Pricing Pharmaceutical Drugs: An Oligopoly in Action

Economists refer to a market that is dominated by a few producers who act collusively as an oligopoly.  This term may not be very familiar in this context, but the behaviors it represents are quite common.  Wikipedia provides this description of what is involved.

“Oligopolistic competition can give rise to a wide range of different outcomes. In some situations, the firms may employ restrictive trade practices (collusion, market sharing etc.) to raise prices and restrict production in much the same way as a monopoly. Where there is a formal agreement for such collusion, this is known as a cartel. A primary example of such a cartel is OPEC which has a profound influence on the international price of oil.”

“Firms often collude in an attempt to stabilize unstable markets, so as to reduce the risks inherent in these markets for investment and product development….There are legal restrictions on such collusion in most countries. There does not have to be a formal agreement for collusion to take place (although for the act to be illegal there must be actual communication between companies)….”

If a few companies control a market, they have the option of competing on price and quality, hoping to increase profit by gaining market share. However, that requires hard work and it is risky.  Why do that when a more stable situation can be attained by agreeing, tacitly or otherwise, that the market is big enough to be shared, with each participant charging whatever the market will bear for its product.  This path provides the illusion of competition and avoids any suggestions of monopolistic abuse.

There are specific market situations that invite monopolies or oligopolies.  Consider the case of a good being provided that is so essential that society could not exist without it.  Water is an example of a commodity without which life itself could not exist.  Electrical power is a commodity without which society could not exist.  These are areas in which society has decided that they were too important to be left to free-market vagaries.  The standard solution is to set up strictly regulated monopolies to provide these goods and services.

The defense industry provides an interesting example of a market dominated by a few large contractors.  Producing state-of-the-art defense systems is an expensive process requiring considerable experience and technical resources, quantities that few can attain.  The nature of the defense establishment essentially requires that a few good corporations be maintained so that its needs can be met—just enough to provide some technical competition, but not so many that the scale of capabilities fall below some critical level.  This area also should provide contractors with considerable leverage in pricing their products.  After all, what is more important than protecting our civilization, our society, and our lives?  Well, guess what?  The Defense Department and its contractors have agreed to mechanism by which the profits of the defense contractors can be limited to a reasonable rate of return.  A modest rate of return on a large source of revenue is a quite healthy business model.

A study (Defense Department Profit and Contract Finance Policies and Their Effects on Contract and Contractor Performance) by the Institute for Defense Analyses looked at the complex options and incentives provided to contractors and concluded that the effective rate of earnings on sales was between 5% and 10%, and the system was working well.

“At roughly 5–10 percent of sales, earnings of defense companies are typically a lower fraction of total sales than those of firms in other industries.”

“Our study shows clearly, however, that the profits of the major U.S. defense contractors are above the levels required to keep them in the defense industrial base.”

There is another industry whose value to society rivals that of defense.  The pharmaceutical industry produces medicines that are critical to our health and welfare.  Often its products are the difference between life and death.  It is also an industry comparable in size to that of defense and could have decided that a modest profit rate on huge revenues was an acceptable business model.  Instead it has announced its intention to extract every dollar it can from its customers and our society.

Paul M. Barrett and Robert Langreth provide insight into the current state-of-affairs in an article in Bloomberg Businessweek titled How Much Should a Miracle Cost.  The article appears online with a different title: Pharma Execs Don't Know Why Anyone Is Upset by a $94,500 Miracle Cure.

The authors provide an excellent example of the tacit collusion involved in forcing drug prices ever higher.  Consider the pricing history of drugs for multiple sclerosis.  As new and supposedly better drugs arrived on the market they increased in price.  Instead of trying to compete for market share by lowering price, competitors raised the price of the older drugs to match that of the newer ones.  It is a strange market in which you can lose market share but maintain profit flow by increasing the price of your product.

“In the 1990s, multiple sclerosis drugs generally cost about $10,000 a year. As new MS treatments have hit the market, the prices of older ones have risen to the higher levels of newcomers, researchers reported in April in the journal Neurology. Today, all MS drugs cost $50,000 to $60,000 a year, or more.”

For years we have been told that drugs must be expensive because of the long and expensive research and development involved in bringing a drug to market.  Those were lies.  R&D is a small expense compared to the marketing costs required to keep doctors prescribing their medications no matter what the cost and no matter what the competition might be.  Now they no longer even bother with lies.  They believe that they are in such a powerful position that they can admit that they will maximize their profit no matter who gets hurt in the process. 

The issue of pricing elevated to a boil when Gilead Sciences marketed a very effective drug that promised to cure those infected with hepatitis C.  Gilead obtained this miracle drug by using its accumulated wealth to purchase the original developer, Pharmasset, for $11 billion.  Gilead assumed responsibility for marketing the product and getting it approved by the FDA.

The drug hit the market under the name Sovaldi and subsequently in a more convenient form as Harvoni.  The price of Sovaldi was $1,000 per pill, or $84,000 for a full treatment.  Since there are thought to be at least 3 million hepatitis C sufferers in the US, treating them at that price would cost over $252 billion.  Worldwide, there are thought to be 150 million sufferers.

The community gasped when the price was announced and demanded to know how Gilead arrived at it.  Gone were the claims of costs to be recovered.  Now the logic was that Gilead should be paid what the drug was worth.  Price should not be an issue; the focus should be on value.

“Milligan [Gilead’s president] responded to the mounting unease at Sovaldi’s $84,000 price tag during a symposium at the Brookings Institution in Washington. The company, he said, charged what it thought the market would bear. ‘We looked very hard at what value we were bringing to the system,’ he explained, ‘but at the end of the day, the pricing analysis was relatively simple: What is the current cost of other therapies?’ He continued: ‘We were providing more value, better outcomes, shorter duration, better patient experience at the same cost as the standard of care’.”

This reasoning seemed to involve tallying the costs of treating a person without Sovaldi, adding up the lifetime of costs and perhaps death, converting that into a dollar cost, and demanding that it be handed over to Gilead immediately.  By this logic, there can be no savings in healthcare costs due to R&D because any savings must be turned over to the developer of the product—immediately.

The effect of releasing Sovaldi was not to diminish costs, but to increase them.  The extreme expense of the treatment meant that insurers and government administrators had to limit access to the drug to only the most sick.

“More than two dozen state Medicaid programs for low-income patients, as well as for-profit insurers such as Anthem, have restricted coverage for Sovaldi to those with severe liver damage. ‘Never before have drugs been priced so high to treat such a large population,’ says Steve Miller, chief medical officer at Express Scripts, the country’s largest manager of drug benefits for employers and insurers.”

Those in early stages of the illness will be forced to wait for treatment until their condition becomes more severe.  An infectious disease that could possibly be eliminated will continue to harm more individuals.  According to Gilead officials the fault lies not with them, but with policymakers who refuse to recognize the new reality of drug treatment in this country.

“American society needs to make tough choices, Milligan [Gilead’s president] says. ‘It’s not up to Gilead to forward that conversation,” he says. ‘It’s up to public policymakers to forward that conversation’.”

Gilead and its pricing policy represent the future if drug companies have their way.  The grand strategy is to produce many drugs aimed at small sections of the population.  If these drugs are successful they can be claimed to be expensive to develop and have only a small market.  Therefore, they will be terribly expensive—priced at “whatever the market will bear.”

“More and more pharmaceutical manufacturers are seeking to develop specialty drugs because of the rich payouts associated with Sovaldi and Harvoni. Profits can be so hefty because the American health-care finance system allows companies to charge more or less what they choose. In Europe, governments negotiate directly with manufacturers, which keeps prices lower. In the U.S., that doesn’t happen. Medicare, the federal insurance program for senior citizens, is barred by law from using its size to negotiate discounts.”

“Half of the 38 cancer drugs introduced since 2010 cost $10,000 a month or more. All were at least $5,000 a month, according to data from Memorial Sloan Kettering Cancer Center in New York. Some of those drugs merely extend life expectancy for a matter of months.”

Targeting a captive audience that needs your drugs to exist and charging them “what the market would bear” is a well-known business model.  However, in the old days such people were hunted down and put in prison—if not executed.

Depending on a market-based system to provide needed drugs has never made much sense.  Can one really expect the market to make the appropriate decision on how to allocate resources between high-profit cancer drugs and low-profit antibiotics.  Pharmaceutical companies have always depended on the government to fund the training of their scientists and provide the long-term R&D required for developing their products.  It is time for them to recognize that they are part of society and must make accommodations accordingly.  They must not be allowed to hold society hostage to their profit desires.

The much-maligned defense industry has made an accommodation with society.  Perhaps it provides an example of where the drug industry should be headed.  Defense contractors are creative and innovative—some would argue too much so—and they drive the definition and development of new weapon systems.  And they are healthy, profitable corporations thriving under government regulation.

Infants, Fetuses, and the Complicated Issue of Pain

Anti-abortion activists have been attempting to argue that fetuses are capable of feeling pain at a certain stage of development and therefore legalized abortion should be limited to only the earlier periods.  Whether or not one agrees with this logic, it would at least seem that medical science should be able to make such a determination about pain or no pain.  Interestingly, the concept of pain is not well defined.  In fact, medical specialists have argued for centuries over whether or not neonates (recently born infants) are capable of experiencing pain.  Given that, how accurate might they be in figuring out what a fetus might be experiencing?

Joanna Bourke, a British historian, has produced a fascinating book on the subject of pain: The Story of Pain: From Prayer to Painkillers.  She convinces us that pain is an elusive quantity.  There is no way of measuring it directly.  A physician must depend on the description of the pain by the patient or draw her own conclusions based on evaluating the signals of pain being expressed by the patient.  It is well known that expression of pain is a learned response that varies from one culture to another, from one gender to another, and from one generation to another.  It is also well known that extreme physical injuries can be endured with little or no pain, and extreme pain can be experienced with no discernible cause.  As Bourke expresses the situation:

“As a type of event, pain is an activity.  People do pain in different ways.  Pain is practised within relational, environmental contexts.  There is no decontextual pain-event.  After all, so-called ‘noxious stimuli’ may excite a shriek of distress (corporal punishment) or squeal of delight (masochism).  There is no necessary and proportionate connection between the intensity of tissue damage and the amount of suffering experienced since phenomena as different as battle enthusiasm, work satisfaction, spousal relationships, and the color of the analgesic pill can determine the degree of pain felt.”

Pain is experienced both as a sufferer as an observer of the sufferer (think physician or nurse).

“….people perceive pain through the prism of the entirety of their lived experiences, including their sensual physiologies, emotional states, cognitive beliefs, and relational standing in various communities.”

A physician confronted with a patient claiming to suffer pain must try to deduce a diagnosis from the symptoms as well as judge the level of the pain and decide what, if anything, must be done about it.  For the latter task, the physician has his knowledge, his experience, and his biases at his disposal.  Given those meager resources, some rather outrageous conclusions have been reached by the medical community over the years.  Here the focus is on the varying beliefs concerning the ability of young infants to experience the sensation of pain.

“….for much of the eighteenth and early nineteenth centuries, infants were believed to be exquisitely sensitive to noxious stimuli.  This changed from the 1870s, with many scientists and clinicians claiming that infants were almost totally insensible to pain, a belief that was only debunked from the 1980s.” 

Bourke points out that ether and chlorophorm came into common use as anesthetics in the mid nineteenth century.  The belief that infants felt little if any pain, being common at the time, meant that infants were subjected to surgical procedures and were less likely to receive an anesthetic and even a post-operative analgesic than an adult.

“The author of Modern surgical Technique (1938), for instance, claimed that ‘often no anesthetic is required’, when operating on young infants: indeed ‘a sucker consisting of a sponge dipped in some sugar water will often suffice to calm the baby’.”

The claim that pain insensibility in children was proven wrong in the 1980s does not mean that medical practitioners immediately became concerned about pain in infants.

“A study in 1995 revealed that pre-term infants were subjected to an average of sixty-one painful procedures while in the neonatal intensive care unit.  In another study, published in 1987, neonates were subjected to about three invasive procedures an hour.  In addition, neonates were actually less likely to be given analgesia than older children.”

There are reasons why physicians would hesitate to administer anesthetics or analgesics to recently born infants, but Bourke claims the data indicates that attempting to ease pain actually improved the health outcomes of the infants.  Nevertheless, to this day, there is reluctance to practice effective pain-management on infants.

“In the late 1980s, although 80 per cent of paediatric anaesthetists believed that neonates felt pain, only 11 per cent would prescribe opiate analgesia after major surgery.  Even as late as 1998, a leading expert admitted that ‘assessing the presence and severity of pain in children has proven surprisingly difficult’ and was contributing to the ‘undermanagement of pain in young children’.  In a 2010 paper, not only did 50 to 90 per cent of the nurses believe that children over-reported pain, they also consistently gave less pain relief to infants than had been either prescribed by the hospital physician or recommended by national standards.”

Given that pain management in infants remains contentious to this day, is it likely that the questions surrounding the issue of pain that might be experienced by a fetus is going to be resolved in an orderly and scientific manner?

“The late twentieth century also saw the emergence of heated debates about the sentience of embryos and very prematurely born infants.  These wars were driven largely by the pro- and antiabortion movements, but also by an increased emphasis on the phenomenological and psychological dimensions of pain.  As a result, the tension between people arguing that embryos and very young humans were acutely sensitive and those insisting on their inability to truly feel became increasingly polarized and politicized.”

Various arguments can be made about when a fetus might begin to experience pain based on when certain stages in the evolution of the nervous system and brain are reached, but none of these things can prove pain is experienced.

Bourke indicates that there are data that suggest a way out of this dilemma.  It has been noted that:

“….’surgical manipulation of an unanesthetized fetus would stimulate its autonomic nervous system’, while operations on premature infants showed that many physiological indicators of stress….could be observed.  Crucially, these indicators decreased when adequate anesthesia was provided.”

These indicators of stress suggest pain, but do not prove it; the administration of anesthesia eliminates the indicators of stress and thus eliminates any indication of pain.  If one is concerned about a fetus suffering pain, there is an obvious step to take.

Anesthetize the fetus before performing an abortion!

Unfortunately, the antiabortion troops are not interested in practical solutions.  Their goal is to gain political capital and there is no limit to what they are willing to do.

In 1984 the film The Silent Scream was made available.

“It purported to reveal ‘abortion from the victim’s vantage point’.  Using ultrasound imaging, the film showed a ‘child’ (as Dr Bernard Nathanson, the narrator and physician in the film called the 12-week-old foetus) being ‘torn apart, dismembered, disarticulated, crushed, and destroyed by the unfeeling steel instruments of the abortionist’.”

Bourke reminds us that what the film actually shows is a bunch of people associated with the pro-life movement murdering what they believe to be a child.

“The film which can be seen as a ‘snuff film’ in the sense that antiabortionists participated in the killing of a ‘child’ was seen by around 150 million people.”

So much for being pro-life!

Britain and the US: Two-Party Politics and Winner-Take-All Elections

The surprising results of the recent national elections in Britain have generated some interesting commentary from British political observers.  Given that the US and the British tend to move in similar directions, politically, socially, and economically, many of the observations are relevant to issues of importance to the US.

From a US perspective, the observation that the Conservative Party (Tories) won a sufficient number of seats to form a government on its own and the Labour and Liberal Democratic parties lost a significant number of seats suggests that the British electorate is becoming more conservative, and that progressive or liberal ideas are falling into disfavor.  Such a conclusion is particularly troubling to those with liberal leanings given the results of the 2014 mid-term elections.  Geoffrey Wheatcroft has produced an article for the New York Review of Books that warns us that such simple assumptions are dangerous because the situation is much more complicated.

Wheatcroft’s concern is not so much the unexpected dominance of the Conservative Party as the political stability of Great Britain itself.  To express his fears he titled his essay Britain: The Implosion.  He provides some illuminating voting data on the conservative/liberal issue.

“….a 6.5-point lead for the Conservatives, who had 36.9 percent of the popular vote to Labour’s 30.4. Labour had in fact slightly increased its overall vote from five years before, and increased it more than the Tories increased theirs, but that’s small comfort. The only thing that counts is which party wins the most votes in each parliamentary constituency. The Tories won 331 seats, Labour 232.”

“Cameron ought to be chastened by the knowledge that fewer than four votes in ten were cast for his party, and less than a quarter of the whole electorate voted Tory. The overall Tory vote increased by only 0.08 percent since the last election, while Labour’s increased by 1.4 percent. But his party will not be chastened at all.”

What actually occurred should have led to a small increase in Labour representation in an electoral system where representation is proportional to the percentage of votes received.  Neither Britain nor the US has such a system.  The person who receives the most votes in a given district is the representative of that district.  The British seem to refer to this as a “first-past-the-post-system,” while in the US it is more usually referred to as a “winner-take-all” system.  It is this aspect of electoral politics that allows small changes in voting results to produce large changes in representation.  The most significant result from the British election was the sweep of seats by the Scottish National Party (SNP) in Scotland, an area that is definitely left-leaning.  The movement of liberals in Scotland to the SNP and the fear of Scottish independence in other parts of Britain combined to lower vote totals for Labour and other liberal parties.

It is often said that winner-take-all electoral systems can only support two significant parties.  For much of its recent history British elections were determined by competition between the Conservative and Labour parties.  That has begun to change.  In 2010, Cameron’s Conservative Party was forced to form a government in an alliance with the Liberal Democrat Party which won 57 seats.  In 2015 it won only 8 seats.

“We have had periods when third parties held the parliamentary balance, as the Irish party did in favor of the Liberals after 1910, or when there was true three-party politics, as in the 1920s, with Labour coming up to overtake the Liberals. But if, as A.J.P. Taylor said of that time, the British electoral system ‘was ill adapted to cope with three parties,’ how much less adapted is it to cope with electing a Commons where eleven parties are now represented, five of which campaign throughout the whole country, and six more of which are from the ‘Celtic fringe,’ Scotland, Wales, and Northern Ireland?”

Wheatcroft seems to be concerned with the demise of a single liberal alternative to the Conservatives, and with the potential for chaos and perhaps even the dissolution of the United Kingdom, from the rise of nationalist parties like the SNP. 

What is of greatest interest to us in the US is whether or not the devolution of two dominant national parties into multiple issue-focused parties might be a good thing or a bad thing in terms of running a government.

In the US, it is easy to interpret stories of countries where multiparty accommodations are being made to form a functioning government as a sign of ultimate weakness in governance, if not incompetence.  But is that true?  Or might it indicate a more advanced and more productive means of governing a complex society?

David Runciman addresses this issue directly in comments on the recent election that appeared in the London Review of Books.  He summarizes the conventional wisdom in this manner.

“….few people dissent from the line that it is better to have a government that can pass legislation and take decisions when it needs to than to be stuck with one that stumbles on hand-to-mouth from vote to vote. We seem to prefer certainty to confusion.”

He then proposes that a single party majority (the US equivalence would be one party controlling both houses of Congress and the presidency) has historically not proven to be more efficient at governance.

“What evidence is there that majority governments are better at governing? The fundamental long-term problems this country faces – inequality, a struggling education system, growing health costs, changing employment patterns, environmental threats – are ones that a series of majority governments (and I include the coalition, which had a big parliamentary majority) have failed to address. This is not just a left/right issue. Blair didn’t tackle them, despite his massive parliamentary ascendancy, any more than Thatcher did.”

Rather, the evidence supports the notion that political systems that incorporate proportional voting and thus encourage multiparty governance have been more efficient.

“The two countries that have seen the greatest rise in inequality over the past couple of decades are Britain and the United States. Both have a first-past-the-post system designed to offer a clear choice between two main parties. Yet whichever of the two parties wins, the drift towards inequality has been inexorable. This contrasts with continental Europe, where there are barriers in the way of vastly unequal distributions of wealth and power and where there also happen to be proportional representation systems that force multiple parties to negotiate for influence and outcomes.”

Britain and the US face complex problems in a complex world over which they have little control.  They must deal with this environment in an arena in which special interests, feeding off the increased inequality, have ever more resources with which to purchase the allegiance of a given party.  A majority party is not so much better able to make decisive decisions as they are more easily bought.

“Majority governments flatter to deceive. They are not more decisive. They are just more biddable.”

“Decisive, single-party governments are not the way to resist these forces, because their freedom of manoeuvre makes them easier to buy off without anyone else being able to hold them to account. What national democracies need is not more autonomy but more barriers in the way of any single political faction or grouping being able to call the shots. The presence in government of multiple parties representing multiple interests helps to give democracy a measure of defence against the whirlwind of money that swirls around it. It makes it harder to sell out, because it makes it harder to do anything reckless. I realise that doesn’t sound like a ringing endorsement of democracy. But for now it’s the best one there is.”

One might expect that majority governments will feel free to proceed boldly in implementing policy.  Runciman believes that history suggests otherwise.  One is free to be bold only if one is free of worry about being reelected.

“What single-party governments do, instead of making the messy compromises that might offer their populations some real protection, is focus their attention on the areas where their freedom of action can make an immediate difference….It is no coincidence that first-past-the-post states also tend to turn into national security states: their governments have the capacity to take aggressive action against immediate threats that appear amenable to massive concentrations of firepower, regardless of the long-term consequences….Unencumbered executive leaders worry about being lumbered with the blame for any failures of national security, because their autonomy leaves them exposed to carrying the can. Majority governments spend more time avoiding the risks that impinge on them than mitigating the risks that threaten the rest of us.”

How do such considerations apply to the US?  One might argue about the level to which political parties are under the control of plutocratic interests, but clearly money buys influence and power in our country.  The Supreme Court has gone so far as to declare that the purchase of political power is a perfectly acceptable attribute of our political system, and any attempt to enforce equality of political opportunity is unconstitutional.

One suspects that the voting public fears—perhaps subconsciously—the consolidation of too much power in a single party.  It seems to be content with the notion that control of congress and the presidency should not reside in a single party.  One also suspects that the closeness of national voting in presidential elections arises from some political dynamic rather than any similarity in attractiveness of the particular candidates.  If Runciman’s cynicism is accepted, one could conclude that as soon as one party acquires enough power to pursue a specific agenda it demonstrates its ineffectiveness, incompetence, or recklessness and drives the electorate back towards the minority party—a form of political equilibration.

Even the politicians themselves recognize the danger that exists in single-party governance.  The much-maligned filibuster option incorporated in the rules for Senate deliberations were not determined by constitutional mandate, but by a mutual recognition that “we are not to be trusted.”  This single procedure has been very effective in limiting the power of the majority over the minority that Runciman recommends. The party in power complains about the filibuster rule but maintains it because it knows it will soon be out of power.

One might embrace the minority veto power that exists in the Senate as a good thing.  In a spectacularly diverse country like the US it would be highly unlikely that a relative handful of politicians, or a handful of technocrats, would be able to assess complex social problems and come up with an optimal solution for the nation as a whole.  While the national government frets about its inability to take action, we have state and local governments performing what might be referred to as social experiments.  Let these various experiments play out and compete for social approval.  Those that can demonstrate sufficient effectiveness to obtain broad acceptance can then be canonized as national law.  This is the process gay marriage and minimum wage legislation are following. 

Would the US have a more effective means of governance if it possessed a multiparty system?  We will probably never know.  It is extremely difficult to create a new party capable of gaining representation under our current winner-take-all policy.  We have a number of parties that gain a place on ballots but they almost never win a seat in government.  Occasionally, a charismatic individual will make a run for the presidency as a third party or independent candidate and gather a significant number of votes, but this movement dissipates as soon as the leader retreats from the battle.  The best opportunity to create a viable third party arose when the Southern states tried to protect their racial policies from being dismantled. This was a regional issue in which a majority of voters in that region could be expected to vote for the party candidate, similar to the situation in Scotland.  Ultimately, the Southern politicians decided that their best strategy was to move their block of votes from the Democratic Party to the Republican Party.

One advantage of a multiparty system would be a shorter and simpler election process.  In many countries one votes for the party of choice not the candidate of choice.  In multiparty environments, the views of the candidate are defined by the political platform of the party, otherwise he/she would not be the candidate.  In our nominally two-party system, the Democratic Party would harbor environmentalists, union supporters, gay-rights advocates, feminists, and a few socialists; the Republican Party would provide a home for states-rights advocates, Christian evangelists, libertarians, and advocates of corporate interests.  Each of these subgroups could, in principle, be represented by their own party.  Since they are not, then the public has no way of knowing what the specific beliefs of a Republican or Democratic candidate might be from merely their party label.  This is one reason why our election campaigns are so long; a candidate must try to sell himself/herself to all these specific subgroups and that can take a long time.