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For more than 50 years, federal and state lawmakers have been fighting “price gouging” in the prescription-drug industry. This slippery term is best defined as “prices higher than my poor, sick constituents can afford to pay, and higher than my taxpayers want to pay to give the drugs to them as welfare.” Both political parties can find cause for outrage in drug shortages and dramatic price increases.
Creators’ monopolies—patents and copyrights for limited terms—are guaranteed in the Constitution, which explains that the purpose is to “promote the progress of science and the useful arts.”
To some, that’s price gouging with a constitutional passport. The Big Pharma companies, whose owners and employees invented most of the world’s important drugs, charge something close to the true value of their inventions for as long as they can.
When a patent expires, the market is supposed to take over and prices are expected to drop because of competition. But it doesn’t always happen.
In 1984, Congress passed a law making it much easier for upstart companies to produce copycat versions of drugs after the inventors’ patent monopolies have expired. Former Rep. Henry Waxman, a California Democrat, teamed up with Sen. Orrin Hatch, a Republican of Utah, to sponsor the law.
The copycats no longer had to spend three to five years meeting strict Food and Drug Administration requirements for new clinical trials—with paperwork to match—before bringing out cheaper, generic versions of the same drugs. The FDA established a simpler path for turning drug inventions into low-priced commodities.
More than 100 drugs with patents that had already expired quickly came onto the market in generic versions, and competition pushed down prices by as much as 90%. The generic companies had scant development costs and low production costs, so they could prosper with low prices.
As Waxman, Hatch, and their allies in organized labor and consumer activism intended, their generic-drug law was for many years the most important piece of pro-consumer legislation in the field. By 2015, generic drugs accounted for 88% of all prescriptions, up from about 20% in 1983. But the expected freewheeling competition turned out to last only a relatively short time.
Competition drove down prices to a bare-minimum cost of production, but that drove out all but the most efficient manufacturers. Then, competitors sorted themselves out into specialties, seeking economies of scope, and many merged to create economies of scale.
An unexpected result was that big inventive research-oriented pharmaceutical companies began to look like dinosaurs. They reduced their investments in research, closing labs and dismissing staff. Even monopolies couldn’t create enough profit to pay for decades of research and decades of compliance with premarket regulations intended to guarantee efficacy and safety.
Fortunately for the progress of science, Wall Street moved in to finance hundreds of speculative companies, each working on one or two drugs for as long as their funding lasts. The big companies are now primarily marketing and advertising giants, reducing their risk of failure by buying the rights to new products from the successful start-ups.
Equally unforeseen was industrial shrinkage: With fewer and bigger generic-drug companies, the market for generics began to look more like the brand-name market. More than 50% of generic drugs are supplied by only one or two manufacturers, so generic prices now are often as firmly fixed and profitable as those of patented drugs.
To some, this clearly inefficient market structure smelled like money. People like Martin Shkreli noticed that some drugs lose patent protection but don’t attract generic competitors. Such drugs are obscure, except to those patients who need them and to the investors who want to jack up prices.
Shkreli has become the most notorious price gouger in the generic-drug industry. He founded Turing Pharmaceuticals with a plan to find and acquire drugs for which patents had expired but no generic was being made. One of the first subjects for exploitation was Daraprim, a drug used in treating an illness associated with AIDS. In 2015, the company raised the U.S. price of the drug from $13.50 to $750 per pill, practically overnight.
Shkreli said, “If there was a company that was selling an Aston Martin at the price of a bicycle, and we buy that company and we ask to charge Toyota prices, I don’t think that should be a crime.”
With such an attitude, it was no surprise that Shkreli was declared a public enemy by some senators and both 2016 presidential candidates. He was also prosecuted for deceiving investors in a previous company—nothing to do with Daraprim—and convicted in U.S. District Court in New York on Aug. 4. He hasn’t been prosecuted for price gouging because that’s not a crime. Yet.
On the Offensive
The Maryland legislature, controlled by Democrats, recently passed the first state law against price gouging—raising prices “excessively” or “unconscionably”—for generic drugs and those whose patents have expired. Gov. Larry Hogan, a Republican, allowed it to become law without his signature, but the governor warned that it might have unintended consequences. It takes effect on Oct. 1.
The consequences of price fixing may be unintended, but they shouldn’t be unexpected; history is littered with consequences of governmental price fixing and with official denials of responsibility.
It’s easy for legislators and their constituents to understand that a corporation using a monopoly on production to raise prices to the stratosphere has abused its customers.