It Costs What!? Why Prices Rise and Fall - and Why We Don’t Need Pharma Price Controls

prescription drugs in packages

Recently we've been hearing politicians such as Sen. Ron Wyden (D-Ore.) chomping at the bit to put price controls on pharmaceutical drugs, with almost no sense of economics or history about how prices change over time.

In 1926, a nice radio cost $7,175 (in 2019 dollars), and it took up more space than the giant flat screen you probably have in the family room. Speaking of TVs, in 2007, a 50-inch HDTV cost $7,046 (models of the same size and with much better quality go for about $250 today). In the "golden age" of airplane travel, tickets cost at least double today's prices. In 1975, buying and selling stock cost $100 per transaction (it's now less than $5). And calling your aunt in Los Angeles from New York for ten minutes cost $27.75. The same call now is practically free -- 2.3 cents per minute -- or actually free, with a service like Skype. One measly megabyte of computer memory cost $411 million in 1957 -- now the same amount costs less than a single penny.

The examples above are almost hard to believe, as it's easy to forget about challenges of the past when we face our own problems now. But miraculous productivity increases and plummeting prices aren’t the whole story. In some other areas of the economy, prices went up over time.

Fighter jets, for instance, cost about two-and-a-half times more with each new generation, a trend that's been steady since 1950. College tuition has been increasing at a rate of about 250% per ten years over the last several decades, far higher than the rate of inflation, which is about 3% per year, or 35% over ten years when compounded.

Rising Health Care Costs

And of course there's health care, the most well-known instance of a major part of the economy with rapidly rising costs. Between 1960-2017, health care spending rose an average of about 9%. For perspective, $1000 invested in 1960 would be worth $136k in 2017 at that rate, ignoring inflation. (From inflation alone, $1000 1960 dollars would be about $8k in 2017 dollars.)

It's common to hear politicians indignantly demanding lower prices, but less often do we hear an attempt at explaining why in some areas of life, things get markedly better every year, and in others, worse at a pace that is plainly unsustainable over a longer time horizon.

In other cases, clearly wrong theories are put forward. Here's one, from what is otherwise a very informative and useful history of how health care policy has impacted health care spending over the past half century at The Balance:

For example, U.S. private doctors' offices need seven people to do billing for every 10 physicians. A big reason is that there are so many types of payers. In addition to Medicare and Medicaid, there are thousands of different private insurers. Each has its own requirements, forms, and procedures. Hospitals and doctors must also chase down people who don't pay their portion of the bill. That doesn't happen in countries with universal health care.

You see, it's expensive because it's so complicated! If only we had a simple system designed from the top down, things could be so much cheaper! Central planning leads to lower prices…not.

This idea sounds very silly when you compare health care to the many other types of hideously complicated and difficult problems that have been overcome in order to provide you things extremely cheaply, relative to what they once cost. Health care billing is hard, but so is managing a global fleet of airplanes, or tracking millions of shipments, or keeping the shelves stocked at thousands of stores, etc., etc. Only a few of these things get more expensive every year; the rest get cheaper.

One common thread in cases of rapidly escalating costs, however, is either the absence of competition, the absence of consumer cost, or both. In other words:

- On the demand side, hey, if I'm not paying for it, why not?

- On the supply side, if there's nothing those sucker customers can do about it, then screw em!

Government Interference

Health care is a great example of how government interventions undermine both the existence of competition and the removal of consumer cost. Government piles demands like logs on a roaring fire in the form of subsidies and generous benefit programs, hinders companies' ability to produce health care with all manner of arbitrary regulations and interference, and undermines competition either directly or accidentally through the barrier to entry created by enormous compliance costs.

Price controls are just about the worst thing you could do in this situation. Price controls would eliminate one of the few remaining economic signals that gives any kind of rationality to how this market is structured.

Despite artificially low prices that controls might create, we consumers will still pay. We will pay with rationing, with shortages, and with the absence of drugs that might have been invented, but weren't. This is how the story ends in every attempt at price controls in history, and it's much worse than prices.

If you want an idea of how prices might be used to achieve the same kinds of productivity growth we see in electronics, airlines, shipping, retail, and many other spheres, look at Medicare Part D.

Part D came in 40% under budget in its first decade. The government accountants were stupefied. How could this be!? It starts with an understanding of what makes prices go up or down in the first place. Part D gives a wide range of choices to enrollees, who can pick cheaper and less generous plans, or more expensive plans with fuller coverage, and lets companies duke it out for those customers.

Price controls or “inflationary caps” or whatever you want to call them, will kill innovation, reduce choice, and lead to rationing. Price controls are the wrong choice, the wrong solution. We should be headed in the exact opposite direction and bring the power of free markets to bear.