Price controls and taxes reduce access to medicine

The beginning of this year marked the introduction of the new amended medicine pricing regulations, which have been a bone of contention for a number of years. The initial regulations were proposed in 2004 and were immediately challenged by the retail pharmacies. The matter was heard in the Cape High Court, Supreme Court of Appeal and finally in the Constitutional Court where it was declared that the regulations were invalid and had to be amended.

The government has committed itself to reducing the cost of medicines and healthcare to patients in an attempt to improve the overall welfare and health of the nation. While the government may have good intentions in wanting to increase access to medicines and good quality healthcare, the imposition of price controls results in many unintended consequences. In the long run these controls will merely compromise SA’s healthcare system and reduce access to medicines.

Price controls are normally promoted and devised under the guise of assisting the poor and alleviating poverty. Yet in almost every case it is the poor that suffer most from price controls. In SA and most other countries, it is the rich that have access to the high volume, low mark-up retailers that can offer cheaper goods in large urban areas. SA’s poor generally shop in low-volume, high mark-up establishments in the townships simply because they are conveniently located. However, price controls tend to penalise the low volume establishments that serve the poor, therefore forcing them to travel to urban centres, incurring costs and inconvenience in order to shop.

The result of the imposition of the price controls is that a number of these low-volume, high mark-up establishments will simply close down. Indeed, the Pharmaceutical Society of South Africa (PSSA) estimates that over 100 small pharmacies have already closed since the introduction of the regulations. Moreover, the society estimates that as many as 75% of pharmacies may be at risk of closing as a result of the regulations. The closure of these pharmacies would severely affect access to medicines and decrease the provision of medical services to isolated communities. The regulations have also discouraged many individuals from entering the field and prompted others to relocate – this in an environment that is already constrained by a lack of qualified medical personnel.

SA has traditionally been a favoured destination for drug companies to conduct research and development because of the sound scientific base, good infrastructure and range of different population groups with widely different social statuses in which to run trials. The drug price regulations will reduce incentives to conduct such trials and invest in scientific infrastructure and knowledge as the ability to make appropriate returns on the investment has been reduced.

Despite the best intentions of the government to make drug prices as transparent as possible, the pricing regulations merely frustrate the efficient functioning of the market. SA is one of the few developing countries that do not levy significant tariffs on pharmaceutical products and devices and it should be commended for this and held up as an example for others to follow. However, the government continues to impose a value added tax (VAT) of 14 per cent on pharmaceutical products and devices. This tax is highly regressive since it disproportionately affects the most vulnerable members of our society.

VAT is counter-intuitive in the sense that it is levied purely to raise government revenue but if one of SA’s objectives is to have a healthy and productive population it makes no sense to levy a tax that penalises the sick. If the government is really concerned about increasing access to medicines it will eliminate all taxes on pharmaceuticals and other medical devices.

The government’s preferred policy of price controls will not result in increased access to medicines. On the contrary, in the long run it will simply serve to reduce access to medicines in SA.

Author: Jasson Urbach is an economist with the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Free Market Foundation

America's top 20 selling prescription drugs

#1 Lipitor for high cholesterol, produced by Pfizer. Sales $8.4 billion.

#2 Zocor for high cholesterol, produced by Merck. Sales $4.4 billion.

#3 Nexium for heartburn,, produced AstraZeneca. Sales $4.4 billion.

#4 Prevacid for heartburn, produced by Abbot & Takeda. Sales $3.8 billion.

#5 Advair Diskus for asthma, produced by GlaxoSmithKline. Sales $3.6 billion.

#6 Plavix for heart disease, produced by Myers Squibbs & Sanofi-Aventis. Sales $3.5 billion.

#7 Zoloft for depression, produced by Pfizer. Sales $3.1 billion.

#8 Epogen for anemia, produced by Amgen. Sales $3.0 billion.

#9 Procrit for anemia, produced by Johnson & Johnson. Sales $3.0 billion.

#10 Aranesp for anemia, produced by Amgen. Sales $2.8 billion.

#11 Enbrel for rheumatoid arthritis by Amgen & Wyreth. Sales $2.7 billion.

#12 Norvasc for high blood pressure by Pfizer. Sales $2.6 billion.

#13 Seroquel for schizophrenia by AstraZeneca. Sales $2.6 billion.

#14 Effexor XR for depression by Wyeth. Sales $2.6 billion.

#15 Zyprexa for Schizophrenia by Eli Lily. Sales $2.5 billion.

#16 Singular for asthma and allergies by Merck. Sales $2.5 billion

#17 Protonix for heartburn by Wyeth. Sales $2.4 billion.

#18 Risperdal for schizophrenia by Johnson & Johnson. Sales $2.3 billion.

#19 Neulasta for side effects of chemotheraphy by Amgen. Sales $2.2 billion.

#20 Remicade for rheumatoid arthritis by Johnson & Johnson. Sales $2.2 billion.

Consider now the level of competition. In the top five selling positions there are five different pharmaceutical companies. Among the top ten selling drugs patents are held by nine different companies.

Of the top 20 selling prescription drugs in the United States three of the drugs are owned by Pfizer. But these drugs face stiff competition as well. Pfizer produces Lipitor for high cholesterol but Merck also competes with Zocor. AstraZeneca sells Nexium for heartburn but Prevacid by Abbot & Takeda, also for heartburn, is nipping on their heels and there is also Protonix by Wyeth.. Several drugs compete in the field of treating anemia and rheumatoid arthritis. There are two major drugs competing for the treatment of schizophrenia.

The fact is that the pharmaceutical industry is far more competitive than is often thought.

Will anyone lament Pfizer's loses?

I can't tell you how often I have heard people whine about the "excessive profits" that pharmaceutical companies earn on some specific drug. A Google search on "pharmaceutical greed profit" turns up well over a quarter of a million hits.

One "activist" is quoted by the World Socialist Web Site as claiming that "Drug companies are killing people by charging excessive prices." and "The greed of AIDS profiteers is killing impoverished people with AIDS."

These activists tend to find a drug that has turned a high profit and harp about it endlessly. Other drugs, which inflict massive losses are not mentioned. Take the case of Pfizer and the drug torcetrapib, a drug that raises good cholesterol and ought to reduce heart attacks. Pfizer, according to the New York Times, has invested over $1 billion in just this drug alone.

It was widely seen as a major break through that would benefit millions. But testing shows it has side effects and it has been scuttled. The head researcher noted: "This drug, if it worked, would probably have been the largest-selling pharmaceutical in history."

And if it had worked, and was the largest selling drug in history, then Pfizer would have been constantly attacked for their greed and excessive profits. Will any activists now lament the $1 billion lost?

Pfizer is cutting staff by 10,000. It has already said it will be reducing its sales force by 2,200. The company says it has to cut its spending by $4 billion. Some of the drugs that it produced, which succeeded, are losing their patent protections shortly. Among them are Zoloft and Zithromax.

Other promising drugs are in the pipeline and may be profitable. But those are several years away from market. The regulatory system on drugs is very time consuming and costly. It can take years to get approval. Some of those "promising" drugs may turn out to be a torcetrapib rerun.

Anti-market "activists" frequently demand that profits for companies like Pfizer be "limited". Yet there is no way to limit losses. And more drugs fail than succeed. For every one drug that goes to market thousands are shelved. And of those that do go to market only 30 percent cover their costs.

The typical scam from "activists" is to take the profitable drug and announced how much it cost to develop just that one drug. They then show how the profits were vastly higher than the costs and cry "unfair profits," "corporate greed". What they ignore is the cost for the thousands of experiments that didn't work, where there are no profits just losses. They ignore the fact that successful drugs must pay for unsuccessful ones. Profitable drugs also pay for the drugs that do make it to market but lose money.

While the costs of the drugs are mentioned the "activists" rarely mention the "savings". And most people never consider this issue.

Someone who is HIV+ can reduce their rate of hospitalization by taking drugs. Yes, they spend more on drugs in the process but they also spend less on hospital care. It is estimated that new AIDS "cocktails" cut hospital costs by $2,000 per year. And the older treatments were less effective. In 1995 the number of U.S. deaths from AIDS was 50,610. By 2000 it had dropped to 15,245.

A paper for the National Bureau of Economic Research by Frank Lichtenberg found: "Replacing 1,000 old prescriptions with 1,000 new prescriptions will increase drug costs by $18,000 but will reduce the number of hospital stays by nearly six. Since the average cost of a hospital stay is $7,588, a total reduction of $44,469 in hospital costs could be expected." Even this underestimates savings "because use of new drugs reduces average length of stay as well as the number of stays." This research found that the savings in non-drug medical expenses "is about four times the increase in the costs of the drugs -- so reducing the age of drugs substantially reduces the total cost of treatment."

But the critics only look at the extra cost for the new medicines and not the extra benefits. One study found that the average 1998 price for drugs introduced in 1992 was $71.49 for each prescription. The older drugs these replaced averaged $30.47. The critic would notice the doubling of the prescription price but ignore that the financial benefits of the drugs for the patient exceeded the additional costs. "[R]eplacing older drugs with newer counterparts would have several important benefits: reductions in mortality, morbidity, and total non-drug medical costs. People taking new drugs were significantly less likely to die by the end of the survey than those taking the older medications. They were also significantly less likely to miss days at work than people taking old drugs."

The bottom line is that newer drugs improve the life of the patient and cut total medical costs. There are cheaper, older, generic drugs that would cut the cost of drugs per year but raise the cost of medical care in general.

The average profit of pharmaceutical companies is higher than the average company but then the research and development costs are much higher as well. An above average return reflects above average costs. And future R&D is paid for from these returns. Less profits mean less investment in future drugs. It is no coincidence that where drug prices are strongly regulated new developments are rare. The sad thing about the torcetrapib failure is not just the $1 billion loss but the future absence of billions in profits that would fund future research as well.

Another dishonest tactic used by "health activists" is to take the marginal cost of additional pill and compare it to the selling price. Say that drug X sells fro $3 per tablet. But once in production the production cost per pill might be 10¢. This is considered proof of the greed of the industry. After all the profit per pill is $2.90. But this assumes zero costs for R&D for this drug and it ignores the costs of drugs that failed to make it to market. The 10¢ may pay for that one pill but where does the money come from for everything else?

As the New York Times noted the failure of torcetrapib is "a big loss for Pfizer and heart patients." The company lost $1 billion in investigating this dead end. And heart patients will see no improvements in their condition.

Now it seems to me the Times headline is very perceptive. What is a big loss for Pfizer is also a big loss for patients. And what would have been a big gain for Pfizer would have been a big gain for patients. Next time some new drug makes record profits I hope the New York Times remembers this headline and what it means.