Minimum Efficiency Standards vs. Price Control

When and how regulators allow drugs to come to market is an complex and fascinating process.

In order for drugs to be sold to the public, they must gain approval by the FDA (U.S.) or EMEA (EU).   This involves multiple stages of clinical trials, often costing many millions of dollars.  The uses these trials to evaluate if the drug has a minimum efficacy level and how severe the side effects are.  Approximately, only five in 5,000 compounds that are tested in the laboratory will end up in human trials and only one of these five will be approved by the FDA or EMEA.

After a drug is approved, many coutries regulate drug prices.  Price regluation varies siginificantly across countries.  For instance:

  • Germany: Allows price freedom only for innovative drugs.
  • United States: Prices are free but HMOs and Pharmacy Benefit Managers create formularies with price incentives to use “preferred drugs.”
  • France, Italy and Spain: Drug prices are set through negotiation between the government and industry.
  • United Kindgom: The government does not control individual prices, but instead regulates drug company profits.  Pharmaceutical firms set drug prices freely at product launch; only subsequent price increases require approval. Firms are penalized if profits exceed government guidelines. These are no universal guidelines on drug company profits.  Instead they are negoitated on a company by company basis.

So which framework is best: using a minimum efficiency standard (MES) only or also using price controls (PC)?  Atella, Bhattacharya, and Carbonari (2008) weigh in the debate using evidence from the U.S. and Italy.  Their theoretical model predicts that “average drug quality delivered is higher under the MES regime than in the PC regime or a in combination of the two.  Second, PC regulation reduces the difference in terms of high-low quality drug prices. The empirical analysis based on Italian and US data corroborates these results. ”

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