Cecil Bohanon and John Horowitz: Is the US footing the bill for pharmaceutical innovation?

Americans pay about four times higher prices for patented prescription drugs than do people in other countries, which boosts the profits of large pharmaceutical companies.

Four times higher prices for identical goods exemplifies price discrimination. Price discrimination occurs when companies charge different customers different prices for the same product or service based solely on willingness to pay rather than on cost differences.

Price discrimination often enables greater access to essential products and services, especially for low-income buyers, while providing companies with the revenue needed for future innovation.

For decades, progressives have criticized pharmaceutical companies’ high prices and profits. Now, the Trump administration is joining the chorus. Suppose we compel pharmaceutical companies to lower prices in the United States. In that case, they will likely cut back on developing new drug therapies, because the profitability of innovations will decline. Consumers in many other countries might not have access to new, innovative drugs. Interestingly, the Trump administration and consumer advocates typically don’t mention that Americans pay about two-thirds of what people in other countries pay for generic drugs.

Some things that look like price discrimination might not be. For example, charging more for something that’s costlier to provide is not price discrimination; it’s cost-based pricing. An instance of cost-based pricing might be Bohanon’s coiffeuse, who charges men lower prices for a haircut than she charges women. When asked about the price difference, she quickly responds that women’s haircuts are more complex and take longer than men’s. The price difference is because of cost differences, not price discrimination.

To illustrate price discrimination, consider a small-town dentist who charges the wealthy banker $100 for routine care but charges the struggling widow just $30. If regulations mandated uniform pricing, the dentist might raise all prices to $100, pricing out vulnerable patients such as the poor widow; lower all prices to $30, threatening the dental practice’s profitability; or relocate entirely, leaving the community without dental services.

Many people view price discrimination as inherently immoral and insidious, especially people who pay or perceive they are paying higher prices because of demographic or economic factors. However, if pharmaceutical companies were required to charge uniform global prices, they would likely abandon lower-income markets entirely or, perhaps more concerning, dramatically reduce funding for research and development of new treatments.

Pharmaceutical innovation that produces new therapies relies on the higher profits from premium-paying markets, like the United States. Short-run gains must be balanced with long-run pain—a tough choice.•

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Bohanon and Horowitz are professors of economics at Ball State University. Send comments to [email protected].