Drug Prices Drop
by John Goodman
Issue 94 - October 24, 2007

Did you see a recent item in the news that prescription drug price inflation over the past year was only 1%. That's the lowest increase in three decades. In fact, it's the lowest increase since the Labor Department began its current method of tracking.

That's without any government negotiation of drug prices! Without Medicare price fixing of the type used for physician and hospital services. Without any significant pay-for-performance. With even less managed care, although with more managed-care type financial incentives.

So what's happening? Some attribute this outcome to the "Wal-Mart effect." Last fall, Wal-Mart began offering many generic prescriptions for $4 a month. Kmart responded with its own price discount program. Publix, a grocery chain, started filling certain antibiotic prescriptions for free.

True enough, generic price moderation is greatest where Wal-Mart stores are more numerous; but that's only part of the story. In the drug market, suppliers are competing on price and quality. That rarely happens in the markets for physician and hospital services.

A breakthrough moment occurred a few years ago with the emergence of Rx.com, an Internet-based, mail order supplier that offered low prices and high quality (lower error rate than neighborhood pharmacies) to patients nationwide. Soon there were competitors. Today there are web sites where you can learn about generic substitutes, therapeutic substitutes and over-the-counter substitutes, in addition to price information.

Why do we get price and quality competition for drugs, but not for other therapies? Consider that:

o Every time we spend $1 in a hospital, only 3 cents comes out of our own pockets.

o Every time we spend $1 in a doctor's office, only 10 cents comes out of our own pockets.

o Yet we pay 25 cents out of pocket for every $1 we spend on drugs.

Ask yourself this question: If Blue Cross were paying all the drug bills, would Rx.com even exist today? Would Wal-Mart be offering $4-a-month prescriptions? Would Publix be giving away antibiotics for free?

The fact that there is the most price competition in the market for drug therapies and the least for hospital therapies is an illustration of Goodman's Law, which says that innovation and entrepreneurship are inversely proportional to the degree of third-party payment. I thought of this law while attending a recent conference at which third-party payers were all deploring the way doctors practice medicine.

John Goodman is president of National Center for Policy Analysis. For a New York Times piece on prescription drug price inflation, go to:
http://www.nytimes.com/2007/09/21/business/21generic.html?_r=1&oref=slogin