By ALAIN ENTHOVEN and KYNA FONG Nancy Pelosi has promised that when the Democrats come into control of the House, they will repeal the ban preventing Medicare from negotiating directly with pharmaceutical companies, within the first 100 hours. She must expect that this legislation will bring down drug prices dramatically. In fact, it is not obvious that allowing the government to negotiate with pharmaceutical companies will lead to lower prices than those achieved by private drug plans. There are several good reasons that government negotiations may not decrease drug costs. First, negotiations are a bargaining process. The relative balance of bargaining power determines at which price the deal is struck. People often confuse market power with bargaining power. The thinking goes, the larger the share of the market the buyer represents, the greater the bargaining power and thus the lower the prices negotiated. That line of reasoning fails with drugs, however, because the seller is frequently a monopolist so it cannot be threatened with replacement by a substitute. Instead, the only threat is exclusion from the market. Rather than market share, a party's bargaining power is determined simply by its ability to say no, to walk away from the table without an agreement. Whether the government or a private drug plan has greater bargaining power is not clear. Which can walk away more easily and declare that some brand-name drug will not be covered on the formulary? Private plans like Kaiser or United are able to negotiate deep discounts with pharmaceutical companies precisely because of the plans' ability to say no -- the ability to include some drugs and to exclude others, allowing the market to judge the resulting formulary. On the other hand, when the government negotiates, its hands are tied because there are few drugs it can exclude without facing political backlash from doctors and the Medicare population, a very influential group of voters. In fact, the government negotiating on behalf of Medicare beneficiaries may lead to some unintended adverse consequences. Since direct-to-consumer advertising is legal in the U.S., there is nothing preventing pharmaceutical companies from funding a torrent of advertisements for the "latest and greatest" drug, thereby creating a strong demand within the Medicare population for coverage of the drug. How firm can the government stand when negotiating for a drug being clamored for? This is not the sort of bargaining power that will lead to lower prices. Secondly, by acting as one large buyer, the government will cause price discounts to become more expensive for pharmaceutical companies. In other words, the minimum price that the pharmaceutical company is able to accept increases. All else equal, this will lead to higher, not lower, prices. When private drug plans are negotiating individually with pharmaceutical companies, those companies have the power to "price discriminate," meaning they can charge lower prices to some drug plans and higher prices to others. This ability allows for large discounts. If Pfizer is able to give a deep discount to Kaiser without giving a similar discount to United, then it is less costly for Pfizer to give Kaiser that discount. If, however, Pfizer can give a deep discount to Kaiser only if the same discount is granted to all other Medicare drug plans, then the discount becomes very expensive. Experience with the Medicaid best-price rule, passed as part of OBRA '90, provides both empirical and anecdotal evidence of price discounts becoming more expensive when buyers' discounts are forcibly linked together. The best-price rule states roughly that Medicaid will be granted a price for a drug that is the lowest price offered to any buyer of that drug. If that price is not low enough, Medicaid receives a fixed discount off the average price. In effect, the best-price rule transforms all private discounts negotiated between a pharmaceutical company and a drug plan into public discounts for Medicaid. Research by academics, along with a slew of anecdotal evidence reported in the press, suggests that after passage of the Medicaid best-price rule, the days of deep discounts to private drug plans have been numbered. Instead, for most drugs the dispersion in prices has declined significantly and the overall level of prices has increased. Even with products for which there are therapeutic substitutes available, price competition has become less intense. All that aside, many will argue that, clearly, government negotiations lead to lower prices -- just look at Canada, or Britain, or France. True, those governments may obtain lower prices than the public pays in the U.S., but the real question is: Do those governments negotiate lower prices than what would be negotiated were smaller groups of buyers able to deal individually with pharmaceutical companies? Moreover, a great advantage that governments in other countries have over the U.S. government is the ability to control entry. Without direct-to-consumer advertising, citizens in other countries don't even hear about new drugs until the government has approved the drug and negotiated an amenable price. Interestingly, with the expansion of the Internet and unrestrained information flow, other governments have been facing new challenges. Earlier this year, a well-publicized legal battle brought by a U.K. woman against the NHS's decision not to cover Herceptin for early-stage breast cancer has compelled the NHS to reverse its original decision and to offer coverage for that drug. Finally, there is the familiar economic argument that the market-determined price is the only fair price. How can the government determine what price is "fair," what price appropriately reimburses pharmaceutical companies for all their research and development efforts? How can the government determine what prices will encourage the right levels of future innovation? The government negotiating prices only leaves room for additional gains through political lobbying and campaigning, activities at which pharmaceutical companies have proven themselves rather adept. Congressional Democrats need to be careful in making the logical leap from market share to bargaining power. Empowering the government to negotiate with pharmaceutical companies is not necessarily equivalent to achieving lower drug prices. In fact, neither economic theory nor historical experience suggests that will be the outcome. Members should think carefully before jumping on the bandwagon -- this promise may bring just the opposite of what was ordered. Mr. Enthoven is a professor emeritus at the Graduate School of Business at Stanford, where Ms. Fong is a doctoral student in economics.
negotiated drug prices
I'm no expert on this subject by any stretch of the imagination. I'd heard the usual "Big Pharma is evil!" vs "No price controls!" argument and I figured that was the basic gist of it. However, these two economists offer a different take, suggesting that negotiating prices might actually increase the price. They may be wrong, but it's worth reading, as this wouldn't be the first time a political agenda leads to unintended consequences. To my knowledge, these economists are completely nonpartisan.