Great Disappointment: Some Policymakers Ignore Basic Economics in Drafting Prescription Drug Pricing Policies

Great Disappointment: Some Policymakers Ignore Basic Economics in Drafting Prescription Drug Pricing Policies

Last week, the U.S. Senate leaders started efforts in reviving the Build Back Better bill, including Medicare prescription drug price regulations. The main provision is to allow Medicare to negotiate drug prices directly with manufacturers for up to 10 drugs between 2026 and 2029, after which 10 more drugs would be added to the list. 

According to Kaiser Health News

“… policy summaries that were used by Democrats writing the bill and shared by Democratic staffers — on the condition that they not be published — suggested that Democrats believed that ending pricing monopolies on 15- and 20-year-old drugs would spur innovation by encouraging companies to develop new drugs.”

What? Did I read that right?

Such a belief reflects the ignorance of some policymakers in Washington D.C. Or it might be worse – they just bury their heads in the sand. 

Ask any investment professionals. This is not how investment decisions are made. 

Sensical investment decision-making would result in a reduction in research and development (R&D) for the drugs benefiting the Medicare population.

Let’s do a simple thought exercise. Suppose a manufacturer has $1 billion to invest in R&D and compares various options. The selection criterion is the amount of money they can earn in today’s dollars (i.e., the present value). 

We can further decompose the return into two components: (1) the return earned between Year 1 and Year 15; and (2) the return collected in Year 16 and beyond. If Medicare negotiates prices for older drugs 15 years after they are approved by the Food and Drug Administration, the second component will become smaller. Because the price negotiation applies to the Medicare population only, the second component for the drugs targeting the non-elderly population is not affected.

As a result, compared to the status quo, the manufacturer will be less likely to invest in drugs for the elderly population if Medicare negotiates drug prices. 

The notion that reducing the prices of old drugs would encourage new drug development does not make sense. 

Furthermore, prior academic research has consistently demonstrated a positive relationship between potential market size and investment in R&D. 

Investment in R&D is sensitive to changes in potential market size: each 1-percent increase in potential market size is associated with an average 1.5-percent increase in R&D investment. In other words, the proposed Medicare price regulations, if implemented, would reduce the market size of the Medicare market, leading to a decline in R&D investment. 

In particular, after the implementation of Medicare Part D, the increase in R&D investment for drugs targeting Medicare beneficiaries was larger than that for drugs targeting non-Medicare populations. The R&D increase for drugs in the six protected classes was larger than those in non-protected classes. 

All evidence points in one direction: Medicare drug price negotiation would lead to a decrease in investment in R&D and thus, a fewer number of new drugs for Medicare beneficiaries. 


Despite overwhelming evidence from academic research, some policymakers continue to ignore basic economic principles – when the demand decreases, the supply will decrease accordingly.