Because they can, but should they?

Mylan is the company that produces the EpiPen, a device that injects a measured dose of epinephrine when someone has a severe allergic reaction. Mylan didn’t invent the drug or device. The company acquired it in 2007 from Merck, which bought the rights for the drug years earlier from another company. By some estimates, Mylan’s EpiPen controls roughly 90 percent of the market for epinephrine injection devices. When Mylan purchased the rights to the EpiPen in 2007, the drug cost about $100 for a two-pen set. It currently retails for more than $600.

Mylan isn’t the only company to buy a drug and then dramatically increase its price. Earlier this year, the Wall Street Journal (as well as other news outlets) reported on pharmaceutical companies that buy rival’s drugs and then jack up the prices. A noteworthy example is Martin Shkreli, a hedge fund manager and CEO of Turing Pharmaceuticals, who bought the drug Daraprim and raised its price from about $13 a dose to $750. The drug is used to treat a variety of infections and other diseases. Turing bought the rights to the drug from a company, which bought the rights to the drug from another company, which bought the rights to the drug from another company, …

Why did Mylan increase the price of the EpiPen? Why did Turing increase the price of the drug Daraprin? Because they can. The companies control exclusive rights to the drug and the demand for the drugs are highly inelastic. First, by having exclusive rights over the drugs and with little if any competition, they possess monopoly power. This means they can act as price makers rather than price takers. Second, as I explained to my microeconomics students today, demand for the drugs is inelastic because there are few substitutes to them and they are necessary. This means that consumers will not (or cannot) be very responsive to large changes in prices. If you are subject to severe allergic reactions, you probably will not forgo the drug if its price increases. You will grumble and complain but buy it anyway. Thus, the combination of monopoly power and inelastic demand makes raising prices economically rational.

The drug companies and other commentator point to other reasons for high drug prices. Some argue that the patent system and long and costly regulatory approval processes are to blame. While these affect the initial costs for many drugs, they don’t explain why the price rose so quickly years after the drug has been on the market. If Daraprim was profitable at $13.50 a dose, then patenting and regulatory costs won’t explain the 5,000 percent increase in its price after Turing bought it.

According to an article in today’s Wall Street Journal, drugmakers are pointing a finger at middlemen for rising drug prices. Drug company executives say that the system is to blame. Everyone has to take a cut, such as pharmacy-benefits managers. Drug companies say that they have to offer increasingly larger rebates to pharmacy-benefits managers to induce them to accept their drugs as part of their company’s health plans. These benefits managers, in turn, are blaming drug prescription services and health insurers. While there might be some merit here, it’s hard to believe that middlemen and insurance companies are largely responsible for the dramatic increases in drug prices. I can’t imagine that a benefits manager will say “no” to the only drug that is available to treat severe allergic reactions or some infections. Drug companies won’t have to offer large rebate inducements if their drug prices were not already very high.

To be sure, the problem is complicated. Should we force drug companies to price their products “reasonably”? What is a reasonable price for a life-saving drug? Who’s to say that $20 or $30 or even $50 is unreasonable for Daraprim? These companies also employ thousands of workers and their stocks are part of savings, retirement and other investment portfolios for many people. If we mandate lower prices for drugs, then what happens to drug company employees and investors?

If drug companies can raise prices, and justify the price increases on economic grounds, then should they? Economic considerations are important, but they are not the only values that matter. Fairness matters too. Is it fair to ask patients to pay 5000 percent more for a lifesaving drug?

Fairness can be more difficult to justify than economic rationale. But we can simplify things. While there are many bases for arguing “fairness,” all of them are grounded in expectations. When our expectations are met, then we have little grounds for arguing unfairness. However, when expectations are not met, people typically feel justified in claiming unfairness. Consumers with a history and experience in paying $13.50 for a drug to treat infections will continue to expect that prices will be about the same the next time they buy the drug. While most people can expect gradual increases in prices, for instance due to inflation, there is no reasonable argument anyone can make that would convince me that consumers would expect a 5000 percent increase for Daraprim or a 500 percent increase for the EpiPen in a relatively short period of time. If drug companies want to increase prices more than what consumers expect, then the companies need to speak directly to consumers and change their expectations. That is fair. But I expect that will be quite a challenge for drug companies.


Are we better off today than our grandparents were in the 1950s?

I finished reading Robert Gordon’s massive book, The Rise and Fall of American Growth: The U.S. Standard of Living Since the Civil War. And it is massive, topping 750 pages including notes and references.

Gordon’s thesis is simple: American growth and the improvement in the standard of living for people living between 1920 and 1970 was better than the improvement in growth and living standards for people living between 1870 and 1920 and for those living between 1970 and today. Stated differently, while my grandparents had it better than their grandparents, the improvements that my grandparents experienced were more substantial than the improvements I have seen.

The reason is that the inventions and innovations that occurred between 1920 and 1950 were more significant and had a greater impact on labor productivity and personal well-being than the inventions and innovations that occurred before and after that time period. Gordon systematically reviews “all” of them (hence the long book). He considers improvements in food, housing, transportation, communication, health, working conditions, financial services.

Here are simple examples: Going from no cars in the late 19th century to cars available to most households in the early 20th century had a greater impact on people and businesses than going from cars then to cars with airbags and rearview cameras today. Similarly, going from no electric lighting to electric lighting had a greater impact than going from electric lighting to more efficient electric lighting. Going from no penicillin to penicillin was more profound than going from penicillin to more powerful penicillin. Going from no telephones to telephones was more important than going from telephones to mobile phones today. The list goes on and on. People living between 1920 and 1970 saw more radical changes in their lives than people living since the 1970s.

What made the book fun was the presentation of stories and historical examples he gave. Even if you are not interested in the economics behind his thesis, you can read the chapters and gain insights about how life improved for people during the early half of the 20th century.

Gordon raises some warnings. It is not likely that we will see the kind of growth that the economy and people experienced from 1920 to 1950–what he refers to as the “Great Leap Forward”–anytime soon. And worse, the widening level of inequality we are seeing will only make things worse. The growth rate of real income for the top 10 percent and for the bottom 90 percent of persons in the U.S. was about the same in the mid 20th century–about 2.5 percent per year. But since the 1970s the top 10 percent of wage earners has seen real wages increase more than 1.4 percent annually while real wages for the bottom 90 percent of workers have decreased during the same time period. This is not good for a healthy, growing and productive economy.

Unintended consequences of new technologies

A couple of headlines from today’s Drudge Report caught my eye: 100 tiny robots replaced humans to wait in line… and Police use droid to snatch rifle from barricaded suspect….

I like new technologies. I like the smartphones, flat screen TVs, the satellite radio in the car I recently rented, and the fact that I can drive rather than walk or ride a horse to where I want to go. Technology can be great. But there can also be side effects and unintended consequences. As a trained economist, I think it is appropriate to ask whether the benefits of technologies outweigh the costs. There will always be costs, some of which we won’t recognize immediately.

Today I attended a lecture by a University of Missouri graduate student who did some work this summer in Guatemala with Heifer International. In one village she visited, women cooked food on open fire pits in their thatched houses. The fire pits created a lot of smoke in the homes. Heifer helped households get cooking stoves with ventilation pipes that took the smoke out of the homes. The stoves required less wood than the open fire pits and solved the problem of smoke in the rooms. But there was a side effect. Guatemala has a lot of rain. The open fire pits dried out the thatched roofs. The new stoves do not, hence the unintended consequence. There is also the advantage that smoke clears out mosquitoes and other insects, which doesn’t happen now.

An important problem that new technologies create is our becoming dependent on them. Dependency in turn can result in a loss of skills. Scholars refer to this as “deskilling.” How many people can answer what 7 x 8 equals, boil an egg or orient ourselves on a street without asking Siri?

Reminds me of the scene from the 2012 Avengers movie. SHIELD’s helicarrier is losing altitude because one of its rotors was damaged in an attack. Nick Fury tells the pilot to put the flying ship over the ocean. The pilot responds that they lost their navigation system. Nick Fury tells the pilot, “Is the sun coming? The put it on the left!” Nick didn’t forget how to navigate without GPS, but apparently the pilot did.

Let’s be wise about our use of technology. Before it makes us dumb.