High drug prices in the U.S. significantly contribute to the high cost of health care and health insurance. Rand Corporation found that in 2016 Americans spent $10,300 per person on health care, and 17% of that was on drugs. The U.S. has 5% of the world’s population but spends half of the total world expenditure on drugs. Such expenditure increase will lead to serious disruption in the health care system and in Americans’ lives.

The latest state data for 2014 shows that Utahns spent $784 per capita on prescription drugs and medical nondurables (PD&MN), one of the lowest amounts among states (Kaiser Family Foundation). That is 33% of the total per capita spending on health care, much larger than in some Scandinavian countries. However, using average growth rate of 1.8% per year for the decade 2004-2014, the 2014 per capita expenditure on PD&MN in Utah would increase to $857 in 2019.

The claim, by Budget Director Mick Mulvaney, that drug prices have fallen for the first time in 50 years is erroneous. The use of pharmaceutical drugs data from the Consumer Price Index is very unreliable, according to the National Bureau of Economic Research. In fact, the list prices of more than 3,000 drugs increased, and they decreased for only 117 drugs as cited by KFF on April 7, 2019.

Drug companies argue that the development of drugs is risky; 90% of drugs in clinical trials fail according to the Rand study. However, even though development of many new products is risky, industry R&D costs are exaggerated. In addition, risk is the hallmark of any innovation, development and market acceptance of resulting products. Moreover, Bloomberg in January 2015 ranked the U.S. sixth in innovation from the top after South Korea, Japan, Germany, Finland and Israel, countries with lower drug prices. Partly it reflects lower spending on R&D as a percent of the gross domestic product.

Patents provide incentives for innovations and risks involved in the development of drugs. Professors Adam Jaffe and Josh Lerner report in their book, "Innovation and its Discontents," that the modern patent system has existed since 1836, when it extended the 14-year term of the 1790 Act by seven more years. However, since 1995 patent law provides 20 years of protection from the time of filing the application. But it has many loopholes.

DrugPatentWatch reports that pharmaceutical companies earn 80% of their revenues from patented drugs’ monopoly. Monopoly increases prices by restricting quantity, hence earning enormous profits. Companies maintain their monopoly by manipulating the law, by new formulations, and by new administration of drugs. For example, simplifying doses, extended release versions and new methods of administering (oral dose or nasal spray) are some of the tactics to extend patents’ duration.

Deep-pocketed companies engage in lawsuits to block generic drugs competition or buy generic drug makers to suppress the promotion of generics and maintain their patented drugs monopoly. Robert Posen, Harvard Business School lecturer, suggested that innovations and granting of patents should be sped up by hiring more experts and adopting the “first to file” rule for the applications, rather than wasting time discovering who first came up with the idea. Also, “first to file” rule will reduce frivolous and costly lawsuits since the patent office will decide the first filing date. Granting extensions should be rare.

“Cross licensing”, where companies agree to license their patents to each other as a device to expedite innovation, has outlived its usefulness. It depresses competition by blocking entry, especially of new startups. Small companies face threats of expensive infringement lawsuits or unwillingness of large companies to enter “cross-licensing” agreements or face substantial royalties in any agreement, thus thwarting competition and increasing prices.

On June 10, Bloomberg Business Week reported that American drug companies Merck & Co and Bristol-Myers Squibb are facing stiff competition in prices in China from some Chinese companies that have patented their drugs to treat the same health conditions. For example, the drug Tuoyi by Shanghai Junshi Biosciences Co. to treat melanoma (skin cancer), sells for 1/3 less than the price for Merck’s drug Keytruda in China. Allowing importation of drugs and Medicare to negotiate lower drug prices to counter monopoly power will also deescalate prices in general.

Professors Jaffe and Lerner cogently state, “Thus, the patent system — intended to foster and protect innovation — is generating waste and uncertainty that hinders and threatens the innovative process.” I might add that it also destroys completion.

Mathur is former chairman and Professor of Economics, Department of Economics, Cleveland State University, Cleveland, Ohio. He blogs at http://mathursblogonomics.blogspot.com.

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