WHY MEDICARE PART D IS BAD POLICY
The following commentary was delivered by Professor Michael Meeropol on WAMC radio in December of 2005
WHAT’S WRONG WITH MEDICARE, PART D?
As I speak, Medicare recipients are deciding whether to sign up for the new prescription drug plan. I want to focus on the most serious shortcoming of this controversial program. The program does not permit Medicare to use its purchasing power to negotiate for discounted prices on the drugs sold under the plan.
When Medicare reimburses hospitals and doctors it tries to reduce medical cost inflation by slowing the rate at which provider compensation increases. But the law does not permit it to do the same with prescription drugs.[1]
Drug prices are high in large part because of government granted patent protection. Patents give the owners monopoly rights. If you want a specific drug, you pay what the company charges. There are no competitors.[2]
If Medicare could use the power of its large volume purchasing to force drug companies to cut Medicare a deal, the result would partially compensate for the price advantages the drug companies have due to government enforcement of their patent monopolies.
So why did Congress explicitly forbid Medicare from doing what, for example, the Veterans Administration does on a regular basis, namely bargain for discounted prices in exchange for large volume purchases?
One could be cynical and assert that the Pharmaceutical Industry is very generous to people running for Congress and that the industry gets what it pays for.
However, let’s let one member of Congress speak for himself. At the time of the vote, one member of Congress who strongly supported the prohibition against price bargaining said on NPR that when government uses its purchasing power to force a lower price on the market it’s just another word for PRICE CONTROLS.[3]
This was the sum of his argument. In other words, if the government uses bargaining power to force a seller who has a monopoly to sell at a discount, that is the SAME THING as the government actually SETTING THE PRICE to begin with!
To show how irrational this argument is, we need only look at REAL government price setting. Regulated public utilities can only sell to their designated customers at the price determined by the regulators. The only recourse they have when they believe they are being forced to charge too low a price is to try to persuade the regulators to change their minds.[4]
By contrast, if Medicare were to use its deep-pockets purchasing power to induce pharmaceuticals to make discounted deals with the program, [PAUSE] every one of those companies could “pass” on the opportunity and continue to sell drugs to other consumers. Those companies who would make deals with Medicare would do so because it makes good business sense.
Meanwhile, IN THE PRIVATE SECTOR we have countless examples of high volume purchasers getting bargain prices from suppliers.
Wal Mart, for example, charges the lowest retail prices in the country on average, in large part because it is such a large purchaser. It can in effect force its suppliers to offer merchandise at rock-bottom prices.
I know that Wal Mart’s price advantages are often explained by its low salary structure and poor benefits, but that is under dispute. However, there is NO DISPUTE that Wal Mart gets its suppliers to sell at very low prices.
How does Wal Mart get these very low prices? By BARGAINING with its suppliers – the very thing Medicare is prohibited from doing.
So what’s the difference that leads supposedly free-market advocates to celebrate what Wal Mart does while prohibiting Medicare from doing the same? Is it because Wal Mart is not the government making it okay to force suppliers to constantly search for lower and lower cost items? -- often utilizing incredibly low-paid labor from, for example, China where, despite the rhetoric of Communism, workers are not allowed to form independent unions and bargain for decent wages?[5]
Meanwhile, Medicare, a government agency, would be bargaining not for a rock-bottom price from a vendor, but for a discount from a pharmaceutical giant on a price already inflated by a patent monopoly.
Unfortunately, due to the lack of wisdom of Congress, Medicare remains under this ridiculous prohibition, and that is the key failure of the Prescription Drug Bill.
[1] There are other things wrong with the plan as well. It is overly complicated with a wide variety of plans, each covering different drugs with different levels of payments. It involves a “donut hole” where participants get coverage up to a certain amount and then must pay a large sum out of pocket before the “catastrophic” part of the coverage kicks in. However, the most important shortcoming is the fact that the plan will do nothing to curtail medical cost inflation. The supporters of these “competition models” argue that the private sector firms competing for customers will produce great efficiencies and cost savings and give participants variety rather than what would exist if, for example, Medicare were a single payer for all pharmaceutical purchases. The problem with this argument is that it’s totally theoretical. Yes, competition sometimes can lead to reduced costs but in fact every time private insurance companies have competed with traditional Medicare, they have proven to cost MORE not less. That is why, in this law, Congress said that the only way to participate in Medicare, Part D, is through some private company. To control hospital reimbursement costs, Medicare operates an inpatient prospective payment system under which payments are made at a predetermined rate which represents the national average for treatment of such patients. A hospital that delivers the cost at a lower rate gets to keep the difference. A hospital that delivers the cost at a higher rate, loses money. [See 2004 GREEN BOOK, Background Material And Data on the Programs Within the Jurisdiction of the Committee on Ways and Means [GPO, 2004]: Vol. I, Part 2, P. 26.]
[2] I know there is a long tradition within journalism, politics and economics that says without patent protection there would be no more research to find new drugs and improve old ones. That is errant nonsense and the best source I can give you is an exhaustive study by Merrill Goozner, The $800 Million Dollar Pill, The Turth Behind the Cost of New Drugs (U. of California Press, 2004). The fact remains that because of patent protection, lots of drug company research is worthless “copycat” research to find a drug that does the same thing as the one with the patent but is chemically different (Think the difference between Viagra, Cialis and Levitra). Much drug company research is financed by the government already. It has been estimated that drug prices are inflated over 100% by patent protection. I might also remind people that in the case of life-saving retro-virals to fight AIDS, patent protection and the high prices charged internationally for licensing these drugs literally kills people in low income Third World countries.
[3] I’m not being coy here. I don’t remember who said it, but I do remember hearing it on a broadcast on WAMC around the time the bill was passed.
[4] The model applies to what are called “Natural Monopolies.” A public utility with high fixed costs like an Electric Company or local Cable company is given a monopoly – competitors are not permitted to enter the market. In exchange, there is a (usually state) regulatory commission which sets the rates. IN economic theory terms, they set the rate at the average cost of producing the electricity (or gas, etc.) so as to guarantee the investors in the company a “fair” rate of return. The argument then usually revolves around whether costs are being measured accurately and whether the rate of return predicted is indeed “fair.”
[5] I bring this up not to hype the issue. Wal Mart imports a tremendous amount of its merchandise from China. This phenomenon has created the concept in the retail industry of the “China price” for an item. The reason the “China price” is a standard is because Chinese workers are paid very low wages (they make Mexican workers appear to be living like Kings by comparison) and their businesses turn out items very quickly. The high productivity combined with low wages in Chinese factories creates low per unit labor costs which more than make up for the cost of shipping the merchandise halfway round the world to US outlets. [Business Week actually had an article about the "China Price."]
WHAT’S WRONG WITH MEDICARE, PART D?
As I speak, Medicare recipients are deciding whether to sign up for the new prescription drug plan. I want to focus on the most serious shortcoming of this controversial program. The program does not permit Medicare to use its purchasing power to negotiate for discounted prices on the drugs sold under the plan.
When Medicare reimburses hospitals and doctors it tries to reduce medical cost inflation by slowing the rate at which provider compensation increases. But the law does not permit it to do the same with prescription drugs.[1]
Drug prices are high in large part because of government granted patent protection. Patents give the owners monopoly rights. If you want a specific drug, you pay what the company charges. There are no competitors.[2]
If Medicare could use the power of its large volume purchasing to force drug companies to cut Medicare a deal, the result would partially compensate for the price advantages the drug companies have due to government enforcement of their patent monopolies.
So why did Congress explicitly forbid Medicare from doing what, for example, the Veterans Administration does on a regular basis, namely bargain for discounted prices in exchange for large volume purchases?
One could be cynical and assert that the Pharmaceutical Industry is very generous to people running for Congress and that the industry gets what it pays for.
However, let’s let one member of Congress speak for himself. At the time of the vote, one member of Congress who strongly supported the prohibition against price bargaining said on NPR that when government uses its purchasing power to force a lower price on the market it’s just another word for PRICE CONTROLS.[3]
This was the sum of his argument. In other words, if the government uses bargaining power to force a seller who has a monopoly to sell at a discount, that is the SAME THING as the government actually SETTING THE PRICE to begin with!
To show how irrational this argument is, we need only look at REAL government price setting. Regulated public utilities can only sell to their designated customers at the price determined by the regulators. The only recourse they have when they believe they are being forced to charge too low a price is to try to persuade the regulators to change their minds.[4]
By contrast, if Medicare were to use its deep-pockets purchasing power to induce pharmaceuticals to make discounted deals with the program, [PAUSE] every one of those companies could “pass” on the opportunity and continue to sell drugs to other consumers. Those companies who would make deals with Medicare would do so because it makes good business sense.
Meanwhile, IN THE PRIVATE SECTOR we have countless examples of high volume purchasers getting bargain prices from suppliers.
Wal Mart, for example, charges the lowest retail prices in the country on average, in large part because it is such a large purchaser. It can in effect force its suppliers to offer merchandise at rock-bottom prices.
I know that Wal Mart’s price advantages are often explained by its low salary structure and poor benefits, but that is under dispute. However, there is NO DISPUTE that Wal Mart gets its suppliers to sell at very low prices.
How does Wal Mart get these very low prices? By BARGAINING with its suppliers – the very thing Medicare is prohibited from doing.
So what’s the difference that leads supposedly free-market advocates to celebrate what Wal Mart does while prohibiting Medicare from doing the same? Is it because Wal Mart is not the government making it okay to force suppliers to constantly search for lower and lower cost items? -- often utilizing incredibly low-paid labor from, for example, China where, despite the rhetoric of Communism, workers are not allowed to form independent unions and bargain for decent wages?[5]
Meanwhile, Medicare, a government agency, would be bargaining not for a rock-bottom price from a vendor, but for a discount from a pharmaceutical giant on a price already inflated by a patent monopoly.
Unfortunately, due to the lack of wisdom of Congress, Medicare remains under this ridiculous prohibition, and that is the key failure of the Prescription Drug Bill.
[1] There are other things wrong with the plan as well. It is overly complicated with a wide variety of plans, each covering different drugs with different levels of payments. It involves a “donut hole” where participants get coverage up to a certain amount and then must pay a large sum out of pocket before the “catastrophic” part of the coverage kicks in. However, the most important shortcoming is the fact that the plan will do nothing to curtail medical cost inflation. The supporters of these “competition models” argue that the private sector firms competing for customers will produce great efficiencies and cost savings and give participants variety rather than what would exist if, for example, Medicare were a single payer for all pharmaceutical purchases. The problem with this argument is that it’s totally theoretical. Yes, competition sometimes can lead to reduced costs but in fact every time private insurance companies have competed with traditional Medicare, they have proven to cost MORE not less. That is why, in this law, Congress said that the only way to participate in Medicare, Part D, is through some private company. To control hospital reimbursement costs, Medicare operates an inpatient prospective payment system under which payments are made at a predetermined rate which represents the national average for treatment of such patients. A hospital that delivers the cost at a lower rate gets to keep the difference. A hospital that delivers the cost at a higher rate, loses money. [See 2004 GREEN BOOK, Background Material And Data on the Programs Within the Jurisdiction of the Committee on Ways and Means [GPO, 2004]: Vol. I, Part 2, P. 26.]
[2] I know there is a long tradition within journalism, politics and economics that says without patent protection there would be no more research to find new drugs and improve old ones. That is errant nonsense and the best source I can give you is an exhaustive study by Merrill Goozner, The $800 Million Dollar Pill, The Turth Behind the Cost of New Drugs (U. of California Press, 2004). The fact remains that because of patent protection, lots of drug company research is worthless “copycat” research to find a drug that does the same thing as the one with the patent but is chemically different (Think the difference between Viagra, Cialis and Levitra). Much drug company research is financed by the government already. It has been estimated that drug prices are inflated over 100% by patent protection. I might also remind people that in the case of life-saving retro-virals to fight AIDS, patent protection and the high prices charged internationally for licensing these drugs literally kills people in low income Third World countries.
[3] I’m not being coy here. I don’t remember who said it, but I do remember hearing it on a broadcast on WAMC around the time the bill was passed.
[4] The model applies to what are called “Natural Monopolies.” A public utility with high fixed costs like an Electric Company or local Cable company is given a monopoly – competitors are not permitted to enter the market. In exchange, there is a (usually state) regulatory commission which sets the rates. IN economic theory terms, they set the rate at the average cost of producing the electricity (or gas, etc.) so as to guarantee the investors in the company a “fair” rate of return. The argument then usually revolves around whether costs are being measured accurately and whether the rate of return predicted is indeed “fair.”
[5] I bring this up not to hype the issue. Wal Mart imports a tremendous amount of its merchandise from China. This phenomenon has created the concept in the retail industry of the “China price” for an item. The reason the “China price” is a standard is because Chinese workers are paid very low wages (they make Mexican workers appear to be living like Kings by comparison) and their businesses turn out items very quickly. The high productivity combined with low wages in Chinese factories creates low per unit labor costs which more than make up for the cost of shipping the merchandise halfway round the world to US outlets. [Business Week actually had an article about the "China Price."]
posted by WNECONOMICS at 4:29 PM
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