Megan McArdle has a recent piece claiming that Americans should continue paying high prices for drugs to incentivize pharmaceutical innovation. To briefly summarize, her argument consists of hurdle rates 101. This is all well and good, but aren't libertarians supposed to care about all of society, not just pharmaceutical innovation? Let's apply reductio ad absurdum. There is no market mechanism setting prices for on-patent drugs, just drug companies saying "we did some market research so we think the price should be X" balanced with a vague threat that Senator Elizabeth Warren will cordially invite pharma CEOs to the Senate (and say mean things on Twitter) when they overreach on prices. Without a market mechanism, how do we know the "correct price?" Suppose a drug costs $1,000 per pill. Is this the correct price? What about $10,000 per pill? Or $100,000? When does it become too much? If we pay 1000% more, will we get 1000% more pharmaceutical R&D spending in return? When I say too much, I want card-carrying libertarians to get my meaning, so I mean "crowding out innovation and growth in the rest of the economy." But of course I also mean "too much" in the usual sense, i.e. "this pill is crowding out the growth of my bank account." Ha.
The NIH budget is $31.3 billion in FY2016, while American prescription drug spending stands at $425 billion. If we decreased the NIH budget by $15 billion, what do you think would happen to the long-term rate of new drug discovery? If we decreased pharma revenue by $15 billion, what would happen? On the flip side, what if we increased the NIH budget to $60 billion? What if we increased pharma revenue to $455 billion?
Here's one model of drug innovation: the big discoveries happen mainly within academia and small drug companies. At this point it is known to some degree that the drugs might work. Large pharmaceutical companies buy up the rights to these promising discoveries, and primarily provide the service of managing regulatory risk on the (hopeful) way to market. They are also quite good at phase III clinical trials, post market supply-chain management, and derivatizing small molecules within their existing intellectual property umbrellas. Following FDA approval, they provide the service of naming a price that they think the health system will bear. This step might carry the greatest regulatory risk of all: name a price too high for an essential drug, and the federal government might start stepping in to control prices industry-wide.
I don't think McArdle would like that.