Reprinted from Smirking Chimp
High drug prices have been big news lately. Some of this has been due to straight out price gouging by the likes of Martin Shkreli, everyone's favorite young punk hedge fund tycoon and potential convict. However the more common problem stems from the exorbitant price charged for important new drugs like the Hepatitis C drug Solvaldi.
Gilead Sciences, the patent holder for Solavldi, has a list price for this drug in the United States of $84,000 for a three-month course of treatment. The company argues the drug is worth the price since it can cure people of a debilitating and potentially deadly disease.
While the drug clearly has great value, that does not necessarily justify its high price. After all, the firefighter who rescues your family from a burning house has also provided a service of enormous value, but she doesn't expect to get paid millions of dollars for her work.
The issue with Sovaldi is actually very similar to the issue with the firefighter. It doesn't actually cost anything like $84,000 to manufacture the drug and deliver it to patients. We know this for certain because there are generic manufacturers in India that can produce high quality versions and sell them profitably for $200-$300 per treatment. This means that Gilead Sciences may be charging a price that is more than 300 times what is needed to cover the manufacturing and distribution of the drug.
The justification that Gilead Sciences and other drug companies offer for their prices is the need to recoup their research costs. They argue they need the monopoly provided by patent protection so that they can charge prices high enough to cover both the research costs on successful drugs and also all the money spent researching drugs that failed.
There are serious questions about the industry's actual research spending. Much money goes to marketing, since the industry has enormous incentive to promote the sale of a drug selling for 300 times the cost of production.
There is also much money that goes to copycat research, since monopoly pricing gives competitors an incentive to get a share of the rents enjoyed on a breakthrough drug like Sovaldi. This can lead to lower prices in a world where the government is granting patent monopolies, but this duplicative research would generally have little value if drugs were sold in a free market.
And much of the research is often done on the government's nickel. Many important new drugs, including Sovaldi, rely heavily on research that was funded by the government through the National Institutes of Health.
There is a better route. If the government actually paid for the research, not just at the early phases but through the clinical testing and FDA, then there would be no reason for patent monopolies. Drugs could be sold in a free market just like toothpicks and plastic cups. We wouldn't have big problems debating whether Medicare, Medicaid, or private insurers should pick up the tab if the next major cancer drug cost $200 a treatment instead of $200,000.
There are various mechanisms through which the government can finance research. It could offer a prize for promising new drugs and buy up the patent rights, as some economists like Joe Stiglitz has proposed.
An alternative is to pay for the research upfront. This can be done through the private sector with companies bidding for long-term contracts to conduct research in major areas. An advantage of this route is that a condition of the funding could be that all the results are made fully available to other researchers and the public as soon as practical. This should lead to more rapid progress since science advances most quickly when it is open.
Of course no one is going to switch from the current system to an alternative overnight. Any alternative would have to be tested and demonstrate its superiority. An obvious way to phase in a move to the direct funding system would be to have publicly funded clinical trials. If the government paid for the trial of a promising drug, after first buying up the patent rights, it could then make any new drug available at the free market price once it was through the FDA approval process.
An additional advantage of going this route is that all the clinical test results would be fully available to other researchers and physicians so that doctors could determine if a particular drug is likely to be useful to specific patients. For example, the trials may have evidence that a drug is not especially effective for older people or for those taking arthritis medications. While a pharmaceutical company selling a drug for a markup of 10,000 percent may not be anxious to highlight such evidence, a company that is paid exclusively to conduct clinical trials has no motivation to conceal data.
This is where Bill Gates comes in. With the current gridlock in Washington, which is likely to persist even after the election, we are not going to see any action on financing research any time soon. However a wealthy philanthropist certainly could pick up the cost of financing the clinical trials of several promising new drugs.
According to recent research by an economist with close ties to the drug industry, the total cost of all three phases of the testing process comes to a bit over $300 million, counting the costs of going through FDA approval. If we accept his assumption on failure rates, this would imply costs of roughly $1 billion on average to get at a drug through the approval process. If we allow $500 million to $1 billion for the purchasing the patent rights to promising compounds, we have a total tab of $1.5-2.0 billion, which is well within the resources of the Gates Foundation and in fact several other charitable foundations and wealthy individuals.