Archives For anticompetitive market distortions

Drug makers recently announced their 2019 price increases on over 250 prescription drugs. As examples, AbbVie Inc. increased the price of the world’s top-selling drug Humira by 6.2 percent, and Hikma Pharmaceuticals increased the price of blood-pressure medication Enalaprilat by more than 30 percent. Allergan reported an average increase across its portfolio of drugs of 3.5 percent; although the drug maker is keeping most of its prices the same, it raised the prices on 27 drugs by 9.5 percent and on another 24 drugs by 4.9 percent. Other large drug makers, such as Novartis and Pfizer, will announce increases later this month.

So far, the number of price increases is significantly lower than last year when drug makers increased prices on more than 400 drugs.  Moreover, on the drugs for which prices did increase, the average price increase of 6.3 percent is only about half of the average increase for drugs in 2018. Nevertheless, some commentators have expressed indignation and President Trump this week summoned advisors to the White House to discuss the increases.  However, commentators and the administration should keep in mind what the price increases actually mean and the numerous players that are responsible for increasing drug prices. 

First, it is critical to emphasize the difference between drug list prices and net prices.  The drug makers recently announced increases in the list, or “sticker” prices, for many drugs.  However, the list price is usually very different from the net price that most consumers and/or their health plans actually pay, which depends on negotiated discounts and rebates.  For example, whereas drug list prices increased by an average of 6.9 percent in 2017, net drug prices after discounts and rebates increased by only 1.9 percent. The differential between the growth in list prices and net prices has persisted for years.  In 2016 list prices increased by 9 percent but net prices increased by 3.2 percent; in 2015 list prices increased by 11.9 percent but net prices increased by 2.4 percent, and in 2014 list price increases peaked at 13.5 percent but net prices increased by only 4.3 percent.

For 2019, the list price increases for many drugs will actually translate into very small increases in the net prices that consumers actually pay.  In fact, drug maker Allergan has indicated that, despite its increase in list prices, the net prices that patients actually pay will remain about the same as last year.

One might wonder why drug makers would bother to increase list prices if there’s little to no change in net prices.  First, at least 40 percent of the American prescription drug market is subject to some form of federal price control.  As I’ve previously explained, because these federal price controls generally require percentage rebates off of average drug prices, drug makers have the incentive to set list prices higher in order to offset the mandated discounts that determine what patients pay.

Further, as I discuss in a recent Article, the rebate arrangements between drug makers and pharmacy benefit managers (PBMs) under many commercial health plans create strong incentives for drug makers to increase list prices. PBMs negotiate rebates from drug manufacturers in exchange for giving the manufacturers’ drugs preferred status on a health plan’s formulary.  However, because the rebates paid to PBMs are typically a percentage of a drug’s list price, drug makers are compelled to increase list prices in order to satisfy PBMs’ demands for higher rebates. Drug makers assert that they are pressured to increase drug list prices out of fear that, if they do not, PBMs will retaliate by dropping their drugs from the formularies. The value of rebates paid to PBMs has doubled since 2012, with drug makers now paying $150 billion annually.  These rebates have grown so large that, today, the drug makers that actually invest in drug innovation and bear the risk of drug failures receive only 39 percent of the total spending on drugs, while 42 percent of the spending goes to these pharmaceutical middlemen.

Although a portion of the increasing rebate dollars may eventually find its way to patients in the form of lower co-pays, many patients still suffer from the list prices increases.  The 29 million Americans without drug plan coverage pay more for their medications when list prices increase. Even patients with insurance typically have cost-sharing obligations that require them to pay 30 to 40 percent of list prices.  Moreover, insured patients within the deductible phase of their drug plan pay the entire higher list price until they meet their deductible.  Higher list prices jeopardize patients’ health as well as their finances; as out-of-pocket costs for drugs increase, patients are less likely to adhere to their medication routine and more likely to abandon their drug regimen altogether.

Policymakers must realize that the current system of government price controls and distortive rebates creates perverse incentives for drug makers to continue increasing drug list prices. Pointing the finger at drug companies alone for increasing prices does not represent the problem at hand.

In a recent Truth on the Market blog posting, I summarized the discussion at a May 17 Heritage Foundation program on the problem of anticompetitive market distortions (ACMDs), featuring Shanker Singham of the Legatum Institute (a market-oriented London think tank) and me.  The program highlighted the topic of anticompetitive government-imposed laws and regulations (which Singham and I refer to as anticompetitive market distortions, or ACMDs):

Trade freedom has increased around the world, according to the 2016 Heritage Foundation Index of Economic Freedom, due to a decrease in trade barriers, particularly tariffs. Despite this progress, many economies struggle with another burden that is increasing costs for families and businesses. Non-tariff barriers and overregulation, in the form of government-imposed laws and regulations, continue to stifle innovation and competition. These onerous and excessive regulations, backed by the power of the state, benefit the well-connected and act as an additional layer of government favoritism. Meanwhile, individuals are strapped with higher costs and fewer options.  

Singham and three colleagues (Srinivasa Rangan of Babson College, Molly Kiniry of the Competere Group, and Robert Bradley of Northeastern University) have now produced an impressive study of the economic impact of ACMDs in India (which has one of the world’s most highly regulated economies), released on May 31 by the Legatum Institute.  The study applies to India’s ACMDs the authors’ “Productivity Simulator,” which aggregates economic data to gauge the theoretical economic growth potential of an economy if ACMDs are eliminated.  Focusing on the full gamut of ACMDs affecting a nation in the areas of property rights, domestic competition, and international competition, the Simulator estimates the potential productivity gains for individual economies as measured in changes to GDP per capita, assuming all ACMDs are eliminated.  Using those productivity estimates, the Simulator can then be employed to derive resultant nation-specific estimates of potential GDP increases from “perfect” regulatory reform.  Although a perfect “regulatory nirvana” may not be achievable in the “real world,” Productivity Simulator estimates have the virtue of spotlighting the magnitude of forgone welfare due to regulatory excesses.  Even assuming a degree of imperfection in Productivity Simulator estimates applied to India, the results are startling, as the Executive Summary to the May 31 report reveals:

 “The [May 31] Study makes the following key findings:

» If India eliminated all its distortions it would be the fifth largest economy in the

world, and in GDP per capita terms, it would rise from being ranked 169th to being ranked 67th.

» If India eliminated all its distortions it would generate over 200 million new jobs, and reduce absolute poverty to zero.

» If India improved its insolvency rules, opened up to foreign investment in certain areas and better protected intellectual property rules, the number of people living on less than $2 per day would be reduced from 770 million to 627 million.

» Simply optimising its regulatory environment with regard to the World Bank Doing Business Index would lead to a productivity gain of only 0.07%.

» Improving its insolvency rules, opening up to foreign investment in certain areas and better protecting intellectual property (L2) could lead to a productivity gain of 148%.

» Fully optimising its distortions could lead to a productivity gain of 1875% of which the Indian economy would capture almost 700%.”

I look forward to further application of the Productivity Simulator to other economies.  Research reports of this sort, in conjunction with studies carried out by the World Bank and the Organization for Economic Cooperation and Development that employ other methodologies, build a strong case for sweeping market-oriented regulatory reform, in foreign countries and in the United States.

The Heritage Foundation’s Index of Economic Freedom is an annual data compilation that provides an ordinal ranking of economic freedom in nations throughout the world, based on such country-specific measures of economic liberty as commitment to limited government, strong protection of private property, openness to global trade and financial flows, and sensible regulation.

The 2016 edition, released on February 1, found that the “United States continues to be mired in the ranks of the ‘mostly free,’ the second-tier economic freedom category into which the U.S. dropped in 2010.  Worse, with scores in labor freedom, business freedom, and fiscal freedom notably declining, the economic freedom of the United States plunged 0.8 point to 75.4, matching its lowest score ever.”  In addition to a detailed statistical breakdown of country scores, this edition included six essays on various topics related to the nature of economic freedom and its assessment (see here, here, here, here, here, and here).

Those readers who are interested in the economic effects of anticompetitive regulatory distortions around the world may wish to turn to the essay entitled “Anticompetitive Policies Reduce Economic Freedom and Hurt Prosperity,” co-authored by Shanker Singham (Director of Economic Policy at the Legatum Institute) and me, whose key points are as follows:

Excessive government regulation interferes with individual economic freedom. It also imposes a substantial burden on national economies, reducing national wealth and slowing economic growth. Over the past decade, The Heritage Foundation has documented the large and rising cost to the United States economy stemming from overregulation. Regrettably, however, sizable regulatory burdens continue to characterize many (if not all) economies, as documented by the Organisation for Economic Co-operation and Development (OECD) and the World Bank.

One regulatory category that has garnered increased attention in recent years is government rules that distort and harm the competitive process. Competition everywhere faces restraints imposed by governments, either through laws, regulations, and practices or through hybrid public–private restrictions by which government sanctions or encourages private anticompetitive activity. Government-imposed restrictions on competition, which we term anticompetitive market distortions (or anticompetitive regulations), are especially pernicious because they are backed by the power of the state and may be largely impervious to attenuation through market processes. Often, these restrictions—for example, onerous licensing requirements—benefit powerful incumbents and stymie entry by innovative new competitors.

In recent years, recognizing the harm caused by anticompetitive regulations, international institutions have attempted to identify and categorize various types of harmful regulations and to estimate the consumer welfare costs that they impose. The intent of these efforts is to help governments move away from anticompetitive regulations. Such efforts, however, are often stymied by producer lobbies that tend to underplay the harmful effects of such regulations on consumers.

Ferreting out and publicizing the economic impact of these regulatory abuses should be given a higher priority in order to promote economic freedom and prosperity. In this chapter, we first outline the concept of anticompetitive regulations and the arguments for combatting them more vigorously, suggesting the importance of developing a neutral measure (a metric) to estimate their harmful impact. We then describe efforts by two major international organizations, the OECD and the International Competition Network (ICN), to develop methodologies for identifying anticompetitive regulations and to provide justifications for elimination of those restrictions. We then briefly summarize research (much of it supported in recent years by the World Bank) that estimates the nature and size of the economic welfare costs of anticompetitive regulations. Finally, we turn to ongoing research that focuses on a broad metric to measure the economic impact of these regulations on property rights, international trade, and domestic competition.

The Heritage Foundation continues to do path-breaking work on the burden overregulation imposes on the American economy, and to promote comprehensive reform measures to reduce regulatory costs.  Overregulation, unfortunately, is a global problem, and one that is related to the problem of anticompetitive market distortions (ACMDs) – government-supported cronyist restrictions that weaken the competitive process, undermine free trade, slow economic growth, and harm consumers.  Shanker Singham and I have written about the importance of estimating the effects of and tackling ACMDs if international trade liberalization measures are to be successful in promoting economic growth and efficiency.

The key role of tackling ACMDs in spurring economic growth is highlighted by the highly publicized Greek economic crisis.  The Heritage Foundation recently assessed the issues of fiscal profligacy and over-taxation that need to be addressed by Greece.  While those issues are of central importance, Greece will not be able to fulfill its economic potential without also undertaking substantial regulatory reforms and eliminating ACMDs.  In that regard, a 2014 OECD report on competition-distorting rules and provisions in Greece, concluded that the elimination of barriers to competition would lead to increased productivity, stronger economic growth, and job creation.  That report, which focused on regulatory restrictions in just four sectors of the Greek economy (food processing, retail trade, building materials, and tourism), made 329 specific recommendations to mitigate harm to competition.  It estimated that the benefit to the Greek economy of implementing those reforms would be around EUR 5.2 billion – the equivalent of 2.5% of GDP –  due to increased purchasing power for consumers and efficiency gains for companies.  It also stressed that implementing those recommendations would have an even wider impact over time. Extended to all other sectors of the Greek economy (which are also plagued by overregulation and competitive distortions), the welfare gains from Greek regulatory reforms would be far larger.  The OECD’s Competition Assessment Toolkit provides a useful framework that Greece and other reform-minded nations could use to identify harmful regulatory restrictions.

Unfortunately, in Greece and elsewhere, merely identifying the sources of bad regulation is not enough – political will is needed to actually dismantle harmful regulatory barriers and cronyist rules.  As Shanker Singham pointed out yesterday in commenting on the prospects for Greek regulatory reform, “[t]here is enormous wealth locked away in the Greek economy, just as there is in every country, but distortions destroy it.  The Greek competition agency has done excellent work in promoting a more competitive market, but its political masters merely pay lip service to the concept. . . .  The Greeks have offered promises of reform, but very little acceptance of the major structural changes that are needed.”  The United States is not immune to this problem – consider the case of the Export-Import Bank, whose inefficient credit distortionary policies proved impervious to reform, as the Heritage Foundation explained.

What, then, can be done to reduce the burden of overregulation and ACMDs, in Greece, the United States, and other countries?  Consistent with Justice Louis Brandeis’s observation that “sunshine is the best disinfectant,” shining a public spotlight on the problem can, over time, help build public support for dismantling or reforming welfare-inimical restrictions.  In that regard, the Heritage Foundation’s Index of Economic Freedom takes into account “regulatory efficiency,” and, in particular, “the overall burden of regulation as well as the efficiency of government in the regulatory process”, in producing annual ordinal rankings of every nations’ degree of economic freedom.  Public concern has to translate into action to be effective, of course, and thus the Heritage Foundation has promulgated a list of legislative reforms that could help rein in federal regulatory excesses.  Although there is no “silver bullet,” the Heritage Foundation will continue to publicize regulatory overreach and ACMDs, and propose practical solutions to dismantle these harmful distortions.  This is a long-term fight (incentives for government to overregulate and engage in cronyism are not easily curbed), but well worth the candle.