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Patent system adds hundreds of billions every year to health care costs

COMMENTARY | October 13, 2009

Economist Dean Baker says drug and medical device patents drive up costs enormously but are seldom if ever mentioned in the debate over health care reform. Drugs and equipment that could be sold profitably for a few dollars may instead sell for thousands. (One in a series, ‘Reporting the Collapse.’)

By John Hanrahan

Noted journalist, author and food expert Michael Pollan recently wrote in a New York Times op-ed piece that diet-linked diseases – obesity, Type 2 diabetes, cardiovascular disease, many types of cancer – have “become the elephant in the room in the debate over health care” because they have been little mentioned by politicians or the mainstream media as a major contributing factor to rising medical costs.

Economist Dean Baker sees another expensive health care elephant in the room that is likewise drawing little attention from politicians, economists and the press: The system of patent protections on prescription drugs and high-tech medical equipment. And Baker has a proposal to change this system and thereby, he says, save hundreds of billions of dollars a year in health care costs.

Baker, co-director of the Washington, D.C.-based Center for Economic and Policy Research (CEPR) and an author and columnist for The Guardian Unlimited of London, would like to see the press bring this issue of costly patented prescription drugs and medical equipment into the national debate over health insurance and health care reform.

Baker, who also writes a media-critique blog “Beat the Press” on economic issues, said in a recent interview with Nieman Watchdog that “there has been almost no discussion by economists, politicians or the press of how patent protection for medical equipment and prescription drugs drives up costs and makes health care so expensive.” Because of these patent monopolies, drug and medical equipment manufacturers “can charge what they want,” far more than what it actually costs to produce and distribute each new unit of prescription drugs or medical equipment.

In some cases, Baker said, the markup from what a drug or piece of medical equipment actually costs to produce and what is charged to the patients and their insurers can be several thousand percent, well in excess of what would be a reasonable profit. He sees this pricing as akin to an exorbitant tariff which, if applied to goods in an international trade setting, would have “economists screaming and jumping up and down.”

As Baker elaborated in an article he wrote for the May-June 2009 issue of Boston Review:

“Fundamental economic principles tell us that goods should be sold at their marginal cost of production – the cost of producing one more unit of the good. If a company needs to pay twenty dollars for the material and labor used to produce one more shirt, then shirts should sell for twenty dollars plus a small profit-earning markup. The price-equals-marginal-cost principle maximizes economic efficiency and limits opportunities for fraud and corruption. Building on this principle, economists also strongly advocate globalization: the elimination of trade barriers allows consumers to buy goods and services from where they are cheapest, thus maximizing global efficiency and output.

“Unfortunately, when it comes to health care, these principles are routinely violated. Prescription drugs that could be manufactured and sold profitably for a few dollars per prescription may instead sell for thousands. Performing one more high-tech scan or other medical test may require just a few cents of electricity and a couple of hundred dollars worth of a technician’s or a doctor’s time. But diagnostic procedures can be billed at several thousand dollars a shot. Prices are often well above marginal costs, yet economists involved in health care reform rarely recognize this as a problem.”

Take for example the stent, which is a wire metal mesh tube used during the majority of coronary angioplasty procedures to prop open an artery, thereby increasing blood flow to the heart muscle and relieving chest pains. Typically, as Baker noted to us, these devices are billed to the patient at $1,500 to $2,000 each – “yet the actual cost of manufacturing one of these is more in the ballpark of $15.”

Baker noted to us that some drugs can cost patients $200,000 or more per year, when the actual manufacturing and distribution costs of such drugs would be closer to $200 per year. Examples of expensive patent protected drugs abound. The trade publication Drug Store News reported in its August 13, 2007 issue that treatment with the colon cancer drug Avastin costs a patient $100,000 per year, while Cerezyme, used to treat Gaucher disease, costs a patient an average of $200,000 per year “with some adult patients paying more than $500,000 per year.” A drug that treats hemophilia costs a patient $100,000 a year, while another to treat a rare form of blood disease costs $200,000 a year, according to a November 25, 2008, article on the Workforce Management Web site.

In place of the existing system of developing new drugs and medical devices under 20-year patent protection (with possible 5-year extensions), Baker proposes what he believes would be a far less expensive alternative that would also better serve patients: Namely, expanding public funding to the National Institutes of Health to allow NIH to go beyond the basic research it now performs to enable it to play a key role in developing and testing new drugs and medical equipment. (As it is, critics have frequently pointed out that drug companies have used initial research by NIH scientists to develop drugs, including the expensive drug Cerezyme, noted above.)

Under his proposal, NIH could either undertake the research and development itself, Baker said, or could contract out the work to big medical device companies and big pharmaceutical companies such as Pfizer – but with the provision that the patents for such drugs and equipment developed in the private sector with federal dollars would be in the public domain immediately. Likewise, he said, all research data, tests, and patient trials would be publicly available to doctors, hospitals and patients to enable them to make better informed decisions on what treatments are best for particular patients. Instead, doctors and patients currently have to rely primarily on what financially self-interested corporations – who hold on to secret, proprietary and often negative information – divulge about their products.

Baker estimates that funding the up-front costs of such research and development through NIH would be some $30 billion a year and, as he told Nieman Watchdog, "The amount of medical costs this would save on prescription drugs alone is striking. There are estimates that in 2012 patients would be charged something like $330 billion on prescription drugs that are under patent. If those patents were in the public domain, these same drugs, applying marginal-cost pricing, would probably cost patients more in the neighborhood of $30 billion. The savings could be enormous. And the same goes for medical equipment.

“With this alternative system, we wouldn't have drug companies charging $200,000 a year for drugs that might cost them something like $200 a year to produce. And you would get a much better system, with all the information publicly available to allow doctors and patients to make better informed decisions on methods of treatment.”

Drug and medical equipment companies contend that their patented products are priced so high because they are attempting to recoup the often-huge costs for research, testing, patient trials and the like. And they strongly resist – through expensive lobbying campaigns and political contributions – any perceived threat to their patents and the high prices they charge for their patented products. This became evident again earlier this year when drug and medical device lobbyists sought – unsuccessfully –to kill a provision in the economic stimulus legislation that provided some $1.1 billion for “comparative effectiveness research” into which treatments work best for specific diseases.

Baker acknowledged in his Boston Review article that, in urging his economist colleagues to apply the principles of marginal-cost pricing to prescription drugs and medical equipment and to advocate for changing the patent protection system, he is pushing an issue that hasn’t attracted much attention within his profession.

But it should be noted that Baker has gone against the grain of his profession before – and has been proved right. He was among the relative handful of economists who warned early on (and who were widely ignored by the press, politicians and other economists) that the housing boom was likely a bubble that could burst with disastrous consequences. As early as 2002, Baker wrote a paper entitled, “The Run-Up in Home Prices: Is It Real or Is It Another Bubble?” An August 2005 Bankrate.com article cited Baker as having warned of a housing bubble “for years,” and quoted him as saying that the housing bubble would pop a lot louder than the tech-stock bubble of the late 1990s.

As President Obama seeks to identify unnecessary or exorbitant medical costs that can be cut as part of a health care reform initiative, the subject of patent protection and its relationship to rising costs would be a fertile field for the news media to investigate. By getting the president, members of Congress and economists to discuss this issue, the press can perform the valuable service of shedding light on this overlooked aspect of the health care debate.


Next in the ‘Reporting the Crash’ series:
Story ideas from an expert.
 Dean Baker becomes assignment editor for a day and asks for stories on deficits and on the mathematical basis for estimating the right size of stimulus program. (There is a mathematical basis; it’s called Okun’s law.)

Earlier in this series:
Doing a better job coping with economic disaster. Writer Henry Banta lays out what has gone wrong and why it is so important for the press to do a better job.

Rein in entitlements? No. Increase them, says James Galbraith. It’s time the press stopped falling for false, ongoing efforts to portray Social Security and Medicare as going broke, says Galbraith in the first installment of his interview with John Hanrahan.

As joblessness rises, reporters need to focus on calls for a second stimulus. Dean Baker sees a new, large stimulus as urgent. He has an alternate plan, also: Give companies tax credits to reduce workers’ hours (but not their pay) and put on new staff to take up the slack.

Galbraith: Deficits are the solution, not the problem. The University of Texas economist views aiding households, not banks, ia the key to recovery. He is highly critical of most coverage of deficits and fiscal policy and singles out the Washington Post editorial page as the worse offender.

Posted by Silicon Valley Guy
10/14/2009, 01:42 AM

Yes, and....

A more complete analysis of the REIMBURSEMENT model as well as the total cost of developing a medical device or drug would provide more insight.

I'm a lead member of a startup working on a new medical device - after investing the better part of a year analyzing the potential for a different family of devices for chronic illnesses. Insurers kept telling us they didn't want to reimburse for chronic illnesses, I invite Mr. Hanrahan to ask them why, so we shifted to oncology.

We have had to identify a need that insurers will reimburse, then develop the science, then build prototypes in cooperation with doctors, then raise millions of dollars, then get it through FDA testing regimen, then put in through 1-3 years of trials, and if our clinical trials are successful obtain final FDA approval, obtain reimbursement codes, then build a facility to manufacture, market the product to doctors and insurers, and maybe, just maybe, make enough to repay our investors before we founders/inventors make enough to justify a decade of work.

A couple decades ago friends of mine developed the science behind a seminal medical device used today by millions of Americans. Their reward was being laid off and having their stock diluted as their companies ran out of money before broad adoption.

It's accurate that there are some very expensive devices which are very inexpensive to make, but may take decades to get to market.

If we're going to change the business model for medical devices, we need to start with insurers, as they are calling the tune with reimbursements.

Let me put it this way: The nation MAY be spending $300 billion too much on medical devices and drugs that provide some benefit for patients.

On the other hand we are paying $300-450 billion a year for ZERO VALUE to health insurers, about 30% of every private insurance dollar.

medical equipment
Posted by Alexander
09/30/2011, 10:10 PM

I agree with you, if we went to a health care then inversely when we were in a shopping center. Price that we get in a shopping center is different from the price we have to spend on health care. I've also found some health care facilities that have high quality with low price. I like it

By: Alexander

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