• How much could Medicare save in drug costs?

    Oh, oh, call on me! Call on me!!!

    In her first question at her first budget committee hearing on Tuesday, Rep. Suzanne Bonamici (D-Ore.) asked the Medicare actuary how much the federal government could save if Medicare could use its market clout to negotiate lower drug prices, such as the Department of Veterans Affairs does. [via Julian Pecquet]

    The answer ($510 per beneficiary per year) is in one of my recent papers with Steve Pizer and Roger Feldman.


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    • How would drug companies react? Do they remain static at having this downward pressure put on their prices? In other words, is $510 both a short-run and long-run savings and, if not, in what direction would you anticipate this regulation pushing long-term drug trends? Long-term pharmacy sector innovation? If it’s such a free lunch …

    • Great paper but limited real-world applicability unfortunately.

      Formulary restriction as a cost-saving technique is commonly used in the private sector as well but has not worked anywhere near as well as with the VA due to a variety of reasons. Chief among them is that both physicians and patients find them burdensome and in some cases, clinically inappropriate and so loopholes are created, which in turn weakens their effectiveness.

      Anyway, the VA pays below the average cost (Megan McArdle talks about this at length in her prior work) and that works because it is a small customer in the scheme of things. However, not all payors can pay below average cost and above marginal cost (pharmacos would go bankrupt if they did) and so the VA model is not really scalable as I doubt Medicare is small enough to not materially affect margins.

      Even if we did succeed with Medicare, drug companies would just try to cost-shift to other payors if the approach Austin advocated was implemented or otherwise, leave the market.

    • Your reliance on profit maximization theory in this case is pretty far removed from real world behavior unfortunately. Most pharmacos that I have worked with are not particularly great at pricing (especially in comparison to industries like retail) nor, given the level of imperfect information they have, do they claim to be so (see the Provenge fiasco). If you integrate more behavioral economics into your mindset, I think you will find it much easier to believe the cost-shifting hypothesis and more real-world work (perhaps, hanging out with senior executives whose bonuses are based on arbitrary targets?) would also help I think move us closer together in our views. Also, the two studies cited in your link do not really come to a definitive conclusion so I am a little lost as to why you cite them so confidently.

      Anyway, even were I completely wrong on the cost-shifting point, its pretty tangential to the arguments made in the post above. You leave the other arguments in the post unanswered. I would be interested to see what you think of those…