Government Sues to Raise Drug Prices

The headline in the NYTimes read “Schering Case Demonstrates Manipulation of Drug Prices.” The article continued:

A $345.5 million settlement by Schering-Plough yesterday to resolve a government Medicaid investigation provides a detailed glimpse into how drug companies can manipulate prices to overcharge state and federal programs.

Government officials have taken a keen interest in how drug makers price and market their drugs in recent years, and the settlement is the latest in a series reached with large drug makers over accusations that they have overcharged Medicaid. Last year, Bayer paid $257 million and GlaxoSmithKline paid $86.7 million to settle similar allegations.

Now you probably think this article is about how drug firms acted collusively in order to raise prices, right? Nope, read carefully and you will see that intense competition from Allegra caused Schering to reduce the price of Claritin. Great! Not according to the Feds. The price reductions violated Medicare’s Most Favored Customer clause which requires pharmaceutical manufacturers to give Medicare the lowest price they offer any other customer.

Most Favored Customer/Nation clauses are routinely analyzed in game theory texts as ways for firms to tacitly collude to raise prices. The idea is simple – it’s easier to commit not to compete if lowering price for one customer means lowering prices for all customers. Indeed, this is precisely why the antitrust authorities often sue to prevent firms from using MFC clauses. The evidence supports the theory, after the MFC clause was introduced pharmaceutical prices rose.

The US Attorney may think that “we’re fighting to keep the costs of health care down for everyone,” but in truth by reducing competitive pressures to lower prices they are helping the pharmaceutical firms to maintain a cartel.

Addendum: Put it this way, now that the government has successfully sued the firms for reducing prices do you think a) the firms will now cut the price to Medicare to match the rebates or b) stop giving rebates?