At the Washington Post‘s Wonkblog, Jason Millman argues that expensive drugs are often worth the cost (“Why extremely expensive drugs are often worth the cost,” October 6). Although expensive specialty drugs like Sovaldi for Hepatitis C cost thousands of dollars a month, they may provide significantly greater benefits than traditional drugs — including “treatments for complex diseases with few or no previously effective options.”
Neoclassical economists say that price is set by the marginal utility of a good to the buyer. That’s true, as far as it goes. But taking that language according to its ordinary meaning, we get the extremely misleading, simplistic impression that price is set by how much something’s worth to us. “Marginal utility” carries a very specific technical meaning: The utility to the consumer of the last (or marginal) unit consumed. Marginal utility depends on the total supply and demand under the spot conditions of the market. When goods are reproducible and there are no artificial constraints on production, the supply will tend to fluctuate in response to demand until the amount demanded equals the amount supplied. The last unit supplied sells at a market clearing price equal to the cost of production.
We only see reproducible goods priced at their absolute utility to consumers when things go wrong — i.e., when output is artificially restricted or the seller is a monopolist, and thus able to price the good based on how much the consumer needs it rather than how much it cost to produce. This is called monopoly pricing or price discrimination. The classic example of setting a price based on what something is worth to the buyer is the $10,000 glass of water sold to a desert traveler dying of thirst.
Big Pharma defenders argue that patents are necessary because marginal cost pricing won’t repay the large initial R&D investment for developing drugs. But most drug R&D actually goes to gaming the patent system — developing “me too” versions of drugs whose patents are about to expire, or testing to secure patent lockdown on every major variant of a drug — not developing new drugs.
The other side of monopoly pricing is targeting the price to individual consumers’ ability to pay. In traditional manufacturing this was called “dumping.” A company would run its lines at capacity to minimize unit costs, selling as much of the output at the monopoly price. Then they would sell what was left over at whatever lower price less affluent consumers could afford — often dumping part of it at less than the cost of production. We see the analog of this in drug commercials all the time: “If you’re unable to afford [drug], [company] may be able to help.”
Medicare D and Obamacare amount to subsidizing people who can’t afford to buy glass of water insurance so that they’ll be able to afford to pay the water salesman $10,000. They amount, therefore, to massive subsidies to the drug companies and to healthcare providers. Thanks to government, Big Pharma is able to price gouge an even larger share of the population who would previously have been able to pay.
The proper approach is to remove the monopoly — in the case of drugs, by eliminating the patents on them. Unfortunately that is unlikely to ever happen regardless of which major party is in power. It would be an unthinkable assault on the basic foundations of corporate capitalism in a country where the state has always — even (or especially) during “progressive” times like the New Deal — been intimately connected with corporate power.
Instead the most viable solution is likely to be bypassing the unholy alliance between the state and the pharmaceutical industry, using the rapidly developing capabilities of do-it-yourself biotech to produce illegal open-source knockoffs of expensive drugs. In every area of economic life, capitalists depend on state-enforced monopolies and enclosures of one kind or another. But the rise of people’s technologies like cheap, small-scale means of production are making such monopolies increasingly unenforceable. The days of the Lords of Scarcity are numbered.