The Commonwealth Fund has put out yet another report comparing U.S. drug prices with other nations that belong to the Organisation for Economic Co-operation and Development. The Fund’s report comes to the shocking (!) conclusion that U.S. drug prices are higher than other countries. This is largely true, the report points out, for the 10 drugs that the Biden Administration has targeted for price controls.
What the report fails to elucidate is why this is the case.
If one is familiar with international business and international relations generally, one realizes that there is a lot of freeloading that goes on. China, in particular, is notorious for pilfering American intellectual property in software and other technologies. European nations are infamous for freeloading off of the U.S. security umbrella provided by American defense spending.
This international freeloading is particularly prominent in the area of pharmaceuticals. The international market for pharmaceuticals is particularly susceptible to freeloading because of the nature of the business model.
Drug companies have very high R&D costs, which are spent upfront before a drug even generates any revenue. Then, typically, once the product is developed, there are very low manufacturing costs to make each pill, particularly for small-molecule drugs, the most common form of drugs.
Consider the opposite business model, that of cars and trucks. Typically, car companies have much lower R&D costs and much higher manufacturing costs. For this reason, it is very difficult to freeload off of the investments made by car companies. If a foreign nation wanted to buy a U.S. car at a 75 percent discount, the car company would say, “absolutely not, as our manufacturing costs are most of the cost of our cars, so we would lose money on every car.” There is even evidence to suggest that autos are more expensive in Europe than the U.S.
The decision to sell at below-market prices is more difficult for a pharmaceutical company. When a nation proposes to buy a drug at a 75 percent discount off U.S. prices, the drug company’s choice is not the same as the car company’s.
The drug company has already spent the lion’s share of funding to develop that drug — that money is gone — and it then costs only pennies to manufacture the pill. If the drug company accepts the 75 percent price cut, they will not technically lose money on each pill; they will instead accept less revenue than they deserve to repay their R&D investments.
So, the drug company’s choice is to walk away from millions in revenue from that country and deny their people a lifesaving drug, or swallow hard and accept an unfair price that is nowhere near the drug’s value. For the sake of shareholders and patients, drug companies typically accept the unfair price and devote the revenue to offsetting their previous investments.
In short, these nations are freeloading off of American R&D, as most pharmaceutical R&D happens in the U.S.
Is this freeloading theory a wild one intended to disparage these countries and justify high drug prices? Let’s consider other areas of freeloading. The U.S. spent $858 billion on defense in 2023, which does not include billions in spending for the intelligence agencies and other components of national defense. This huge expenditure totaled about 3.5 percent of U.S gross domestic product (GDP).
Consider the nations in the Commonwealth Fund’s drug study and their level of spending on national defense as a percent of GDP: Australia 1.9 percent, France 1.9 percent, Japan 1.9 percent, Canada 1.2 percent, Germany 1.4 percent, Switzerland 0.8 percent.
With the exception of Switzerland, the U.S. provides security guarantees for all these nations. In short, these nations are freeloading off of the investments that American taxpayers make in national defense.
Why would one be surprised if these same nations were freeloading off of the investments that Americans make in pharmaceutical R&D by paying higher drug prices?
The only way to fairly address this issue, without constricting the supply of new drugs, is to play hardball in our trade negotiations with these wealthy nations and to force them to pay something closer to market prices for the drugs developed in the U.S. This would end the freeloading and provide more resources for R&D into new drugs.
Instead, not surprisingly, our politicians are rushing to join in on the freeloading.