The Medicare prescription drug benefit was, from the beginning, flawed in the details of its execution. But in general terms it is turning out to be one of the best health care investments our government is making:
Rewarding inventors with inefficient monopoly power has long been
regarded as the price of encouraging innovation. Public prescription
drug insurance escapes that trade-off and achieves an elusive goal:
lowering static deadweight loss, while simultaneously encouraging
dynamic investments in innovation. As a result of this feature, the
public provision of drug insurance can be welfare-improving, even for
risk-neutral and purely self-interested consumers. In spite of its
relatively low benefit levels, the Medicare Part D benefit generate
$3.5 billion of annual static deadweight loss reduction, and at least
$2.8 billion of annual value from extra innovation. These two
components alone cover 87% of the social cost of publicly financing the
benefit. The analysis of static and dynamic efficiency also has
implications for policies complementary to a drug benefit: in the
context of public monopsony power, some degree of price-negotiation by
the government is always strictly welfare-improving, but this should
often be coupled with extensions in patent length.
In other words, the optimal ex post incentive scheme involves some market power for drug makers. To some extent the subsidy counteracts the deadweight loss resulting from that monopoly by lowering real prices to consumers.
Here is my previous post on the topic, also indicating that the Medicare prescription drug benefit is not nearly as costly as has been charged. Of course subsidizing the pharmaceutical companies does not always sit so well with the left, so I am curious whether progressives will accept this result. And I am curious whether they envision single-payer programs as continuing this subsidy, or confiscating pharmaceutical company rents instead.
As a side remark, Martin Feldstein was the one who saw, way back when, that health care economics would become such a major field; kudos to him.
Addendum: Sorry for the omission, here is the paper itself.