Drugs test Clinton's mettle

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THE UNITED States' pharmaceutical industry is an easy target for zealous healthcare reformers. Quite rightly, President Clinton has singled it out as an industry that has grown rich by overpricing drugs in a huge and captive domestic market.

However, the issues are much more complicated than a straightforward case of exploiting US consumers. In attacking pharmaceuticals, Mr Clinton faces a dilemma: how to reduce healthcare costs while preserving an industry that some advisers consider a prime candidate for the list of 'strategic' US industries.

President Clinton promised during the campaign to restore US competitiveness with programmes for high-tech and other leading-edge industries. In many respects, the pharmaceutical industry fits the strategic industry model outlined by Laura Tyson, who chairs his Council of Economic Advisors, and other administration supporters of a modified industrial policy.

The US industry enjoys a global market share of nearly 30 per cent compared with 10 per cent each for the three next biggest players: the United Kingdom, Germany and Japan. It also provides a large number of high-paying jobs in the US and is responsible for a trade surplus in its sector, despite expensive domestic drug prices. In short, the industry fits the classic Japanese industrial policy model of penalising domestic consumers for external benefits, notably global market share, technological leadership and high-wage employment. The Clinton administration must ask itself whether these benefits can and will be retained in a new environment of price controls, stronger government regulation and congressional hostility.

There is no question that the US pharmaceutical industry overprices in the domestic market. The General Accounting Office reported that a sample of US drug products costs 50 per cent less in Canada as a result of differences in government-mandated pricing policies. The US Office of Technology Assessment, an arm of Congress, also released a study which concluded that the drug industry's profits could not be justified by either capital costs or investment risks.

Big US companies - Eli Lilly, Abbott, AHP, and Merck - have profit margins of 15-20 per cent, while only one large competitor, Glaxo , has comparable results, according to David Hale of the Kemper Financial Group. European drug companies typically have margins of 4-6 per cent and Japanese companies 4-5 per cent.

Last month, influential congressional critics released another study which estimated that the US industry earned 'excessive profits' of dollars 2bn a year.

Some industry officials acknowledge that spiralling drug prices are the result of greed, not costs. Roy Vagelas, the influential chairman of Merck, said recently that the price increases of the 1980s were excessive as some companies - not his own - had tried to make up for past periods of lower profits. According to a report in the New York Times, retail prices of US prescription drugs rose by 30 per cent from 1988 to 1992, compared with a rise of 8.5 per cent in general prices during the same period.

Like most things carried too far, the excessive profits have provoked public anger and Congressional calls for reform. Mr Clinton is the first president to respond to long-standing congressional reform efforts by appointing a high-level healthcare reform task force under the direction of his wife, Hillary. Few would disagree that some form of nationwide drug price controls are inevitable.

In an effort to minimise the damage, the industry has proposed voluntary price restraints that would limit average increases to the general inflation rate. It is an admission by the industry that a decade of extraordinary profits is over.

Under the industry's proposal, a company's pricing would be scrutinised by outside accountants, who would submit reports to the Department of Health and Human Services and to the General Accounting Office of Congress. Companies that exceeded the price limit would have to make up the difference in lower prices the following year. Industry officials said the plan was based on the assumption that the government would continue to support innovation in drug research.

Congressional critics were not appeased. Most condemned the proposal as unworkable and threatened tougher legislative restraints. Henry Waxman, a California Democrat who chairs a key health subcommittee, said he was very sceptical that the industry's price averaging system could work, when as much as 40 per cent of US drugs are bought by consumers with no drug insurance. Senator David Pryor, head of the Senate Committee on Ageing, said that no system would be acceptable if it did not lower prices for the average 'cash-paying' consumer.

US drug companies have justified their higher prices on grounds that they pay for costly research and development that leads to innovative new products. On this point, the record is far from clear and more information is needed. According to some studies, many US firms do not spend a larger share of sales revenue on research and development than European rivals, despite their higher margins.

Industry officials argue, however, that US government policies distort the process and lead to healthcare inflation. The long lag in receiving US government approval for new drugs cuts the effective life of patent protection and requires higher prices to ensure adequate returns, they say. Dr Vagelas recently testified to Congress: 'We are betting on things that may not mature and become available to the public for 10 to 15 years. That risk has to be rewarded.' He and others say that US companies do engage in relatively more research and development and that their global market share is proof of the results.

This takes us back to the dilemma. US drug prices are clearly too high and some effort to control them is long overdue, particularly for the elderly and poor. However, the Clinton administration must achieve this without killing off innovation in the industry and its global competitiveness. The Administration may have to swallow slightly less consumer protection than it wants to meet its strategic trade theory and industry goals.