Why is Medicine so Expensive? A somewhat updated blast from the past

Lately my reading (well, listening on audiobook) has featured a lot of Thomas Sowell’s writings on Economics.  I started with Basic Economics, continued with Applied Economics, and is now continuing with Economic Facts and Fallacies.  I have long been wont to talk about the economics behind things in my writings here, basing that writing on more the introductory economics I studied in College and various readings over the years.  Since I’ve mostly talked about things in very basic terms that’s been mostly adequate.  And is, frankly far better than a certain Congressional Candidate who boasts of having a bachelors in Economics and yet who gets the most basic things utterly and completely wrong.

That’s neither hear nor there.  I wrote what follows a little over four years ago.  And in light of my current studies, there’s not much I would change except for a bit of expansion.  So, that’s what I’ll do here.

Over on FaceBook an image posted a Senator’s facebook page asked the question “why are prescription drugs so expensive in the US? It also claimed to answer it: “We are the only major country without a national healthcare program and the pharmaceutical industry can charge whatever it wants.”

Well, let’s leave aside that latter part which ignores things like competition and supply/demand curves. (What?  You’ve never price shopped among different treatments?  Asked if there was a lower cost alternative to some expensive medication?  Whyever not?  I have.)  Instead, let’s look at what effect a “national healthcare program” really has on the cost of medicine.

The production of new medicines and passing the extensive testing required to get them approved is extremely expensive. That cost, and the cost of those medicines that do not get final approval has to be recouped somewhere. Now, all these places with “national healthcare” are a monopsony (that’s “single buyer” in the same way that “monopoly” is “single seller”) and, thus, can dictate the price they will pay. This means the cost of development cannot be recouped there. But it has to be recouped somewhere.
And that means that we’re subsidizing medical research for the rest of the world. Even if something is developed overseas–One of the medicines I used to take (a beta blocker–not allowed while I’m on allergy shots) was developed in Great Britain and only just “aged out” to having generics available–guess who pays to recoup the development costs? Yep. We do.

These other countries don’t make those high fixed costs for bringing new medicines and treatments to market go away.  They simply refuse to pay them.  As a result, we not only subsidize our own research into new medicines and treatments, we subsidize the research of the entire rest of the world.

The problem is, if we stopped doing that–by whatever means, national health care, some “fair price” law, whatever–then research into new medicines would also stop. We could “enjoy” the same level of medical progress as, say, Yugoslavia.

Don’t think so?  Get a copy of an insurance formulary (many of them are available).  These list the various approved medicines at various copay price points.  Go through and list the ones that were developed in the Soviet Union, Communist China, Cuba, or similar highly “socialist” society where it’s all “good of the State” rather than profit motive.

Did you even have to turn the paper over to continue the list on the reverse side?  I didn’t think so.

So, take away “recouping costs” and “making money” from the equation and go instead to  top-down government funded and dictated research and medical progress essentially goes away.  You may reduce the costs of what you have now, but what you have now is all you will ever have.  Again, you don’t make the cost of medical advancement, of bringing new medications and treatments to market by such limits on pricing.  You simply refuse to pay them.  When means, in the end, they don’t get done.

So why, you may ask, do the pharmaceutical manufacturers sell to these other countries if they can’t recoup their development costs?  The answer lies in a concept called “marginal cost” also known as “incremental cost.”  Marginal cost is the added cost of producing one more of something.  If you’re making 10,000 pills, the marginal cost is how much more you have to spend to produce 10,001 instead.  Now, so long as you have some way, some how, to make back the fixed costs you can make money selling more so long as the price is higher than the marginal cost.  Sell 100,000 pills in the US priced to recoup costs and make a profit.  Sell 100,000 pills in the US at the same price and also sell 10,000 in France just a bit more than the marginal cost and make a somewhat bigger profit.  But without that 100,000 selling in the US at a price that recoups cost, the 10,000 to France won’t exist.

As I said, we’re subsidizing the world.

Note that this also means that medicines for rare diseases and disorders will also be extremely expensive.  The cost of bringing a new medicine to market doesn’t get cheaper because a smaller number of people have the problem it’s meant to treat.  Those fixed costs are just as high but you have fewer “doses” to recoup those costs.  If it costs $100 million to bring a new medicine to market and you can rely on selling a hundred million doses, those fixed costs work out to $1 a dose. (I’m going to ignore adjusting for future value vs. present value to keep this simple.  It would actually be somewhat more than $1 a dose because money from future sales is worth less than the same money now.) If, however, you can only count on 10,000 doses, then those fixed costs work out to $10,000 a dose, even if the medicine were free to make.

That’s an extreme case to demonstrate the principle which applies across the board whether the number you can expect to sell is a billion, a hundred million, ten million, or three.  That’s what you have to recoup the fixed costs.

The bright side is that once that cost is recouped, prices do come down. Half the medicines I take every day are “$4 generics” (that’s not a co-pay. That’s what the pharmacy charges). And the ones that aren’t are mostly in the $10-20 range. But all of them were expensive during that limited window the developer had to recoup costs.

The Senator in question, of course, knows all this. At the very least, someone on his staff could explain it to him if he asked. But it’s much more useful for him to use the cost as a means to grab even more government power.  Remember, governments don’t make decisions based on economic thinking and what effects something will have down-the-road (what Sowell called “thinking beyond stage one”).  They make decisions on what sounds good to a population that largely also doesn’t do economic down-the-road thinking and only has to look good until the next election. (And by the time the down-the-road effects come into play, they can usually find someone or something else to blame and not their foolish economic choices.)

And that’s what this is really about–a power grab. The more dependent you are on government, the more they own you.

When it comes to medicines and new treatments, we’re subsidizing the world.  Even when it’s a foreign company that makes the advance, they do so because they can recoup their large fixed costs here.  But if that’s the price for continued development of new prescription drugs and other treatments, I can live with it.  It’s not the ideal but if you end that and you end medical progress, which means my daughter, when she gets older, won’t have anything better than I have today.

And that I can never forgive.

2 thoughts on “Why is Medicine so Expensive? A somewhat updated blast from the past”

  1. That’s funny – I’ve been saying much the same thing for years: /we/ pay for R&D costs, /in/ /addition/ /to/ the cost of the med itself.

    Now, if the various National Health Services (or whatever they’re called in various countries) would loosen their purse strings just a bit, perhaps our paid costs would come down a bit in return (assuming that the pharma companies aren’t suffering from wanton greed, of course.) But if other countries could pick up the tab by a couple of % or so, and profits were to remain static (ordered as such?) then we’d not get raped so hard on meds (considering the dozen or so I take, I know I’d appreciate that greatly!)


    1. I’ve been saying much the same thing for years

      So have I. Note that I wrote the original four years ago (this is just a slightly expanded version of that older post) and it was hardly a new idea to me even then.

      And much of this is touched on in Sowell’s books as well.


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