New Research: Achieving Efficient Prices for Drugs in a Global Context

With Prof Patricia Danzon of the Wharton School, University of Pennsylvania, OHE’s Adrian Towse and Jorge Mestre-Ferrandiz have released an important working paper that addresses how to achieve efficient pricing for pharmaceuticals within and across countries.

With Prof Patricia Danzon of the Wharton School, University of Pennsylvania, OHE’s Adrian Towse and Jorge Mestre-Ferrandiz have released an important working paper that addresses how to achieve efficient pricing for pharmaceuticals within and across countries.

As the authors note at the outset, this is a “complex conceptual and policy problem”. The objective, from a social perspective, is to maximize social welfare by establishing prices that achieve both the optimal use of existing products (static efficiency) and optimal investment in R&D (dynamic efficiency). Achieving this is problematic for the pharmaceutical industry for three reasons.

First, R&D and other quasi-fixed costs of production are high in the pharmaceutical industry, much more so than for other industries. As a result, marginal cost pricing, which will lead to first best static efficiency (i.e. achieve an optimal use of products) cannot provide enough return to fuel continued investment; patents are intended to address this in various ways and will achieve ‘second-best’ dynamic efficiency.

Second, insurance coverage distorts markets. Although it contributes to access and protects patients from financial risk, it also can create the potential for prices to exceed the level that would occur otherwise. Insurers and governments use various price control strategies to manage this, but they are usually ad hoc and not specifically intend to achieve efficiency. In middle- and lower-income countries (MLICs), the lack of insurance coverage means that the distorting effect of insurance on prices is avoided. Other factors, however, contribute to higher prices than might occur in markets that function well – e.g. uncertain product quality and skewed income distributions within a country.

Third, the authors note that “because R&D is a global joint cost benefiting consumers worldwide, efficient global pricing requires appropriate contributions from different countries to this joint cost”. Economic theory suggests that pricing differently across countries (leading to price discrimination) is better than charging the same price if it increases access to drugs, which is feasible given differences in income.

Because both challenges and solutions depend on whether a country has comprehensive insurance, the analysis examines two different insurance contexts: a market with universal coverage, as in many industrialised countries, and one that is predominantly self-pay, as in many MLICs. For countries with comprehensive insurance, the authors discuss the appropriate use of an incremental cost-effectiveness ratio (ICER) that reflects citizens’ willingness to pay for health gain.

They note that current regulatory structures in countries with universal insurance may approximate a value-based differential pricing model if willingness to pay is used appropriately in setting a cost-effectiveness threshold for pricing and reimbursement decisions. If each country unilaterally sets an ICER threshold based on its residents’ willingness to pay, this would lead companies to charge value-based prices that differ across countries with per capita income, among other factors. Some features of current regulatory systems are inconsistent with achieving efficiency including, for example, external reference pricing and the inability to price by indication and/or patient subgroup.

For self-pay countries, the authors discuss the issues of quality standards, information about drug quality and prices, and pricing that reflects differences in income within a country.

The working paper is available for download from the NBER website.

Danzon, P. M., Towse, A. K. and Mestre-Ferrandiz, J. (2012) Value-based differential pricing: Efficient prices for drugs in a global context. NBER working paper series. Working paper 18593. Cambridge, MA: National Bureau of Economic Search.  

For additional information, please contact Dr Jorge Mestre-Ferrandiz.