Progressives against Progressive Medical Innovation

I magine paying $100 for a lottery ticket that pays only $110 on the remote chance that you win. Not a lot of people would take that large a risk of loss for such a small gain. If Senator Bernie Sanders gets his way, biopharmaceutical companies trying to cure obesity will be forced to make these bad bets or, more likely, abandon their pursuit of innovative medicines. Last week, Senator Sanders held a hearing attended by the CEO of Novo Nordisk, the company that developed the popular obesity drug Ozempic, to suggest that Novo price its patent-protected drugs in line with manufacturing costs. This is despite the fact that our patent system was set up to reward innovation by avoiding such pricing. Sanders’s proposals may be well intended, but they would likely come with particularly dangerous consequences for the poor who benefit the most from future innovations in the treatment of obesity.

Few would invest $100 million to develop a drug that made $110 million in earnings, or a 10 percent return, when launched. That’s because only 12 percent of drugs that enter into drug development are approved by the Food and Drug Administration, and many compounds never even progress beyond the research stage. As true for innovation generally, abnormally high profits on winners must pay for all the losers. The high-risk, high-reward nature of the medical-innovation industry explains why its risk-adjusted returns are comparable to those of other industries, even though the few drugs that actually make it to market generate large profits.

Sanders stressed during the hearing that drugs are cheaper in single-payer countries that have existing price controls. What is missed is that those countries act in their own best interests, because they are small and medical innovation is driven by world returns unaffected by small countries’ individual pricing policies. Novo Nordisk, which is Danish, could not generate enough sales selling to 6 million Danes to justify its R&D investments in Ozempic. Because world returns drive innovation, small countries with demand that will account for only a small percentage of a pharmaceutical company’s global sales have no downside in setting stringent price controls, as it does not affect the flow of products they can enjoy through new innovation. Put simply, they face no trade-off between greater access and innovation.

But the size and income of the United States, together with the fact that we have fewer price controls than other countries, mean that we account for 70 percent of global pharmaceutical profits despite accounting for only a bit more than a fifth of world GDP. Were the U.S. to mimic the price controls of smaller countries, Americans themselves would suffer greatly from less access to future cures and treatments. Indeed,  because of the free riding of governments in small countries, prescription drugs have a peculiar pricing pattern. This explains why it is of interest to the U.S. government to pay the highest prices, despite being the largest buyer — the opposite to most markets. This suggests that the appropriate policy is not importing foreign free riding but preventing it abroad through trade agreements or other means.

Private competition, rather than regulation, is a much more productive way to control prices for medicines, as is true for most goods and services. Imagine if we’d imposed price controls on cellphones in the 1980s — once outside the home or office, most of us would probably still be relying on phone booths. Similarly to cellphones, most of the World Health Organization’s essential and cheap drugs started as patent-protected and more-expensive innovations.

For obesity drugs, downward price pressure is already underway and can be expected to grow, with more than 120 obesity drugs currently in the FDA pipeline, including those from new entrants such as Amgen, Pfizer, and Roche. Indeed, even before last week’s Senate hearing, price competition between Novo and its existing competitors was heating up as those competitors started to set their prices below those of Novo. The large volume induced by the high prevalence of obesity in rich countries predictably creates an enormous incentive to innovate and compete.

But unfortunately, this competition may be hampered by the price controls in the Inflation Reduction Act that target top-selling drugs. Given the prevalence of obesity in the U.S., drugs to treat it will likely be best-sellers owing to volume and not necessarily to price. Indeed, if competition brings prices down as expected, sales volumes may rise dramatically, thereby, ironically, making them more-likely candidates for price controls.

Increased price competition is one reason obesity drugs may, contrary to fears raised at the hearing, cut Medicare spending rather than increase it. A more important one is that drug spending is likely to rise, but overall health-care spending ought to fall in time because of a reduction in demand for other forms of care. About 29 percent of Americans above the age of 65 currently have diabetes, and they have higher than average health-care spending, thus representing a disproportionate share of the total $840 billion in annual Medicare spending. Paying for obesity drugs before beneficiaries require treatment for diseases associated with obesity will be valuable. In the end, health-care spending should fall.

The development of new obesity drugs is highly progressive, as obesity afflicts the poor far more than the rich. If these cost-based price controls had already been in place, it is questionable whether today’s miracle obesity drugs would have been brought to market. Obesity-drug innovation is in its infancy. As it grows, new treatments will be cheaper and creatively destroy old ones, just as the new drugs may already be reducing demand for bariatric surgery. Let’s hope politicians and doctors don’t stand in the way of the market’s relentless pursuit of truly progressive medical innovations.