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Drug price controls are a dance with the devil: short-term savings will be overwhelmed by loss of innovation

July 22, 2022
Stat News
By Craig Garthwaite

Democrats have sent the legislative text of a sweeping proposal for drug price controls to the U.S. Senate parliamentarian, who may report on Monday whether the provisions qualify for the budget reconciliation process that allows lawmakers to evade a filibuster and pass a bill with a simple majority. Democrats expect the various drug-related provisions to reduce federal spending by roughly $300 billion over a decade.

That’s a hard number to resist. But the proposal would have other monumental and decidedly harmful implications for American society. There is simply no way for government fiat to force down costs without harming innovation, especially at the startups and small biotechs fueled by venture capital (VC).

All price control schemes have two inescapable and competing effects:

  • They lower costs and increase access to drugs in the short term.
  • But by decreasing the returns investors can expect on successful drug launches, they limit investment in innovation and deprive people of access to future medicines.

Drug pricing policy is about weighing these two effects.

The lion’s share of life-science innovation takes place at startups that rely on venture capital. These companies, which are often spun out of university labs, pursue the riskiest — and most exciting — research, with backing from those who know that most big ideas fail.

Investors accept this risk because they anticipate large rewards from their success stories. If a cure for cancer, or Alzheimer’s, or ALS is ever developed, it will probably come from a startup backed by venture capital. Trimming these potential rewards decreases the incentive to invest. This is particularly true when price controls target exceptionally high-revenue products — the “big wins” that are necessary to justify the inevitable losses that come along the way.

Democrats implicitly acknowledge the potentially far-reaching harms of their policies, because they attempt to temporarily exempt small firms from the price controls for a limited time — but only if those small companies develop a drug and bring it to market themselves, rather than partnering with bigger pharmaceutical companies.

This supposed relief for small companies won’t actually work, though, because lawmakers misunderstand the incentives of investors involved in early-stage drug development.

New products are developed in an ecosystem that involves VC-funded startups conducting initial research and demonstrating a product’s potential. These small labs are often pursuing a single promising treatment. They have no intention of trying to join the ranks of pharmaceutical behemoths. Instead, investors in these firms hope to exit their investments by either selling the company to a bigger firm or partnering with one once an experimental treatment shows potential.

The price they get at these exits is explicitly a function of the expected return of the drug when it is sold by the acquiring firm. So the new legislative carve out won’t save anyone. Subsequent price controls will still erode startup valuations and therefore investment. Venture capital companies could no longer count on exiting their investments with the same level of returns because any future buyer would be staring down the price-control barrel.

Perversely, this attempt to mitigate the harms of price controls will introduce new, wasteful development costs into the system. Facing declining valuations, some biotech startups would attempt to bring experimental drugs to market themselves. This would involve building out the small army of researchers, lawyers, market experts, and salespeople needed to get an FDA-approved drug to patients that is normally the forte of larger firms. Forcing small firms to undertake commercialization efforts to avoid price controls would further raise the cost of drug development and decrease the flow of potential products to the market.

Democrats are willing to acknowledge the innovation-harming effects of their proposals; that’s why the effort to let Medicare “negotiate” drug prices has been adjusted so many times. Every iteration is about reducing immediate harm.

But the evolution masks the eventual damage that could come from even the mildest version of price controls, as few rational investors would believe that this introduction of price controls will be the only bite at the proverbial apple.

Indeed, the legislation appears to plan for a more expansive use of price controls down the line — how else to explain the astonishing $3 billion Democrats have earmarked to implement this “limited” system?

Anyone making investments with an ultimate payoff 10 to 15 years away will rightly be worried about the likely eventuality of a broader system of price controls being in effect by the time their medicine finally hits the market. This uncertainty would create an even greater chilling effect on investments in innovation than the text of the existing legislation. It is time for Democrats to face the brutal economic fact that any system of price controls will harm future innovation and to instead engage in an honest debate about whether the reduced flow of new drugs is worth some savings today.

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