WHAT MAKES U.S. DRUGS SO EXPENSIVE? A COMPARATIVE STUDY OF PRICE-SETTING INSTITUTIONS IN THE USA, GERMANY, AND CHINA

ABSTRACT

This article examines the factors contributing to the high cost of drugs in the United States and compares its regulatory landscape to those in Germany and China. While the U.S. leads globally in the pharmaceutical sector, Americans pay significantly higher prices for prescription drugs due to a lack of direct government price regulation and the presence of numerous regulatory loopholes and institutions that drive up costs. The experiences of Germany and China together show how reasonable government involvement in price negotiations can address the issue of expensive drugs effectively, using either market incentives or more coercive measures.

АННОТАЦИЯ

В этой статье рассматриваются факторы, делающие стоимость лекарств в США крайне высокой, а также сравнивается их регуляторная среда с регулированием в Германии и Китае. Хотя США лидируют в глобальном фармацевтическом секторе, американцы платят значительно более высокие цены за рецептурные лекарства из-за отсутствия прямого государственного регулирования цен и наличия многочисленных регуляторных лазеек и институтов, повышающих затраты на разработку и вывод на рынок лекарств. Опыт Германии и Китая показывает, что разумное участие государства в переговорах о ценах может эффективно решить проблему дорогих лекарств с помощью рыночных стимулов, либо более принудительных мер.

Keywords: drug pricing, pharmaceutical regulation, Medicare, pharmacy benefit managers, patent thickets, product hopping.

Ключевые слова: ценообразование на лекарства, фармацевтическое регулирование, Medicare, менеджеры аптечных льгот, патентные дебри, переключение продукта.

Introduction

Although the U.S. occupies the No. 1 position in the pharmaceutical sector, [1] numerous reports [2; 3; 4, p.1-3] indicate that Americans generally pay more than double what other countries pay for prescription drugs. If the former feature can be attributed by different factors within economics and politics that merit separate scholar works of different spectrum, the latter can be explained by the regulatory and legal landscape. Therefore, it appears beneficial to outline the regulatory factors contributing to such high prices in the U.S. and compare its regulatory system with those countries with strong pharmaceutical sectors but different approaches to drug price regulation, such as Germany and China. By examining these regulatory frameworks, author can understand how reasonable government involvement in price negotiations, as seen in China and Germany, leads to more reasonable drug prices, contrasting sharply with the U.S. model.

Furthermore, in the ongoing worldwide changing dynamics of globalization, there is a probable shift in trade connections between governments, which will likely impact many industries, particularly the pharmaceutical and biotechnological sectors. But it is worth noting that according to an extensive report by White & Case, this change does not signify deglobalization but rather the emergence of "clubs" and "fences" within the global economy.[5] "Clubs" represent regulatory-friendly zones among countries, while "fences" are regulatory barriers. This means that countries will strive to pursue a more independent policy in this area. As developing countries aim to secure critical industries, including pharma, many will face the necessity to strengthen regulatory authorities and practices as more domestic companies engage in drug manufacturing and R&D. This is an additional reason why it is worth considering regulatory loopholes making U.S. drugs so expensive while comparing them to the regulatory landscapes of other countries with strong pharmaceutical sectors.

Finally, why is it necessary to consider factors contributing to the costs of drugs in the U.S. when comparing it with other systems? The reason is that while in most countries prices are directly regulated by the government or negotiated with it, the U.S. remains unique among high-income countries in not having any direct government regulation of drug prices.[6] Therefore, considering regulatory loopholes contributing to the high cost of American drugs, especially when they are mostly driven by regulations, is beneficial and necessary before making comparisons with foreign systems as a whole.

Factors contributing to the drugs’ cost in the U.S.

Numerous factors contribute to the high cost of drugs: starting from the inherently high costs of drug development to the frequent lobbying efforts. [7, p. 1] While these issues are likely present in most countries, they are not pertinent to the current work's objectives, which focus on outlining the unique problems within the U.S. drug pricing and comparing them with other developed systems.Therefore, to achieve this goal, it is necessary to highlight problems specific to the U.S. The following main factors can be outlined:

1. Medicare is prohibited from negotiating directly with drug manufacturers for the prices of prescription drugs, remaining forced to accept heightened market prices.

To put it simply, the American healthcare system comprises government-funded health insurance programs (Medicare and Medicaid), alongside private insurances. Medicare cannot negotiate drug prices and must accept prices set by manufacturers, which is a significant issue as it affects a large segment of the population - seniors and people with disabilities.

More specifically the problems are as follows: the American health insurance includesMedicare, Medicaid and private insurance (prices on which negotiated by pharmacy benefit managers (PBMs)). Medicare is funded by the federal government and is designed to help cover various medical expenses, including hospital care (Part A), medical services (Part B), and prescription drugs (Part D). The problem is that, by law, Medicare is prohibited from negotiating drug prices directly with pharmaceutical companies. [8] Instead, Medicare take private prices negotiated by PBMs acting on behalf of private insurance companies who sponsor Part D plans.Consequently, pharmaceutical companies are incentivized to charge higher prices to private customers, as these prices are extended to government-funded Medicare programs that ought to accept these market prices. [9, p. 524]Thus, this loophole with part D is a significant issue as it affects large part of population covered by Medicare – people aged 65 and older, as well as to some younger individuals with disabilities.

Thus, while it is evident that Medicare pricing is deeply flawed, the next thought that comes to mind is: maybe private insurance companies and Medicaid have a more fair pricing system? Not at all, which brings author to the next factor contributing to the high cost of drugs in the U.S.

2. PBMs inability to lower drugs prices.

Pharmaceutical companies often strive to overcharge private customers because the prices set in the private market can influence the prices paid by Medicare. Medicare Part D plans do not negotiate prices directly with drug manufacturers. Instead, prices are negotiated between pharmaceutical manufacturers and PBMs.

Can then PBMs help to resolve the issue of high drugs’ costs? Unfortunately, according to numerous sources, PBMs contribute to the extensive costs of drugs rather than mitigating them. [10; 11] The difference between what patients pay and what manufacturers receive is distributed among various stakeholders in the drug distribution chain, including PBMs, pharmacies, and insurers. PBMs, in particular, capture a substantial portion of these costs through rebates and administrative fees, which can inflate the overall cost of drugs for insured customers. The lack of transparency in PBM practices further exacerbates this issue, as it is unclear how much of these rebates are kept by PBMs versus how much is used to lower drug prices for consumers. While PBMs theoretically have the potential to negotiate lower prices, their practices often contribute to higher drug costs.

3. The obligation of government insurers to cover almost all FDA-approved drugs.

All drugs must receive approval from the FDA, and the fact that government insurers cover nearly all of these drugs [12, p. 2326] exacerbates the aforementioned issues (such as Medicare's inability to negotiate prices and PBMs' ineffectiveness), further contributing to the heightened cost of drugs in the U.S.

4. Patent law flaws (patent thickets).

Patents generally provide 20 years of exclusivity from the filing date. [13] The term can be extended by up to 5 years under the Hatch-Waxman Act in the U.S., to compensate for some of the time lost during the FDA approval process. [14] Also, thereare several types of patents: process, machine, manufacture, or composition of matter. [15, p. 28]So, it seems that one invention, for example, a chemical compound treating cancer, can be patented several times using different types of patents. For example, such a compound can be patented as a composition of matter, and the process of manufacturing such a compound can also be patented. This is true, [16] and the number of such phenomena can exceed 100. [17, p. 11-13]

In simple terms the process is as follows: pharmaceutical companies often start with an initial patent on a new drug. Over time, they file additional patents related to the same drug, such as on new formulations, methods of use, or manufacturing processes. These additional patents, called continuation patents, don't introduce new inventions but instead make small modifications to extend the overall patent protection period. This strategy, known as creating a "patent thicket," helps pharmaceutical companies maintain market exclusivity for a longer time, delaying the entry of cheaper generic drugs and keeping prices high. [17, p. 11-13]As such, this strategy helps companies prolong their monopoly for certain drugs, incentivizing them to recycle old inventions rather than create new drugs. [18. P. 591] This significantly contributes to the costs of drugs.

5. Product hopping.

Product hopping is a practice closely related to patent thickets, allowing companies to benefit from securing multiple patents on the same invention. It involves introducing new versions or variations of an existing drug, often with later-expiring patents, as the original drug's patents approach expiration. [4, p. 46] The brand then leverages its market dominance to switch doctors, pharmacists, and consumers from the older drug to the newer version. [4, p. 46] Essentially, the brand encourages or forces a "hop" from the old product to the new one. This new version might have slight changes, such as extended-release formulations, different dosages, changes in administration routes, or even slight chemical alterations.

6. Pay-for-delay agreements.

In pay-for-delay agreements, brand-name pharmaceutical companies settle litigation with generic companies by paying the generic to stay off the market for a given amount of time, allowing the brand to enjoy its monopoly for a longer period. [19]. Despite attempts by legislators and antitrust agencies to combat this problem, these pay-for-delay payments have evolved into convoluted forms that still persist today [19].

German approach in price regulation.

In Germany, new drugs are evaluated and priced in comparison to existing treatments for the same conditions [23, p. 2]. The process involves the Federal Joint Committee (GBA) assessing whether a new drug offers incremental benefits over existing treatments [23, p. 2-5]. Drugs that do offer additional clinical benefits receive higher prices, whereas reference pricing applies to new drugs with similar clinical performance to existing products [24, p. 1183]. In simple terms, in Germany, drug pricing is structured around two main systems: Reference Pricing for drugs with no incremental benefit and Price Negotiations for drugs with incremental benefits.

Price Negotiations: When a new drug is introduced, it undergoes an assessment by the Federal Joint Committee (GBA) to determine if it offers any incremental benefit over existing treatments. If the GBA finds that the new drug provides a significant clinical benefit, it is referred to the umbrella organization of health insurers (GKV-SV). The GKV-SV negotiates prices with drug manufacturers to ensure that the price of a new drug reflects its added clinical value compared to existing treatments. This means that if a new drug offers significant health benefits, it can be priced higher, but still within a range that is considered cost-effective [23, p. 2-5].

Reference Pricing: In cases where no incremental benefit is added, reference pricing is used as a mechanism where drugs are grouped into classes based on their therapeutic effects. For example, all medications treating high blood pressure might be classified together. A reference price is set for each class, typically based on the cost of existing drugs within that class. If patients choose a drug that is priced at or below the reference price, their insurance covers the full cost (minus any usual copayments). However, if patients opt for a drug that exceeds the reference price, they must pay the difference out of pocket in addition to their copayment. This system incentivizes patients to select lower-cost, yet effective drugs [23, p. 2-5].

Thus, the German pricing system which motivates pharma companies to price their drugs lower to ensure they fall within the reference price, thereby maximizing insurance coverage and access (as they understand that customers do not want to pay out of pocket for more expensive drugs) [23, p. 2-5]. This competition among manufacturers helps keep overall drug prices lower [24, p. 1185-1186]. In contrast, the U.S. system, where government insurers are required to cover all FDA-approved prescription drugs and Medicare Part D does not negotiate prices directly with drug manufacturers, results in higher drug prices. Pharmaceutical companies often set high prices in the private market as it allows them to extend to government-funded Medicare programs that ought to accept these market prices. In Germany, conversely, pharmaceutical companies have a strong incentive to lower drug prices as consumers will always choose cheaper options of available drugs because of reference pricing (that will require them to pay more out of pocket for expensive drugs).

Furthermore, in conjunction with reference pricing incentives, the price negotiation regime fosters companies to create drugs with incremental value [24, p. 1185-1186]. This is because doing the opposite would force them to lower prices due to the nature of the reference pricing system. Price negotiation regime is not present in the U.S. as well as reference pricing. Additionally, discussed above practices such as patent thickets, pay-for-delay agreements, and product hopping demonstrate that it is often more beneficial for pharmaceutical companies to focus on developing additional patents and negotiating to prevent generics from entering the market, rather than investing in the development of new groundbreaking medicines. The absence of German pricing practices in the U.S. not only encourages companies to prolong patents’ live but also encourages the production of so-called “me too” drugs – drugs with compounds similar to original ones [25, p. 1415]. For example, in 2009the FDA approved the cholesterol-lowering drug pitavastatin, making it the eighth statin drug approved in the US [26. P. 711].

To conclude, author can confidently state that the implementation of the German pricing system in the U.S. would help mitigate, if not resolve, such issues as patent thickets, product hopping, and pay-for-delay, as well as the discussed problems with Medicare and PBMs.

Chinese approach in price regulation.

Historically, in China the Fixed Percent Markup (FPM) policy allowed public hospitals to sell drugs with a markup of no more than 15% of the purchase price. This policy led to high drug prices as hospitals often opted to sell more expensive drugs due to the higher profit margins [27, p. 1].

In 2016 the government started negotiating prices for new drugs to include them in the state medical insurance [28]. These negotiations significantly reduced the prices of blockbuster drugs in China, creating large price discrepancies between China and other markets. For instance, AbbVie Inc.'s arthritis drug Humira price dropped from 7,600 yuan ($1,060) per unit to 1,290 yuan ($180) per unit after being included in China's insurance plan in 2019.[28] In contrast, in the U.S., it costs around $3,379 per unit.[28] Interestingly, Merck’s cancer drug Keytruda faced challenges in China: despite several rounds of negotiations, Merck could not reach an agreement with the Chinese government, leaving Keytruda uncovered by state insurance and priced much higher than local alternatives. Nevertheless, even at $86,000 per year in China, Keytruda remains far cheaper than the $200,000 per year it costs in the U.S. [28].

Furthermore, in recent years, China has implemented new policies to address the inefficiencies and high costs associated with the FPM system. One significant reform is the Separation of Outpatient Pharmacies from Hospitals (SOPH), where hospital pharmacies are outsourced to third-party companies, leaving hospitals to focus solely on prescribing drugs [27, p. 1]. Another key policy is the Zero Markup Drug (ZMD), which mandates that hospitals sell drugs without any markup, effectively eliminating the profit incentive for hospitals to sell higher-priced medications [27, p. 2].

Additionally, China introduced the National Volume-Based Procurement (NVBP) program, which started in 2018 and aims to lower drug prices through pooled procurement and collective bargaining [29]. According to NVBP program, the government buys large amounts of medicines together for the whole country. By doing this, they can negotiate lower prices with drug companies. This happens because by agreeing to buy in such large quantities, the government provides drug companies with a guaranteed sale, which is also beneficial for the companies because they save money on marketing and distribution, while securing a large order. As result, this program significantly reduced drug prices, achieving cuts ranging from 25% to 96% for various drugs included in the pilot phase [29, p. 6].

Therefore, author can see that in China, the government strives to purchase large volumes of drugs while negotiating prices for inclusion in insurance plans. In contrast, in the U.S., the government does not regulate or negotiate drug prices, delegating this function to PBMs, whose role has been robustly criticized for contributing to high drug prices. Although the Chinese system is not as market-stimulation oriented as the German model, it nonetheless incentivizes pharmaceutical companies to lower their drug prices. By doing so, companies increase their chances of securing negotiations with the government and ensuring their drugs are included in insurance plans, leading to stable, large-volume orders [29, p. 6].

Again, in the U.S., there are no such incentives because all FDA-approved drugs must be covered by government insurance. Consequently, pharmaceutical companies are motivated to set high prices for private customers, knowing these prices will be extended to Medicare plans, which cannot negotiate prices.

Conclusion

The outlined regulatory systems with its loopholes in the U.S. in comparison with German and Chinese systems indicate evident reasons of high prices in the U.S. Author see that in the American market companies not only are not incentivized to lower drug prices, conversely, the current regulatory loopholes encourage them to inflate drug prices and prolong their monopolist power. The fact that government do not regulate drugs’ prices bypassing this work to PBMs, whose role has been robustly criticized because of lack transparency and ineffectiveness, is one of main reasons of expensive prices. [11] On top of that, while being free on establishing any prices, the companies can use this bargaining power with government insurance as all FDA approved drugs must be covered by government insurance [12, p. 2326] and Medicare pard D cannot negotiate the prices [8]. Furthermore, this dominant position allows them to inflate prices further, as by selling drugs at high prices to private customers, the companies can extend these prices to insurance plans [9, p.524].

These regulatory loopholes are enhanced by patent related institutions preventing competition that would reduce prices such as patent thickets, product hopping, pay-for-delay agreements. By extending the life of patents and preventing generics from coming to the market, the companies can benefit from outlined regulatory loopholes for long time.

Finally, such dormant institutions as march-in rights provided by Bayh-Dole Act and dormant regulatory bodies – such as Federal Trade Commission (FTC) that cannot handle anti-competitive agreements between brand and generic companies – further allows a distorted system to remain intact [19; 21].

Outlined the German and Chinese experiences together show that the problem of expensive drugs can be effectively resolved using both market incentives and more coercive ones. The German approach illustrates that it is possible and feasible to incentivize companies to develop new, innovative drugs while also encouraging them to reduce prices.Under this system, a company that successfully introduced a drug with significant health benefits can negotiate prices with a special agency. Despite the pharmaceutical company's strong bargaining power in such negotiations, the agency is still able to actually negotiate prices (a situation unlike the widespread one in the U.S., where Medicare Part D cannot negotiate prices). If a drug is less effective, companies are incentivized to lower its price because a higher price would make it less likely for the drug to be chosen by customers, who would then have to pay out of pocket. Furthermore, this scheme makes the development of “me too” drugs less attractive, as these drugs, lacking incremental benefit, would be subject to the reference pricing system, which is, again, less rewarding.

The Chinese experience also confirms the thesis that reasonable government price regulation has a tangible effect on reducing the cost of medicines. The requirement for companies to negotiate prices with the government is balanced by the fact that this allows them to secure large, stable orders of drugs in the future, making this relationship mutually beneficial for society and pharmaceutical companies.

Therefore, author can confidently assume that the implementation of either the German scheme, the Chinese scheme, or a mixture of both would help mitigate, if not resolve, the outlined regulatory loopholes in the U.S.

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