmaceuticals, which had a stranglehold on the market for EpiPens (used to counter allergic shock), began selling them wholesale for $284 apiece, a 600 percent increase over the wholesale price in 2007, and offering them only in packages of two.¹

The three companies appeared to be emblematic of the entire pharmaceutical industry. Between 2008 and 2016, the price of new prescription drugs doubled, and the cost of some older drugs rose many times faster than the annual inflation rate.² A significant number of Americans, especially seniors, reportedly could not afford their medications.

Mounting public anger forced prescription drug prices onto the nation’s political agenda. During the 2016 presidential campaign, Hillary Clinton proclaimed that the prices for some drugs were “outrageous,” and Donald Trump attacked drug companies for “getting away with murder.” During his first year in office, Trump’s condemnations of the drug industry subsided, no doubt in response to the influence of his secretary of health and human services, Alex Azar, the former president of the American division of the Eli Lilly Corporation. But in his State of the Union Address in January 2018, Trump pledged that he would bring the costs of prescription drugs down “substantially.”³ On May 11, 2018, Trump proposed an overall policy for “Putting American Patients First,” which he supplemented with a more specific “blueprint” posted on the White House website. Though the document proposed a few regulatory measures, its overall thrust was that drug prices could be curbed by free-market forces. At the end of May, Trump claimed that some of the largest pharmaceutical firms would enact “voluntary massive drops in prices” within two weeks. That was news to the drug companies, whose leaders had planned no such action. Pressured by the Trump administration, a number of major companies, among them Pfizer, Novartis, and Merck, promised to keep their prices steady for the rest of the year.⁴

In late October, however, just before the congressional elections, Azar declared to reporters that high prices constituted “the greatest possible barrier to patient access.” Democratic strategists gave prescription drug prices high priority in congressional campaigns.⁵ Yet leaders in both parties understood that curbing prices would be no easy task. The pharmaceutical industry, which has long deployed one of the most powerful lobbies in Washington, was increasing its representation in the capital.⁶

No less important, prescription drug pricing, like health care in general, was bewilderingly complex. While the people who run Gilead and Turing may have been worlds apart in character and competence, the companies’ pricings were enabled by the same intricate system of laws, FDA regulations, and dispensing programs, including public and private insurers, that mediate between them and their customers. The system, largely unplanned, is a patchwork product of history, vulnerable to manipulation by the pharmaceutical industry.

Through much of the nineteenth century, as the historian Joseph Gabriel observes in his immensely informative book Medical Monopoly, drug monopolies were largely blocked by patent law and by an ethical code that both physicians and even a number of drug companies embraced. Monopolies could in principle be obtained through patents, but most medicines then consisted of plants, which, along with their extracts, were considered ineligible for patents because they were made by nature rather than by man. Medicinal fabricators nevertheless packaged and bottled a variety of concoctions composed of minerals, metals, and even plants and sold them in shops as “patent” medicines, although most were not legally patented. They protected their products from competitors by keeping the ingredients secret.⁷

“Orthodox physicians,” to use Gabriel’s term, disparaged patent medicine men as quacks and charlatans. They castigated the secrecy surrounding the patent-medicine enterprise, arguing that it prevented physicians from knowing if the ingredients were inferior or dangerous. And they decried monopolies in medicine as pernicious restrictions on accessibility of treatment that privileged profit over the welfare of patients. When what came to be the American Medical Association was established in 1847, the founders adopted a code of ethics that declared it “inconsistent with beneficence and professional liberality” to patent a medicine or prescribe a medicine that was patented, associating such medicines with “disgraceful ignorance, or fraudulent avarice.” Some drug producers—the “ethical” branch of the nascent business, as Gabriel calls it—self-consciously aligned themselves with these norms. They tended not to seek legal patents even on chemically based medicines, which were eligible.

During the half-century after the Civil War, however, the drug business proliferated with new firms, including ethical adherents such as Parke, Davis & Co. and Eli Lilly & Co. The establishment of federal trademark law in 1870 meant that companies could protect their products in the market by trademarking their brand names while keeping the contents secret. Ethical firms disapproved of trademarked drugs, and so did physicians and pharmacists, for much the same reasons that they condemned patented medicines, including secrecy and high prices—“double that which any reputable pharmacist would prepare it for,” a physician complained.

But the ethical firms began to find themselves disadvantaged by their ethics. The multiplication of firms increased competition and placed a premium on the production of new remedies. Companies began to establish laboratories for drug research and development, a trend led by Parke, Davis & Co. The firm came to see that in the absence of patent protection for its products, other companies could compete against it using its own innovations.

This disadvantage was worsened by the entrance into pharmaceutical manufacturing of chemical firms, which had no history of engagement with the medical profession and its ethical resistance to patents. For them, patents were a natural part of business. Beginning in the late nineteenth century, German companies such as Bayer, exploiting their formidable capacity in organic chemistry, produced, patented, and sold in the American market powerfully effective drugs, notably aspirin.

In these new circumstances, the ethical drug companies embraced patents on their products and trademarks on their brands. Physicians increasingly recognized the incentive to innovation that patents provided, the benefits of public disclosure of formulas and ingredients, and the growing identification of patented drugs with efficacy. They also welcomed trademarked brand names as an indicator of a medication’s quality and reliability. The 1906 Pure Food and Drug Act and its 1912 amendment, which were intended to safeguard consumers from dangerous products in part by requiring the disclosure of a drug’s ingredients, also, as Gabriel points out, protected drug manufacturers from competition by producers who falsely or misleadingly described their products’ contents, or who kept them secret.

In 1912 the AMA revised what it now called its “Principles of Medical Ethics,” making it acceptable for physicians to patent their innovations as long as they did not profit from them. Between the wars, universities patented biomedically effective discoveries made in their laboratories, not primarily to make money but, through licensing, to control their use for public good.⁸ Royalties from the licenses were generally used to support academic programs, but in Gabriel’s judgment, physicians also collaborated with manufacturers “to advance both the cause of science and their own personal careers. The pursuit of individual interest, the creation of corporate profit, and the battle against disease were increasingly intertwined.”

Those pursuits were further joined in 1980, early in the era of genetic engineering, when in the Bayh–Dole Act Congress authorized universities—the centers of research into recombinant DNA—to patent and license useful results that might emerge from federally funded investigations in their laboratories. Many research universities and a number of their scientists soon entered into an alliance with the drug industry in profit-minded pursuit of innovation.⁹

In the 1950s reformers advocated for addressing high prescription drug prices—a public-sector issue—with a private-sector solution: competition from generic drugs, i.e., drugs that are copies of originals or that are composed of the same active ingredients and are functionally their equivalents. Established companies selling brand-name products resisted this proposal, as the physician and historian Jeremy Greene shows in his deeply knowledgeable Generic: The Unbranding of Modern Medicine. Likening generics to the adulterated foods in Upton Sinclair’s The Jungle, such companies obtained passage of laws in forty states prohibiting pharmacists from dispensing anything other than brand-name drugs.

The creation of Medicare and Medicaid in 1965 helped turn the tide. Both programs called for the use of generics wherever possible, and, increasingly, so did health maintenance organizations and private insurance plans. Beginning in the late 1970s, the consumer movement helped overturn the anti-substitution laws. By 1984, all fifty states plus Washington, D.C., had passed legislation favoring, and in some cases requiring, the use of generics in place of brand-name drugs.

The growth of the generics industry was also aided by a shift in FDA policy. In 1962, after a crisis over birth defects caused by the West German drug thalidomide, Congress required applicants for FDA approval of new drugs to demonstrate that the drugs were not only safe but also effective. Obtaining approval for a drug, even a generic, now required the filing of a New Drug Application that included data from clinical trials demonstrating that it met both requirements. Would-be generic manufacturers were generally unwilling to go to the expense of clearing that bar. But in 1969 James Goddard, the head of the FDA, dealt with the obstacle by establishing an “Abbreviated New Drug Application” (ANDA), which permitted the generic applicant to qualify for approval by using the clinical trial data accumulated by the drug’s original creator and showing that its product was the original drug’s chemical and biological equivalent.

Supporters of pharmaceutical innovation, drug patents, and generic competitiveness achieved the passage in 1984 of the Hatch–Waxman Act, cosponsored by Senator Orrin Hatch of Utah, a Republican and a vigorous advocate of the pharmaceutical industry, and Congressman Henry Waxman, a Democrat from California and a staunch proponent of consumer interests. The drug industry had long complained that the commercial life of its patents was effectively shortened by the several years required to achieve FDA approval for a new drug. To restore the patent to de facto full life, the act granted new drugs a period of “data exclusivity,” five to seven years from the time they were approved, depending on the drug’s type and/or class of patients. The FDA could not approve an ANDA for a generic that used the originator’s trial data until the end of that period.¹⁰

Hatch–Waxman provided broad encouragement to generics by authorizing quick and straightforward approval of ANDAs that did not run afoul of an originator’s patents. In a procedural category dubbed paragraph IV, it also encouraged generic applicants to challenge an originator’s patents that it considered invalid or weak. The challenger risked having to fight an infringement suit from the originator, but if the originator lost the suit or declined to sue, the first challenger stood to gain FDA approval and be rewarded with 180 days of “market exclusivity” against any other generic competitors.¹¹ It would thus share the market only with the originator for six months, during which monthly revenues might be tens of millions of dollars.

Hatch–Waxman accelerated the growth of the generic industry. So did private insurers, which favored generics in their reimbursement policies, state substitution laws, and revisions to Medicaid and Medicare; both programs hugely boosted demand for brand-name and generic drugs alike. Although the states were not required to provide drug coverage to Medicaid outpatients, all did (and still do); since 1990 the program has included federally mandated rebates from the average price of brand-name drugs. Medicare Part B had been paying the drug costs of patients in hospitals and clinics. In 2003 Congress established Medicare Part D, which extended coverage to outpatients beginning in 2006. Generics, which in 1984 comprised almost 19 percent of filled prescriptions, now account for about 90 percent, and sell for 80 to 90 percent below brand-name prices.¹²

The 1980s marked the beginning of a new generation of drugs, including monoclonal antibodies and cancer therapies such as Humira and Herceptin. These are called “biologicals” because they are manufactured using the biological dynamics of living organisms such as bacteria and because they are made up of molecules more than twenty times larger than those resulting from chemical synthesis such as Lipitor or Prozac. Biologicals are expensive to manufacture, defy precise physical and chemical description, and are difficult to reproduce without detailed command of their methods of production. Companies therefore opted in the main to protect their intellectual property in biologicals by patenting not the products but the methods used to make them, while—in the vein of the patent- medicine men—maintaining knowledge of parts of the process as proprietary secrets.

Faced with the difficulty of reproducing biologicals, the generics industry aimed to devise substitutes for them called “biosimilars”—drugs that closely resemble them and perform similar therapeutic functions. The generics industry pressed the FDA to establish an ANDA option for biosimilars, rightly pointing out that biologicals were fast becoming the most expensive part of the prescription drug market. The brand-name innovators fought the initiative. They were eschewing patents on biologicals as products, and their patents on the methods of producing them, which were imprecise, would be difficult to defend in court against biosimilar competitors.

Greene notes that the weakness of the patent protections turned the attention of originators to the protective period of data exclusivity. If biosimilars could gain FDA approval through the ANDA process after at most five years of data exclusivity, the innovators of biologicals would have little time to reap returns they counted as adequate on the costs of developing them. In 2009 Congress enacted a compromise within the Affordable Care Act. Titled the Biologics Price Competition and Innovation Act, the measure granted original biologicals the extended protection of twelve years of data exclusivity. And it established two routes to ANDA approvals of biogenerics—a straightforward one for biosimilars as such, but a far more expensive and demanding one, requiring clinical trials, for biosimilars that claimed complete therapeutic interchangeability with the original drug.

All the while, the brand-name branch of the pharmaceutical industry continued its war against generics, resorting to a variety of strategies. A number of companies marketed cheaper versions of their own brand-name drugs after the patents on them had expired, relying on advertising and reputation to outsell current or prospective competitors. Some—including Shkreli—restricted the distribution of their drugs to keep them out of the hands of would-be generic competitors, denying them access to the knowledge that would enable replication. Still others exploited Hatch–Waxman to delay competition by filing infringement suits against paragraph IV applicants, which automatically postpones approval of the generic—and extends the monopoly of the original—for up to thirty more months.¹³

In recent years the pharmaceutical industry has sought to thwart competition from biosimilars and has persuaded the legislatures of a number of states to prohibit their substitution for biologicals unless they qualify as interchangeable.¹⁴ It has staunchly defended the twelve-year period of data exclusivity for biologicals, even though the period is shorter in every other pharmaceutical-producing country. And a number of companies have refused to provide samples of their biologicals or information concerning their manufacture to would-be biosimilar producers.

More than two hundred brand-name drugs are currently without generic alternatives. The main reason, it seems, is that the market for the drugs is too small to attract or sustain generic producers. This enables single suppliers to gouge their customers.¹⁵ Some generic companies have also engaged in anticompetitive behavior, including price-fixing.

Henry Waxman retired from Congress in 2015 but as the president of Waxman Strategies, his lobbying and communications firm, remains engaged in encouraging drug innovation while curbing the rise in prices. Perhaps no one knows the intricate interplay of public and private prescription drug policy better than Waxman, who dealt with the subject through much of his fifteen terms in Congress. His 2017 report, Getting to the Root of High Prescription Drug Prices—coauthored with his colleagues Bill Corr, Kristi Martin, and Sophia Duong—is temperate in tone and authoritative in content. It scrutinizes the pharmaceutical industry, health care programs—Medicaid, Medicare, the Veterans Administration, private insurers—price negotiators, pharmacies, and both insured and uninsured consumers. It merits attention not least because it takes this patchwork system as a whole, identifies the connections between its disparate elements and skyrocketing drug costs, and offers a variety of solutions for excessive pricing.

The report holds that the principal price drivers are, for post-patent drugs, the de facto monopolies produced by the failure of markets to enable or attract competitors, and, for new brand-name drugs, the monopolies that result from the patents that cover them, from Hatch–Waxman’s grant of data exclusivity, and from the originator’s patenting additional clinical uses for the drug, which brings data exclusivity for an additional three years. All told, innovators of new small-molecule drugs enjoy on average almost thirteen years of effective market monopoly.¹⁶ While brand-name drugs account for only 10 percent of prescription drug fulfillments, they command 72 percent of drug spending. Waxman alludes to the measure he coauthored: “US prescription drug pricing over the past decade reflects a distortion of the policies enacted by Congress to balance innovation and price competition and to enable access to affordable medicine.”

Not only do the brand-name originators—“pioneers,” to use Waxman’s word—launch their drugs at high prices; some also raise prices without in any way improving their products. The Veterans Administration and Medicaid may lower these prices with federally mandated rebates, but the rebates are subtracted from the average of brand-name list prices. Medicare Part D, which in 2016 covered between 29 and 35 percent of annual prescription drug costs, also begins with brand-name list prices, but when Congress established the program, the pharmaceutical industry successfully lobbied to prohibit the federal government from negotiating on behalf of Part D recipients.¹⁷ Negotiations for the program are conducted instead by a handful of private companies, through their pharma benefit managers (PBMs). The PBMs deal with both brand-name and generic drugs, and they perform the same function for many private insurance firms. They obtain discounts and rebates from the list prices, and in principle pass on most of the savings to purchasers.

Critics contend that Part D prices would be much cheaper if the federal government negotiated them directly with the manufacturers.¹⁸ Spokespeople for the drug industry counter that they are nonetheless negotiated, pointing to the PBMs. But the PBMs keep some unknown portion of the discounts and rebates for themselves and for private insurers, and the entire process is cloaked in secrecy. To reveal any of it, the parties say, would jeopardize the security of proprietary information. The public, including the government, thus has no knowledge or oversight, let alone control, of the disposition of the billions of dollars paid each year into Medicare Part D by its enrollees and the government itself.

The pharmaceutical industry and its advocates justify high initial prices by pointing to the social value of the new drugs—that is, what patients, hospitals, employers, and the government save because they don’t have to cover the long-term cost of treating illness.¹⁹ They also defend them on the grounds that companies need substantial revenues to pay for the research and development—estimated by the drug industry at $2.6 billion or more per successful innovation—required to devise new drugs and see them through clinical trials to FDA approval.²⁰

The drugs do generate long-term value—better, for example, to be cured of hepatitis C by taking pills for twelve weeks than to suffer the extended pain and costs of a liver transplant—but it is questionable, to say the least, that the social savings should accrue to private suppliers. That rationale gains a hearing only because the industry’s products enjoy, at least for a while, the monopoly of a patent. (The Waxman report tacitly rejects the value-pricing argument by simply ignoring it.)

In principle the need to fund drug development is fair enough, but drug prices in general bear little relation to the costs, and value pricing bears none. And as Waxman’s report points out, some highly profitable drugs—for example, the cancer drug Taxol, which has earned billions—were originally devised in academic laboratories with considerable federal support and only then patented and licensed to private companies. The Waxman report also notes that the drug industry spends at least as much on advertising as it does on research and development.

Waxman’s solutions address the system that drives the drug-price juggernaut. So, though in a more piecemeal fashion, do the remedies President Trump has proposed in his blueprint and the months since. In many respects, however, the two plans are a study in contrast, Waxman’s relying far more than Trump’s on public intervention. Trump and Waxman both call for promoting competition through generics by, as Trump puts it, taking “steps to end the gaming of regulatory and patent processes by drug makers to unfairly protect monopolies.” Both urge accelerating the approval of biosimilars.

Both address the exclusivity features of Hatch–Waxman, but here Waxman goes further than Trump: he calls for reducing the data exclusivity period for biologicals to seven years and ending all periods of data exclusivity once a pioneer has recouped some adequate “multiple”—he does not say how large—of its investment in developing the drug, and for abolishing the thirty-month postponement of approval for paragraph IV ANDA applicants and the 180-day period of market exclusivity awarded the first such applicant. Both urge that drug advertisements include price information—in October the Trump administration proposed regulations to that effect—and Waxman calls for them also to include comparisons with alternative drugs so that patients can make more informed decisions about their purchases.²¹

Waxman calls for authorizing Medicare to negotiate Part D drug prices directly with manufacturers and open the process to public scrutiny and oversight.²² Contrary to his campaign promises, Trump does not. Rather, he resorts to fixing the privately controlled system by requiring PBMs to strengthen their negotiating power with drug makers and to pass their rebates directly on to consumers. In October Trump signed a bipartisan bill banning “gag rules”—a condition of sale whereby PBMs and insurers prohibit pharmacists from informing patients of suitable drugs that are not covered by their insurance plans but are cheaper than those that are.²³ He also wants to limit price increases to the inflation rate and provide low-income seniors with free generics.

Trump’s proposals largely ignore market failures. Waxman aims to counter them by establishing federal incentives for the development of additional domestic producers and by allowing the importation of cheaper drugs vetted for safety and efficacy. Trump contemplates importing drugs that are substitutes for those produced by a single, price-gouging supplier that are not covered by patents or grants of exclusivity. Waxman wants to compel drug manufacturers to provide samples and manufacturing information to would-be generic and biosimilar producers. Trump does not.²⁴

Neither Trump nor Waxman addresses more than obliquely the elephant in the room: the prices of new drugs at launch and through the monopolistic years after their sale has been approved. In keeping with Trump’s nationalist aim of putting American patients first, his blueprint declares that the United States should pressure foreign governments to raise their drug prices. The strategy aims to force foreigners to pay a fairer share of drug development costs now borne mainly by the United States. The expectation, implausible on its face, is that American companies, by earning more abroad, would reduce prices at home. In late October, in a preelection attempt at plausibility, Trump announced that his administration was “taking aim at the global freeloading” by proposing that the US government tie the amount it pays for drugs under Medicare B to their cost in other countries, phasing in the shift over five years. American pharmaceutical companies, he declared, had too long “rigged the system” against American consumers.²⁵

Waxman calls on the government to require reasonable prices for brand-name drugs developed with the results of federally funded research. He finds authority for that proposal in the Bayh–Dole Act, which obligates the government to ensure that innovations arising from such research are made “available to the public on reasonable terms.”²⁶

Following the Democratic victory in the House in November, Trump declared that he looked forward to collaborating with Nancy Pelosi to ensure affordable drug prices. But Trump’s blueprint, despite its expansion since it was first released, tended to leave the pharmaceutical industry largely unscathed; one might say that it put the industry, not patients, first. At the beginning of this year, drug companies announced price hikes averaging close to 7 percent on hundreds of medications.²⁷ Democratic legislative initiatives, some of them borrowing from Waxman’s playbook, authorize Medicare to negotiate prices directly with drug companies and abolish the tax deductibility of drug-advertising costs. A measure coauthored by Senator Bernie Sanders empowers the secretary of health and human services to strip a company of its drug patents if the secretary determines that its prices are too high. Amid mounting evidence that a cartel of generic companies had been driving up prices on three hundred drugs, Senator Elizabeth Warren introduced a bill enabling the government to manufacture drugs in cases where competition is nonexistent or suppressed and prices are exorbitant.

Congressman Elijah Cummings, a stalwart critic of the drug industry and now chair of the House Committee on Oversight and Reform, has opened a sweeping investigation into the pricing practices of major pharmaceutical companies. Even Senator Mitch McConnell declared on election day, “I can’t imagine [drug pricing] won’t be on the agenda.” Yet a number of House Democrats have close ties to the pharmaceutical industry, and so do many Republicans, and any efforts at reform will be challenged fiercely by the PBMs and the pharmaceutical industry.²⁸ It would be foolhardy amid the profit-hungry standards and culture of contemporary capitalism to expect the drug industry and its allies in medicine and academia to recommit to anything resembling the ethical code of the nineteenth century. Nor would it be beneficial, practical, or legal to deprive the system of financial incentives to produce new efficacious drugs.

But recall that in the early decades of industrial capitalism, Americans enlisted the government to ensure that the private engines of economic growth better served the public interest. Waxman is hardly alone in thinking that, given the formidable power of the drug industry, mainly private-sector solutions to the public-welfare problem of ever-rising prescription drug prices are inadequate. Polls have revealed that his major proposals for reform enjoy widespread public support. The current system deprives millions of people of the drugs they need, and, as Waxman says, it is helping to make health care costs in the United States “unsustainable.”