Monopoly Basics

High Drug Prices & Monopoly

Americans must pay the highest drug prices in the world because of the high cost of innovation, or so say lobbyists for big pharmaceutical companies. If the United States adopted policies to bring its drug prices in line with those in other advanced nations, they warn, drug companies would be forced to cut their spending on research and development, resulting in fewer cancer drugs, treatments for Alzheimer’s, and the like.

Yet there is a problem with this argument. In recent years, the prices Americans pay for drugs have only soared higher, even as innovation in the pharmaceutical industry slackens. The average number of new drugs approved each year has declined since the 1960s. The drop-off has been particularly steep since 1996, when 54 new drugs came on line, compared to only 30 in recent years.

Moreover, today’s new pills typically have only modest, if any, proven therapeutic value over existing treatments. As a study in the Journal of the American Medical Association found, nearly half of the drugs approved by the Food and Drug Administration between 2005 and 2011 lacked any tangible health benefits, such as prolonging life or relieving symptoms.

How is America managing to get the worst of all worlds when it comes to drugs? Many explanations trace to public policy changes that have led to the monopolization of the drug industry over the last generation.

From the end of the WWII through the 1960s, Americans benefitted from an unprecedented parade of wonder drugs, from broad-spectrum antibiotics, steroids and antihistamines, to the first chemotherapies, and the oral contraceptive known as “the pill.” Though there were complaints about affordability, most of these wonder drugs were reasonably priced by today’s standards.

This was largely the result of government policies that allowed for a comparatively open and efficient pharmaceutical market. These policies enforced standards for safety and effectiveness, provided funding for basic research, and critically, limited patent monopolies and mergers between drug-makers.

But the U.S. has since largely abandoned the policies it previously used to foster healthy competition. The result is a highly dysfunctional pharmaceutical market that produces high prices and less and less innovation.

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The government’s role in structuring the pharmaceutical marketplace dates to the early 1900s when unproven, deceptively marketed patent medicines harmed public health and eroded consumer confidence. Due to these concerns, Congress and President Theodore Roosevelt passed the Food and Drugs Act of 1906, creating the Bureau of Chemistry—the precursor to the Food and Drug Administration. In one infamous case, the bureau successfully fined Clark Stanley for “falsely and fraudulently” marketing his “snake oil liniment.”

This was also, however, the era in which politicians in both parties first embraced the importance of “trust-busting.” In keeping with the wide, bi-partisan opposition to monopoly that lasted up until the 1960s, policymakers did not allow drug companies to combine or abuse their powers in ways that threatened competition.

Government policies, for example, fostered competition by limiting the length of patent monopolies. In other instances, regulators forced drug companies to license their patents when they gained too much market share. Meanwhile, the threat of both civil and criminal antitrust suits kept drug companies from combining or colluding in ways that would significantly reduce competition.

The market for antibiotics illustrates this regulatory regime’s success. After the World War II, many companies competed to sell Penicillin, and the market became less and less dominated by any one player. This helped drive down Penicillin’s price––from $3,995 a pound in 1945 to $282 a pound in 1950.

The next decade saw industry efforts to drive prices back up through monopoly. In 1958, the Federal Trade Commission (FTC) authored a report on the antibiotics industry in which it found that a handful of companies had cornered the market and kept prices high for tetracycline, a broadly useful antibiotic.

But these cartels were rolled back by protracted government countermeasures. After the report’s release, the FTC charged five drug companies with blocking new competitors and fixing prices for tetracycline. Though the FTC could never prove price-fixing in court, the FTC forced the companies to license out tetracycline at a low price. In so doing, the agency broke apart the emerging cartel and ensured a more competitive market for the new and powerful drug.

But beginning in the 1980s, the U.S. started to move away from the policies that had fostered an open market for pharmaceuticals during the wonder drug era. One change was a retreat from antitrust enforcement, which eventually led to a much more concentrated industry. Between 1995 and 2015, 60 pharmaceutical companies merged into just 10.

Congress and the courts also made several changes to patent law that similarly encouraged monopolization, higher prices, and less innovation. These changes have made it easier for drug companies to patent minor variations in drugs, thereby enhancing the power of patent monopolies to suppress competition.

Other changes and loopholes in patent law allow drug companies to pay other firms to keep competing drugs off the market, prolonging their drugs’ exclusive position. The FTC has successfully prosecuted some of these “pay-for-delay” schemes, but drug companies have responded by trading valuables besides cash to achieve the same anti-competitive effects. In addition, companies with branded drugs will stop generic drugs from coming to market by refusing to hand over the samples and safety protocols needed to produce a generic drug. This tactic artificially extends drug companies’ patents and cuts against Congress’s intent to encourage generic drugs.

Other policy changes have had similar effects. In 1980, Congress passed the Bayh-Dole Act, which allowed non-profit institutions to claim patents on discoveries funded by government research. This legislation allowed universities and research institutions to privatize and profit from public investment, closing off others’ access to the fruits of public spending and raising the price of drugs that would be markedly cheaper if they weren’t patented. Because this law encourages more researchers to patent more discoveries, Bayh-Dole also means that more drugs, and more research tools, are covered by patents today. That makes it even more difficult for underfunded researchers or small companies to begin developing new drugs, as more materials are locked away by big firms.

These policy changes have resulted in many negative effects, starting with monopoly pricing. In the drug industry, as with any industry, consolidation facilitates collusion. When a few companies control a market, it becomes easier to maintain an effective cartel because no member can step out of the agreement without being quickly detected by the others. The market for insulin may be a case in point. Since 2010, the three American manufacturers of the drug have all raised their prices by 168 percent, 169 percent, and 325 percent, respectively.

Even without forming cartels, monopolistic companies have a greater ability to raise prices because they don’t face the full pressure of a competitive market. Mylan Pharmaceuticals could raise the price of its Epipen by 450 percent precisely because it held about 90 percent of the market. And this applies to all kinds of drugs, branded and generic alike. Between 2010 and 2015, for instance, nearly a quarter of all generic drugs saw at least one price increase of 100 percent or more, and some saw increases of 1,000 percent or more.

Monopolization also tends to discourage research spending and depress innovation. One reason: merging companies tend to cut research spending. Both Pfizer and Valeant Pharmaceuticals, for example, cut their R&D spending after acquisitions. Academic studies confirm that mergers tend to depress innovation among drug companies. Indeed, many drug companies have turned to mergers and acquisitions to make up for their lack of innovation—acquiring firms with promising or profitable drugs rather than developing such drugs in house.

These developments and tactics have created the current American pharmaceutical landscape. Drug companies grow larger, pursue more mergers and acquisitions, and raise prices. Nearly all Americans have felt the effects of this skewed and unequal market.


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