Medicare Needs a Perspective on “Collective and Cumulative Learning” in Inflation Reduction Act Negotiations
The ongoing negotiations under the Inflation Reduction Act over drug prices between Medicare and pharmaceutical companies confront the complex question of what constitutes a “maximum fair price” (MFP) for prescription medicine. The higher the price on a “MFP” drug under negotiation, the less affordable the drug is to the healthcare system. The negotiators agree, however, that the price of the MFP drug should be high enough to fund the pharmaceutical company’s next round of investment in drug innovation. The question is, with this tradeoff in mind, how high is “fair”?
The drug companies claim that any regulated drug price is “unfair” because the “market” should make that decision. But, as we show in our new INET working paper, “Setting Pharmaceutical Drug Prices: What the Medicare Negotiators Need to Know about Innovation and Financialization”, the market cannot set a price because of a combination of a cost curve that exhibits economies of scale and a revenue curve that reflects the price inelasticity of demand for essential drugs. In other words, prices fall as companies produce more but people also often must have the drugs at any price. Especially given the fact that we grant pharmaceutical companies at least 20 years of patent protection on prescription drugs, unregulated prices are monopolistic, likely with an element of price gouging.
What’s more, as we document in our INET paper, most of the pharmaceutical companies with which Medicare is negotiating the current round of MFP drugs do not use their profits from high prices on existing drugs to fund investment in drug innovation. For the decade 2013-2022, 14 pharmaceutical companies that are included in the S&P 500 Index distributed 105 percent of net income to shareholders, a larger proportion than the highly financialized 98 percent of all 478 companies in the dataset. At 51 percent, pharmaceutical stock buybacks were below the proportion of 57 percent of net income for the 478 companies, but, at 54 percent versus 40 percent, pharmaceutical dividends as a proportion of net income far exceeded that of all the companies in the dataset. The easily demonstrated bottom line is that pharmaceutical companies use high drug prices to fund distributions to shareholders. What’s fair about that?
The response of the drug companies is that, if they don’t “return” value to shareholders, then shareholders will not make risky investments in drug innovation. The problem with this argument is that contrary to conventional wisdom, established drug companies do not, as a rule, seek to raise funds on the stock market to finance investment in their productive capabilities. Their shareholders simply buy and sell outstanding shares on the stock market. How can a company “return” cash to shareholders who never gave them any?
Let’s look at a few companies with which Medicare is negotiating the current MFP drugs. Pfizer did its most recent common stock issue on the public stock market in 1951, Merck in 1952, and Bristol-Myers (now part of Bristol Myers Squibb) also in 1952. Are the shareholders who subscribed to those issues more than seven decades ago still clamoring for “returns” on their investments?
To bolster their untenable arguments, the pharmaceutical companies fall back on the now omnipresent, but deeply flawed, ideology emanating from business schools and economic departments that only shareholders make risky investments in drug innovation. In our INET paper, we debunk that position. Far more risk of investing in drug innovation is undertaken by U.S. households as pharmaceutical employees who engage in what we call “collective and cumulative learning” and as taxpayers who have since 1938 poured over $1.6 trillion in 2024 dollars into life-science research by the National Institutes of Health, including $48.8 billion in 2024.
In recent years, pharmaceutical companies have invoked “fairness” in drug pricing by arguing that the company that markets the drug should be the entity that captures all the “value to society” that the medicine creates by reducing the costs of treatment and increasing the benefits of health outcomes. In our INET paper, for the ten MFP drugs currently under negotiation, we summarize the histories of foundational research and translational research that are both antecedent and external to the drug companies selling these MFP drugs, enabling them to perform some (but not necessarily all) of the clinical research that made possible Food and Drug Administration approval of these drugs as safe and effective.
In reality, drug innovation is a collaborative process that involves a diverse range of contributors over very long periods of time. Academic institutions, government research labs, and non-profit organizations play crucial roles in foundational and translational research, providing the groundwork upon which pharmaceutical companies engage in clinical trials. Most of this collective and cumulative learning process is antecedent and external to the pharmaceutical companies that commercialize the drugs.
The countless number of people involved in these learning processes do not get paid their “value to society”, in part because when they do their work, the value to society cannot be known and in part because they, like the pharmaceutical companies themselves, are contributors to a vast historical process of collective and cumulative learning in foundational, translational, and clinical research that makes drug innovation possible. When they go to the bargaining table, Medicare negotiators need to have a deep understanding–both theoretical and empirical–of these learning processes to negotiate a price that is fair in terms of the affordability of the existing drug and funding investment in the next round of drug innovation. Our INET paper, “Setting Pharmaceutical Drug Prices”, is an introduction to that perspective.
