How the same drug costs three times the price in the US than in Europe

(NOTE FROM JOHN: This really ticks me off. Apparently, governments in Europe tell the drugs companies that they simply can’t charge crazy prices over here in Europe, so they don’t. Instead, they jack the prices up in the US to make up the difference. Absolutely criminal. So why haven’t we heard about this from our elected officials, ever? PS I bought Advair 500-50 for 60 euros this past Friday in Paris – it goes for $272.79 at Costco.)

This post is inspired by John A’s question about his asthma medicine, Advair and draws on conversations I have had with some industry insiders who prefer to remain unnamed. Though Advair is sold under different names in France (Seretide) and in the USA (Advair), it is in both cases the identical drug manufactured by the same company, GlaxoSmithKline. So how is it that “Advair 500-50” costs 60 euros in France ($88 at today’s exchange rate), but $270 at Cotsco in the states – nearly three times as expensive in the USA? And what can we do about it?

First, the most important fact is that France controls the price and the USA does not. While it is not entirely obvious (at least to me) on what basis they pick the price, it is clear that France has a consumer driven system where the government’s goal is to make its citizens happy without worrying at all about drug company profits. But there is no question that the drug company (GlaxoSmithKline) is free to stop selling the drug in France if they can’t make a profit. So we know that they can make money at the controlled French prices – no surprise since they already have the production process up and running and the cost of actual ingredients in prescription drugs is less than 10% (on average) of the selling price in the USA.

But what of the price in the USA? How is that picked? While drug can’t entirely ignore the demand side of the market (e.g., if they price too high, insurance companies can refuse to cover the drug under their plans), they DO have monopoly power. The patent rights that companies get for prescription drugs last 20 years -– but that period includes the time required for clinical testing, reducing the effective patent protected period of sales to less than half that time. Companies make good use of this protection as any capitalist monopolist would — they charge a price designed to maximize company profits.

Should we then just limit prices to the 10% of current prices that represent the cost of actual ingredients? Certainly not. A major portion of the cost of a drug is the research and development that goes into finding it in the first place. After all, years of research and clinical trials are needed for a new drug and only about one in ten drugs that make it to trials ever pan out and make it onto pharmacy shelves. It is only fair that companies be able to recoup this amount. It is worth noting that it isn’t fair at all for the entire cost of R & D to be borne by US consumers alone as is the case right now with controlled prices everywhere else in the world.

But how much does it cost to develop a drug? Big pharma claims at the moment that it costs about $800 million for each new drug. This amount is complete BS as it includes the drug company estimates of what the money could have earned if it had been invested elsewhere rather than being invested in drug development. A more legitimate estimate of the amount it costs a pharmaceutical company to develop a new drug is more like $200 million to $300 million.

But even this number is inflated. Remember that pharmaceutical giants are truly giant. These are huge bureaucracies –- GSK employs about 100,000 people. Efficiency is not a word we would normally associate with such a huge structure. Much of the cost of development is really just life support for the bureaucracy; small biotech companies can do the same R & D at half the cost because they don’t have tens of thousands of employees doing God knows what activities unrelated to discovering and patenting new drugs.

So, are there excess monopoly profit hidden in US drug prices? You bet. Is there excess cost included in the price that could further inflate the price to consumers? No question – our loyalty needs to be to consumers, and not to gigantic corporate bureaucracies.

So what do we do about it? Some will say that what we have to do is regulate prices as France and other countries do. While I wouldn’t argue against doing that at some point, there is a far easier way to make an immediate impact and it is one that has been proposed in Congress already — just open the gates to reimportation of prescription drugs from Canada and Europe. With appropriate safeguards against drugs manufactured elsewhere (e.g., China) we would at a stroke provide some very real competition which would immediately bring down prices here.

But that would eliminate the companies’ ability to recoup R & D costs wouldn’t it? Well, no. It WOULD force them to charge a higher price abroad since in effect that would become the price in the USA as well. If this happened, the increase in price compensating the pharmas for the cost of R & D would then be spread over everyone in all countries, as it should be. The drug companies would have to negotiate that price with each of the governments involved. Which is only fair because let’s drop the pretense that any of this is a free market. It isn’t. And we need somebody with some market weight operating on OUR side for a change. How about our own government?

I teach economics at Cornell University and specialize in macroeconomic policy both in the US and in developing countries. I often travel overseas to do research and consulting in other countries, most recently in Africa and Central Asia. I sometimes wonder how this ever happened, but I guess it is no real surprise after previous careers as a bond trader in the British government bond market, an economist at the World Bank, and a short order cook on the beach in Delaware. My personal obsessions are politics and sailboats so I alternate between being a complete news junkie and being completely unplugged from any media or communications whatever on sailboats wherever there is warm weather. Having grown up overseas in various countries in Latin America I always have a desire to be nearer to palm trees.

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