Pharmac’s free ride won’t last for ever

Dr Eric Crampton
2 July, 2024

If philosophy students remember one thing from their lectures on Immanuel Kant in undergraduate classes, it is his categorical imperative. It’s easy to remember because it’s an awful lot like the old Christian ‘Golden Rule’.

Where the Golden Rule says we should treat others as we’d wish to be treated, the categorical imperative says that we should set rules for our own behaviour that would lead to good outcomes if those rules were followed by everyone.

And New Zealand often likes to imagine itself as an international exemplar for the categorical imperative – from the Zero Carbon Act to the country’s stance against nuclear weapon proliferation.

There’s one area where we might have cause for worry. The European Parliament, in April, adopted a package of proposals that could lead to a European version of Pharmac.

Pharmac is great for New Zealand. But it’s not an example that would serve the world well if followed globally. At least if we take seriously the results of a National Bureau for Economic Research working paper released in late June.

Princeton University’s Professor Kate Ho and Harvard University’s Professor Arial Pakes had a look at America’s subsidisation of worldwide pharmaceutical development.

Those subsidies come in two forms.

First, the American government subsidises for basic research are much higher than that elsewhere. According to Ho and Pakes, whose figures I rely on throughout this column, the American government spends about 0.21% of GDP on health-related research. European governments spend about 0.07% of GDP and other OECD member countries spend only about 0.04% of GDP.

But where America’s National Institute of Health [NIH] spent about $187 billion on pharmaceutical research and development from 2010 to 2019, American pharmaceutical companies spent about $747 billion on pharmaceutical research between 2011 and 2021.

American taxpayers contribute a lot more to global pharmaceutical R&D than do taxpayers elsewhere. But public funding is a relatively small proportion of overall R&D.

Ho and Pakes run simple calculations showing that Americans get about four dollars of benefit for every dollar spent by American pharmaceutical companies on research and development – after accounting for spending by the NIH. Reducing expenditure on R&D would hurt Americans’ (and others’) wellbeing in the future, when there would be fewer new and improved treatments.

Pharmaceutical companies, both American and foreign, can spend that much on research and development in large part because American consumers pay far more for their medicines than do patients elsewhere – the second and more important way that America subsidises global drug development. Almost half of Danish Novo Nordisk’s revenue comes from the US.

A purely profit-maximising pharmaceutical company able to charge different prices in different markets, and able to prevent reimportation between countries, would want to charge more in places that can afford to pay more. Pharmaceuticals are very expensive to develop, but the cost of making one more pill or treatment is not always high. Charging more in richer places, and less in poorer places, makes sense.

So long as drugs cannot be re-imported from poorer markets. And so long as those international price differences do not generate intolerable political pressure within the richer market.

America’s Centers for Medicare and Medicaid Services currently bargains with pharmaceutical companies over prices for ten products. President Biden proposed extending that Pharmac-style bargaining to a much broader set of medications. Ho and Pakes, again on simple calculations, expect a fall in pharmaceutical company revenue of about 16% if that were to happen, and almost a 20% decrease in net profits.

Current patients in America would benefit greatly, but pharmaceutical companies’ expenditures on R&D would drop – with longer term costs.

They also note the European proposal to follow a more Pharmac-style approach. While the European proposal has provisions aiming at encouraging R&D, Ho and Pakes warn that “without a lessening of the international price disparities the political pressure on the U.S. government to decrease pharmaceutical prices is unlikely to abate, with potentially serious consequences for pharmaceutical innovation.”

Ho and Pakes estimate what would happen if every country with per capita GDP of at least $50,000 paid the same amount for each drug. New Zealand is included in that set of 21 countries. Brand-name drugs in America would be about half as expensive as they are now. Prices in New Zealand would rise by 75%.

And so we come to the Kantian problem.

Pharmac has been and continues to be great value for Kiwis. The government drug-buying agency can drive sharp bargains through sole-source contracts where different pharmaceutical companies compete to deliver drugs with similar effects. It’s one reason that Kiwis spend less on medicines.

But if everyone had a Pharmac, the outcome would not be good for innovation. New Zealand largely free-rides on American investments in research and development.

As more places adopt models that look like Pharmac’s, international price discrepancies become more difficult for Americans to tolerate. Pressure to allow drug re-importation from Canada, or to extend Medicare bargaining to more drugs, strengthens.

That pressure is understandable where American consumers disproportionately fund the pharmaceutical research powering global pharmaceutical innovation. But the result will not be good over the longer term, unless the continued artificial intelligence revolution pushes R&D costs down even more quickly.

Ho and Pakes’s figures are rough and ready. But it is rather obvious that Americans contribute disproportionately toward the pharmaceutical innovation from which we all benefit, and that Americans’ tolerance for subsidising the rest of the world is on the wane.

Pharmac faces a lot of challenges, including increased political interference in what should be arms-length drug-buying decisions. Over the longer term, other countries following Pharmac-style approaches risks eroding pharmaceutical innovation, or American policy responses that make it harder for countries like New Zealand to secure lower prices.

It may be worth thinking about what a Kantian Pharmac would look like.


To read the full article on the Newsroom website, click here.

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