Pricey pills and the law that makes them so

Turing Pharmaceuticals' recent decision to raise the price of a drug from $13.50 to $750 per pill, a 5,455 percent increase, was viewed as nothing but corporate greed.

But the issue is not morality. The focus of attention should be on the drug industry's monopoly pricing power and how it might be offset through unified consumer buying power. With Medicare turning 50 this year and its costs continuing to rise, it's an opportune time to allow the federal government to negotiate drug prices.

Turing's ability to set any price it wanted for its product is hardly an aberration in the pharmaceutical industry, and it is not necessarily bad. But it is an oddity in that the drug is more than 60 years old, that it is no longer patent-protected, and that the company's only costs were to purchase its rights.

More typically, it is the new drugs on the market that command a high price. Pharmaceutical companies spend vast amounts of money developing products, many of which are unsuccessful. While the second pill may cost a few pennies to make, the first one could cost a billion dollars. A breakthrough drug's revenue helps recoup those costs while providing funds for future research.

That a new, often life-saving drug can command high prices, though, is a simple matter of economics: When you have a monopoly or close to it, you can charge as much as the market can bear. When that market is largely the government and insurers, it is usually a lot.

The pressure to earn as much as possible, as quickly as possible, is intense in the pharmaceutical industry. The initial high drug prices, even for groundbreaking products, are not necessarily sustainable. There is often a limited time, of unknown length, before a competitive drug hits the market. Thus, to pay for the research and development costs, high initial prices are necessary.

But that does not mean firms should be able to charge whatever price they want to, even if they have the only effective medicine on the market. While few patients pay for their drugs out of pocket, those with cancer and other serious diseases can pay stiff drug expenses.

Insurers or the government bear most of the costs, which really means all of us pay the high prices through our premiums or taxes.

The unfettered pricing ability, as seen with Turing, exists only if the drug maker does not face a buyer with offsetting purchasing power. That is where the government comes in.

Consider Medicare. In 2006, the Part D Medicare drug bill went into effect. This is a massive entitlement program whose costs will skyrocket as baby boomers use Medicare extensively. But the law that authorized the Part D program specifically prevented the federal government from negotiating the price of drugs with suppliers. The government cannot use its buying power to offset the selling power of the pharmaceutical companies.

In contrast, Medicaid and the Veterans Administration can negotiate drug costs.

Under Medicaid, the states set the requirements and negotiate the reimbursement rates, and they tend to do a good job. With the big, bad government involved, the prices Medicaid pays for brand-name drugs tend to be lower than what Medicare pays. And there is even a greater difference between what Medicare is charged and what consumers in other countries, whose governments do the bargaining, pay.

When a large, powerful buying group, such as the government, faces off against a provider that has control over a product, the resulting price will be a compromise: higher than what the buyer would like but lower than what the seller wants. It is estimated that this approach could save as much as $16 billion a year if Medicare paid Medicaid or VA prices.

Pharmaceutical companies need fair returns to keep churning out their amazing products. But entitlements, such as Medicare, are eating up the federal budget. One way to reform Medicare and moderate its cost increases is to remove the bargaining restriction and allow the two behemoths to negotiate prices. This is not government price control, it is government operating cost effectively, which is what we are all demanding.

Joel L. Naroff is the president of Naroff Economic Advisors, a strategic economic consulting firm in Bucks County.