Prices for brand drugs in the United States are three times as high as prices paid in other wealthy countries. With prescription drugs accounting for 10.1 percent of national health expenditures in 2024, high prices substantially burden individuals, employers and governments, the proverbial payers in American health care. One of the dominant political debates of this century has been over how to relieve that burden while not damaging pharmaceutical innovation.
Those seeking to lower drug prices by championing market solutions over regulation discount the extensive barriers to a functioning market. Those advocating for price controls downplay the critical relationship between expected prices and the flow of new treatments.
There is a way forward, what we call “wise regulation,” based on assessing the value of new drugs to patients. It could result in a uniquely American solution, but to get there, we need to understand why high drug prices are so resilient.
First, most branded drugs have market exclusivity through their patents or FDA requirements. The main constraint on manufacturers’ monopoly pricing occurs only when effective therapeutic alternatives—different drugs that treat the same condition—are available. (One savings opportunity involves ending manufacturer abuses of current rules to extend exclusivity far beyond statutory expectations.)
The main constraint on manufacturers’ monopoly pricing occurs only when effective therapeutic alternatives—different drugs that treat the same condition—are available.
The same comprehensive health insurance that makes drugs more affordable to patients severely limits the role of demand in constraining prices. By paying most prescription costs (and the full amount above an annual out-of-pocket maximum), health insurance limits market competition in making drugs affordable by sharply diluting patients’ incentives to use less expensive drugs. Recent insurance reforms that have limited per enrollee annual drug cost and have expanded coverage have likely facilitated higher prices when drugs launch and increasing prices for existing drugs.
Under pressure from regulators to keep patient out-of-pocket costs for expensive drugs low and yet not raise premiums, insurers rely more heavily on administrative tools, such as prior authorization and step therapy, to restrain spending. In addition to facing increasing resistance, these tools have modest impact when high-priced drugs effectively treat the patient’s condition.
Price controls could ease the impact of drug exclusivity and reduce pressures on insurers, but there are two key challenges: The first is the absence of meaningful information on costs of developing specific new drugs, a key component for assessing returns on investment. Many attempts to develop new drugs fail; for investors, these failures are part of the overall cost of developing successful drugs. As a result, approaches to regulate prices of services, such as hospital stays, cannot transfer to prescription drug price regulation.
Second, drug price regulation needs to focus on value, allowing the highest prices for drugs that most significantly improve patient health or reduce mortality. When incentives are revised to focus on value, investors will differentiate high-value opportunities from high-revenue opportunities under current rules. By incentivizing capital markets to steer investment to innovations with the strongest prospects, a revised system will reward development opportunities that are projected to have the highest value.
Organizations such as Institute for Comparative Effectiveness Research increasingly measure the value of high-priced drugs, with these assessments informing regulators and insurers when deciding coverage and pricing. The field is advancing, including development of methods that do a better job in measuring how patients themselves value treatments, such as GRACE (Generalized Risk Adjusted Cost Effectiveness). The key will be allowing those drugs with the largest patient outcome improvements the highest prices.
The Inflation Reduction Act (IRA) has initiated regulating drug prices for Medicare beneficiaries and for long-established high-cost drugs, with rules heavily favoring the government. Although regulating prices in Medicare for drugs that have generated many years of high profits limits reducing returns on investment, the approach omits a very large and growing part of the drug cost problem—prices paid by other payers and for newer, high-cost drugs.
The key to effectively constraining spending on drugs without stifling innovation is regulating drug prices wisely, with the goal of having reductions in funding concentrated in innovations that have the most limited prospects of increasing value to patients.
Less funding for innovation is inevitable if drug prices are to be controlled, although the market will, to some extent, respond by setting higher initial launch prices. The key to effectively constraining spending on drugs without stifling innovation is regulating drug prices wisely, with the goal of having reductions in funding concentrated in innovations that have the most limited prospects of increasing value to patients. In addition to funding the measurement of value, wise regulation would involve all payers and create a meaningful process for manufacturers and payers to negotiate prices, fairly balancing the competing interests of manufacturers, patients, and payers while maintaining adequate incentives for innovation. If unable to agree, a multi-stakeholder group could set the price, perhaps through “baseball style” arbitration that chooses from each side’s “best and final” offer. Yes, there are risks to regulation, but the burden of high drug costs is now so great that the only realistic alternative to wise regulation today is eventual unwise regulation tomorrow.
Paul Ginsburg is a senior scholar at the USC Schaeffer Center for Health Policy & Economics, Professor of the Practice of Health Policy at the USC Price School of Public Policy and is a former vice chair of the Medicare Payment Advisory Commission. Steve Lieberman is a nonresident senior scholar at the Schaeffer Center, a former assistant director at both the Congressional Budget Office and the White House Office of Management and Budget, and a former senior adviser to the Administrator of the Centers for Medicare and Medicaid Services.