Generic drug prices: Why their prices are suddenly surging.

Generic Drugs Kept Health Care Cheaper for 30 Years. Why Are Their Prices Surging?

Generic Drugs Kept Health Care Cheaper for 30 Years. Why Are Their Prices Surging?

Commentary about business and finance.
Nov. 20 2014 9:30 AM

Drug Bust

For 30 years, generic medications helped make health care cheaper. Why is their cost surging?

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Little, generic, expensive?

Photo illustration by Juliana Jiménez. Photo by Thinkstock.

Earlier this fall, a gathering of Washington politicians and wonks celebrated the birthday of a piece of paper: the Price Competition and Patent Extension Act of 1984, also known as the Hatch–Waxman Act. When the bill was signed into law 30 years ago, it streamlined the approval process for bioequivalent generic drugs as soon as the patent expired on the original medication. The subsequent expansion of the generic drug market, from less than 3 out of 10 prescriptions in 1984 to more than 8 out of 10 by 2014, is one of the few success stories among the United States’ many failed efforts to provide high-quality health care at a lower price. Total U.S. pharmaceutical expenditures actually dropped in 2012, and the Generic Pharmaceutical Industry Association estimates that generic drugs saved the American health system nearly $1.5 trillion dollars from 2004–2013.

Beginning this week, however, Washington will host a very different conversation about generic drugs, as independent Vermont Sen. Bernie Sanders (chairman of the Subcommittee on Primary Health and Aging) and Maryland Rep. Elijah Cummings (the ranking Democratic member of the Committee on Oversight and Government Reform) open a set of hearings into the rapid increase in generic drug prices in recent years. Drugs previously available at pennies per pill now cost hundreds of dollars per bottle. And not just esoteric, small-market drugs, either: the antibiotic doxycycline, a workhorse drug for common infections from sinusitis to pneumonia, cost $20 per 500-count bottle last October. Last month, the average price for the same supply was $1,849. For a drug initially approved by the FDA in 1967, the price hike seems mystifying.

What explains the sudden spike in generic drug prices? To answer that question, it’s important to understand how generic drugs emerged as a private sector solution to the public health problem of pharmaceutical access, and why our assumptions about the competitive nature of the generic drug sector may be unfounded. It turns out we may have put too much faith in the competitive nature of the generic drug sector, and that thanks to a largely invisible group of middlemen, it isn’t nearly the free market that we imagined.

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Nearly 25 years before the passage of the Hatch–Waxman Act, consumer advocates on and off of Capitol Hill complained that the high cost of drugs was driven by the protection of brand monopolies long after original patent monopolies had expired. Concluding a set of Senate hearings into the cost of prescription drugs in 1961, Tennessee Sen. Estes Kefauver proposed a bill to increase the competitiveness of the “small companies” trying to produce generically named versions of brand-name drugs sold at much higher prices by larger firms. Though Kefauver’s bill failed, his vision of a virtuous and competitive “little pharma” of imitative generic houses squaring off against a more venal and monopolistic Big Pharma persisted thanks to legislators like Gaylord Nelson in the later 1960s, Edward Kennedy in the 1970s, and Henry Waxman and Orrin Hatch, authors of the 1984 bill that bears their names.

The Hatch–Waxman Act did more than provide a pathway for generic drug approval. It also naturalized a two-phase model of the pharmaceutical life cycle that balanced the necessities of pharmaceutical innovation and pharmaceutical access. In the first, patent-protected phase, a new drug would be available at higher prices exclusively from the company that created it, so that it could recoup its R&D investment. In the second, post-patent phase, a drug would be open to free-market competition, which would bring down prices and make medications affordable for the general public. Thirty years later we have come to accept this model as common sense without recognizing that it rests on two debatable assumptions: that free-market principles work flawlessly to match supply and demand, and that the generic drug industry is a virtuous agent of public policy rather than a competitive industry like Big Pharma itself.

As the rolling waves of generic drug shortages and recent escalations in generic drug prices should remind us, both of these assumptions are questionable. The market’s invisible hand works until it doesn’t, and then, as Adam Smith wrote in The Wealth of Nations, we are left with conditions of market failure when supply doesn’t meet demand. In the generic drug industry, market failure occurs when a crowd of different companies that once competed to sell a drug like doxycycline ditch it to pursue more profitable drugs, leaving just one generic supplier—or a new gray-market monopoly able to raise prices just like brand-name manufacturers. This happens in part because generic companies are drawn toward the market exclusivity of newer drugs when they come off patent, in part because of bottlenecks in the supply of precursor chemicals, and in part because of shrinking margins in the production of older generic drugs. The stampede leaves the supply of many older but essential medicines in the hands of just a few suppliers, whose production lines are unprepared to deal with surges in demand, leading to shortages of key pharmaceutical agents needed for the treatment of cancer, pneumonia, and heart disease, as well as for basic anesthesia. Prices eventually recede—but by then, usually, other drugs are seeing similar cost surges.

The presumed virtue of generic competition is also based on a third assumption: that the therapeutic marketplace allows direct interaction between the supply from competing producers and the demands of health care consumers. But in the decades since the passage of Hatch–Waxman, a host of mediating bodies have proliferated between drug manufacturers and the people they help. Beyond prescribing doctors and dispensing pharmacists there are now pharmacy and therapeutics (P&T) committees of hospitals or insurance plans, which determine which drugs are covered and which are not. There are also pharmacy benefit managers (PBMs) and group purchasing organizations (GPOs), two obscure and thinly regulated parts of the health care sector that determine which manufacturers obtain contracts to supply most hospital and pharmacy chains in the United States. What we first imagine as a free market for price competition turns out, on closer examination, to be a space crowded by different forms of middlemen, whose roles in influencing supply and demand in the generic drug sector are poorly understood. A report that the General Accounting Office will release later this month should provide more detail on how these middlemen work, who they work for, and what federal law has to say about it. In recent weeks, the Department of Justice has entered the fray, too, issuing subpoenas to manufacturers of key generic drugs that have been the subject of recent price hikes.

Hopefully, Sanders and Cummings’ hearings will throw more light into these well-shaded portions of the health care industry. Unlike countries with single-payer systems, which use the power of the purse to negotiate cheaper prices for brand-name drugs, America chose to pursue generic drugs as a free-market solution to the problem of pharmaceutical access. This solution worked well for three decades but is now showing clear signs of market failure, with price hikes and shortages becoming more severe and more frequent. As the real costs of generic drugs undergo some long-needed scrutiny from federal authorities, we should remember not just the means but the original ends of generic drug policy: wider and fairer access to essential medicines.