Monday, June 30, 2003

Micky Kaus had a post about an apparent conflict between two reasonable sounding Republican complaints against a prescription drug benefit.

The first complaint is that, like all other government benefits, spending on this one will go way, way up in the future. Once the camel gets it's nose under the tent, spending on this new entitlement will spiral out of control.

The second Republican criticism is that drug companies will no longer make as much money, and will thus not have as much money to spend on R&D to develop new drugs.

He points to the apparent inconsistency of government drug spending growing out of control, and yet having drug companies not being able to afford R&D. He requested that someone E-mail him if they could resolve this, but while I E-mailed a response solving the problem, he hasn't posted anything to his site. I thought that I would post it here, on the off chance someone actually drops by, and the even smaller chance that they would be interested.

What will get government spending spiraling out of control are two factors, increasing numbers of people eligible for the program, and increasing numbers of drugs covered. As the Baby Boomers retire, and life expectancy rises, more and more people will qualify for a "seniors" drug benefit. Just an obvious conclusion from current demographics and trends. While the case for the benefits received by this growing number of government benefactees is less strong, the chance that they will in fact grow must approach 100%.

Both of these trends will act to dramatically increase government spending, but will also act to reduce drug company profits. The government will, like the governments of Canada and Europe, act to push prices down on the drugs that they include for any benefit. This will, likewise, push drug company profit margins down. As increasing numbers of people are covered for an increasing number of decreasingly profitable drugs, drug companies profits will be severely squeezed, leading to substantial cuts in R&D. Not only will lower profits (and therefore lower cash flow) hurt R&D, the very likelihood of potential drugs being included in a government price sceme will make the cost/benefit analysis numbers for potential drugs come out much worse, decreasing the likelihood of them being attempted.

On a tangent, I can see this having other effects as well. The Law of Unintended Consequences is alive and well. In addition to cutting R&D, what other things will drug companies do in effort to maintain profitability? It seems to me that they would try to divert whatever R&D money they have left to drugs which would be unlikely to be covered by any drug benefit. This would, of course, lead to an even greater lack of new drugs for the very people that Congress wants to assist.