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November 05, 2007
The big impact of pharmaceutical industry profits
Russell Roberts
Proponents of a single-payer system in health care argue that it would save costs because of lower industry profits and lower administrative costs. Arnold Kling argues that the impact would be minimal. Is he right?
According to Public Citizen,
a source not particularly friendly to corporate interests, pharmaceutical industry profits in
2002 (the year I happened to stumble on) were 36 billion. If all pharmaceutical companies were forced to
serve the public at zero profit, that would lower US health care
expenditures from 1.3 trillion to 1.3 trillion.
That's a pretty small change
I'll carry it out to a few more decimal places. In 2002, total
health care expenditurea in the US were $1.342 trillion. So taking out
ALL pharmaceutical profits lowers that number to 1.306 trillion. I
don't think there's any way you can argue that the profitability of the
pharmaceutical industry is a large factor in the size of US health care costs or that moving to a system where government could exploit its power as a large buyer of drugs would lower total expenditures.
Does anyone have data on administrative costs in the current system?
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Comments
re: administrative costs
The number commonly tossed around is 30% for private insurers.
For the overall system, harder to peg, but 30% would not be too far out of range, in my experience.
A fantasy of the single payer group is lower admin costs for the entire system, but based on the costs of billing and settling with Medicare, not so much.
Posted by: save_the_rustbelt | Nov 5, 2007 12:41:15 PM
I think just looking at profits may be a little misleading. We spend as much as 20 of every 100 dollars on drugs....far more then in other countries. Some of it no doubt related to overuse but some do to excess profits, an army of highly paid drug reps, massive advetisement spending and it's spurred over use.
Even so the numbers you show suggest a saving of 2.7 dollars out of 100. That alone is more then rounding off.
The big saving misrepresented in my opinion come from the value of preventative care and the lack of value of layers of administrators, claims experts and lobbyist who would be completely cut out with a govenment run single payor system.
Typical administrative cost for private insurances run 20%.
Kaiser a not for profit health plan, the VA and Medicare all run closer to 5%...numbers similiar to other countries with government sponsered plans.
These are not rounding off numbers we are talking about. We are talking about huge dollar savings. Likewise many lives will be saved, care overall of the population will improve and many banruptcies will be prevented.
Posted by: muirgeo | Nov 5, 2007 1:52:57 PM
Muirgeo,
2.7% is not going to radically change our health care expenditure. But taking out profits would radically change the incentives for innovation. Do you really think more lives would be saved if we had frozen pharmaceutical innovation at the level of 1975?
Posted by: Russ Roberts | Nov 5, 2007 2:04:49 PM
Muriego wrote:
I think just looking at profits may be a little misleading. We spend as much as 20 of every 100 dollars on drugs....far more then in other countries.
************
A large part of what we pay for drugs actually subsidizes the drugs in other countries. Everytime a government reduces what it will pay for a drug, the US has to make up the difference.
Posted by: bbouc | Nov 5, 2007 2:15:49 PM
Or, bbouc, of course maybe the drug is simply not made. I would guess nobody wants to make malaria drugs, for example, since all the countries where they are useful are also places that refuse to pay for drugs.
Posted by: Daublin | Nov 5, 2007 2:40:56 PM
If profits and administrative costs are so terrible, why stop at eliminating them in the health industry? Why not get rid of those pesky elements in other industries? How about creating a single provider Information Technology industry? Think about how much better computers would be without all that complex and expensive competition between companies. Or single provider Automobile industry. Or single provider food companies. Why not have the government decide what a wholesome and nutritious meal should look like and eliminate all that expensive experimentation in fancy restaurants?
Posted by: Charlie Quidnunc | Nov 5, 2007 3:19:31 PM
"We spend as much as 20 of every 100 dollars on drugs....far more then in other countries."
I take with a large grain of salt cost comparisons between different countries. I think part of the disparity is that the US is paying more than its fair share of the sunk research and development expenses and is thereby subsidizing other countries's drug usage.
I wonder to what extent we pay more because we get more. My teenage daughter took very expensive acne medicine for several years. I believe it cost about $200 per month and was mostly paid for by my insurance. My wife takes medication prescribed by her dematologist that is essential cosmetic that is also mostly covered by my insurance. I wonder whether government programs in other countries would pay for such medication.
Posted by: PaulD | Nov 5, 2007 3:19:40 PM
Do you really think more lives would be saved if we had frozen pharmaceutical innovation at the level of 1975?
Posted by: Russ Roberts
I don't see how a single payer system would result in frozen pharmaceutical innovation. There should still be government funded research and private research with the intent for profit and improved therapies. Although indeed getting rid of third party payors or at least making them compete with government purchasers will indeed cut into the industries currently artificially inflated profit margins.
Posted by: muirgeo | Nov 5, 2007 3:25:26 PM
Muirgeo,
You mention Kaiser as having admin costs of only 5%. I have private health insurance, but my wife is stuck with Kaiser. I'm not sure if you've ever had to use Kaiser, but their doctors and policies are horrible. They won't provide necesary surgeries or medicines, or they will put it off until too late in order to cut costs. My wife had to wait until she had mono 3 times and many strep infections to get her tonsils removed, when it would have normally occurred after the second infection. Please use comparable services if you are going to compare costs!!
Posted by: EconStudent | Nov 5, 2007 4:05:44 PM
Muirgeo --
What makes you think that a single-payer model would reduce the impact of lobbyists? I suspect that we would just end up with lobbyists arguing that the single-payer (i.e. the government) should pay more for specific drugs, should/should not pay for abortions, should increase the payment to podiatrists, should pay for a certain type of wheelchair, etc.....
You do have a point, though, that pharmaceutical industry profit isn't a great measure. You also need to add back in SG&A, which includes advertising, commissions, etc.... But, even if you could do that (which you can't, because SG&A also includes stuff you can't reasonably get rid of, like Human Resources), it would only take the $36B to about $80B. (That's my estimate based on looking at a couple of annual reports from large pharma companies.)
Posted by: Chris | Nov 5, 2007 4:09:25 PM
And, shouldn't it only be the "excess profits" that get added back?
If I spend $1,000,000,000 on government bonds that pay 5% I'll have $50,000,000 per year of accounting profits.
I don't see how you can epxect to get billions of dollars invested in new pharmaceuticals without some return to that capital.
Posted by: diz | Nov 5, 2007 5:26:53 PM
Greg Mankiw's column on the subject of healthcare was recently published in the New York Times. Here's the
link to the article.
It's not exactly about pharma companies but it relates to the issue. Speaking of pharma companies - does anyone doubt that the growth of socialized medicine, regulation and price controls killed the pharma industry in Europe? Europe used to be the source of pharma innovation, now it accounts for less than a quarter of all new pharmaceuticals coming to market.
Posted by: Methinks | Nov 5, 2007 5:49:01 PM
"...currently artificially inflated profit margins."-muirgeo
Hmmm...
Total health care exeditures = $1.342T (RR)
Pharma expenses as % of total = 20% (muirgeo)
Pharma profit = $36B (RR)
$36,000,000,000/($1,342,000,000,000 * 20%) = 13.4% profit. I'd call that a fair profit margin considering the risks.
"I don't see how a single payer system would result in frozen pharmaceutical innovation."-muirgeo
Really? It works like this. Assuming that you are intending a single-payor system to reduce profit margins (apologies if your vision is to see pharma profits remains as they currently are), why would a pharma company invest $50M on research that will take years and may or may not pay off if the maximum profit that could be made is, let's say, $5M. If the potential profit were $100M, that might be a risk worth taking. There are far better investment opportunities for $50M that will yield more than $5M and not have the associated risks. The potential for large profits are the only reason for a business to invest large sums of money in risky endeavours.
Posted by: Kevin S. | Nov 5, 2007 6:45:08 PM
"...but my wife is stuck with Kaiser. I'm not sure if you've ever had to use Kaiser, but their doctors and policies are horrible."
Not supported by the evidence.
Posted by: muirgeo | Nov 5, 2007 6:47:57 PM
EconStudent, please go home to your wife and tell her that muirgeo says her Kaiser care is very good.
For some reason, her evidence doesn't count.
Posted by: cpurick | Nov 8, 2007 7:16:10 AM
Chris makes a good point. In a single-payer model where the government pays existing, private institutions to provide healthcare, you will get more lobbying as service providers all lobby to ensure that their specific products and services are covered.
When policy makers and bureaucrats are willing and able to hand out gifts of tax payer money to worthy recipients, there will be no shortage of people with their hands out.
Posted by: mike | Nov 8, 2007 9:50:51 AM
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