Price Controls on Pharmaceuticals

Frank Lichtenberg uses a novel strategy to estimate the effect of price controls on innovation.  Simplifying (see the paper for details) Lichtenberg argues that the profit from a pharmaceutical is essentially P*Q-FC where P is price, Q is quantity and FC is fixed cost.  Most of the fixed cost is due to research and development and getting through FDA hurdles.

The key to Lichtenberg’s strategy is to note that changes in Q have the same effect on profit and thus on the incentive to innovate as changes in P (this is not really true since changes in P also influence Q but Lichtenberg adjusts for the elasticity of demand).  Moreover we can estimate the effect of changes in Q on innovation by looking at how the incidence of a disease influences innovation.  Lichtenberg finds, for example, that pharmaceutical innovation is higher among cancers with greater incidence (e.g. lung versus pancreatic cancer).  Using the Q to innovation relationship he estimates that a 10% reduction in price would reduce pharmaceutical innovation by 5%.

We know that pharmaceutical innovation saves lives and has a very high benefit to cost ratio.  Thus, price controls or other restrictions that reduce prices are almost certainly a bad idea.

Indeed, as I have argued before, health care spending on the margin has very low value.  We know, for example, that Medicare regions that spend twice as much on patients have no better outcomes.  Spending on health care research and development, however, has very high value.  Thus price controls would be a disaster – reducing high value R&D and replacing it with low value current spending.

I fear that short-term thinking by politicians and the public will destroy the US pharmaceutical industry. 


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