In an effort to lower U.S. drug prices, President Trump has signed an executive order tying Medicare’s payments for drugs to the prices paid in other nations. Under this “most favored nation” rule, Medicare’s payments under Part B, which covers medicines typically administered in doctors’ offices, along with Part D, which covers self-administered medicines mostly obtained from pharmacies, could not exceed the lowest price paid in any developed country.
Trump’s gut instinct on drug prices is right: They are too high in the United States and too low abroad, but his advisers led him down the wrong path in addressing this disparity. The pricing disparity stems from government failures preventing price competition, among sellers here and buyers abroad. And the proposed “solution” adds additional layers of government controls that would do little to lower U.S. prices and could actually increase the foreign freeriding that understandably riles the president.
The international pricing disparity that led to the signing of the most-favored-nation rule is profound. A 2020 report by the White House Council of Economic Advisers (CEA), which I chaired until recently, found large and increasing differences in drug prices here and abroad. For example, after adjusting for per capita GDP, Canada paid a mere 35 percent of the price in the United States for the 200 top-selling drugs. Switzerland’s per capita GDP in 2017 was actually 11 percent higher than that of the United States, yet the Swiss paid 39 percent of U.S. prices. Fifteen years ago, other developed countries were paying about half what Americans paid. Now it’s down to less than a third.
The fundamental source of the pricing disparity is very simple but poorly understood. Economic evidence abounds that reduced competition among sellers raises prices while reduced competition among buyers lowers them.
In the United States, there are, owing to government policies, adverse incentives for price competition among drug sellers, raising prices here. Overseas, there’s virtually zero competition among drug buyers — in most nations, a single-payer health-care system buys all drugs. This lower prices abroad.
Instead of adding government mandates to a problem caused by existing government policies both here and abroad, freeing up competition by deregulating the U.S. market and fighting for stronger trade enforcement would address the disparity more smartly — and more squarely sync with the president’s overall economic agenda.
Drug development is tremendously expensive. But by the time a drug gets to a foreign market, early costs are sunk. So, when a foreign government uses its clout to push the price of a drug down, it’s generally better for a drug company to accept that price than to walk away. It is better to make something than nothing. Moreover, small countries have no incentive to contribute to innovation by accepting higher prices, as their sales have a negligible impact on the worldwide revenues that drive innovation — and therefore have virtually no impact on the supply of new drugs coming into their counties.
This is, however, larceny on a global