What the most hated company in America reveals about our insane drug market

Turing Pharmaceuticals tried to hike the price of a drug by 5,500 percent. This not how capitalism is supposed to work.

A corrupt system.
(Image credit: Illustrated | Image courtesy iStock)

Turing Pharmaceuticals recently made heads explode by buying a drug that treats a rare parasitic infection, and promptly hiking its cost from $13.50 to $750 per tablet.

If you want to understand the debate that's swirling around this, you need to start with a very basic precept: In a capitalist market that was actually functioning and competitive, a sudden 5,500 percent price increase would be unthinkable.

The basic moral case for capitalism and markets is that they promote widespread human well-being. They do this, ostensibly, by providing the freedom to experiment with different solutions to human problems, and the incentive to do so via profits. But the profits aren't supposed to last: As solutions are adopted and spread throughout the economy, competition between companies should drive down prices, forcing companies to accept ever smaller profit margins in the process. That's how cell phones went from being a luxury item in the 1980s, to dirt-cheap and ubiquitous today.

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Anyone trying a sudden 5,500 percent price increase in a market for any good should immediately get killed as competitors undercut their price. That Turing thought it could get away with this — and that other companies already have gotten away with it on numerous occasions (see the example of the drug Sovaldi) — is the first clue that the way we buy and sell pharmaceuticals barely deserves to be called a "market" in any meaningful sense.

There are lots of reasons for this, which cut across various ideological or partisan conceptions of the market.

There's the fact that drugs have to go through a gauntlet of tests and trials before they can be approved by the Federal Drug Administration — that's a big cost barrier to competitors looking to enter the market. There's the intrinsic difficulty in establishing distribution chains.

But the two big elephants in the room are patents and the completely irrational design of the U.S. health care system.

Patents are just a monopoly handed to a company by governmental fiat. Regardless of whether you think getting rid of them would be a good idea, our society and markets could in fact function just fine without them. The point is, as long as a company has a patent, competitors can't undercut them — i.e., market forces can't work.

(Now, there's an interesting wrinkle in the specific instance of Turing Pharmaceuticals: The patent on the drug in question — Daraprim — had already long expired. So it's not exactly clear what Turing thought it was doing with such an insane price spike, since competitors should eventually be able to move in and undercut it. Turing may have simply been relying on buearacratic inertia to delay competitors long enough so it could make a killing in the short term.)

Then there's the health care system. Because of the fractured nature of the U.S. health insurance market, insurers have little bargaining clout to get drug providers to bring down their prices. Medicare has the clout to do that. But in one of the craziest aspects of American health policy — thanks to pharmaceutical industry lobbying — federal law expressly forbids Medicare from bargaining with drug providers. The companies set whatever price they want, and Medicare has to just eat it.

Other Western governments deal with these problems in a variety of ways. But one of the most common is they sit down with drug providers and agree on one price for that drug throughout the country. This often gets decried as "price controls," which critics say will trample innovation.

But this is a weird argument. First off, drug companies currently pump about 20 percent of their revenues into research and development, and take another 20 percent out in profits. So they have the money to almost double their R&D budgets as it is, but they just don't want to use it.

Furthermore, governments buy stuff from markets in the same way other big institutions do — they're market actors as much as anyone else. Price-setting by governments is just Costco-style bulk purchasing scaled up to the national level. There's nothing intrinsically "anti-market" about it.

There are certainly situations where it's nonetheless a bad idea. But it's hard to make the case that drug markets are one of them: Drug providers are often massive international companies with vast opportunities to exercise monopoly power. It makes sense for buyers to band together into equally big bargaining units to counter them. ("Monopsony" is the technical term.) It would be no different if we actually had a functioning market in health insurance, and insurers big enough to force drug providers to bring down their prices themselves. The result in both scenarios would be lower profit margins for drug makers.

If you think those lower profit margins are themselves a threat to innovation, then you're not actually arguing against government price controls — you're arguing against competitive markets in drugs, period. And arguing for massive drug makers with massive profit margins and monopoly power, forever and ever amen.

Which seems obviously nuts.

So what do we do about this? There are options: Hillary Clinton has a new proposal to force drug manufacturers to pour more of their profit shares back into R&D. Bernie Sanders wants to change federal law to let Medicare bargain for prices. On the bigger picture level, we ought to drastically reform the patent system, and pump way more money into government research into pharmaceuticals — just do what we've done in lots of other areas, and take the R&D burden off the private markets entirely. And don't underestimate the ability of Obamacare to deliver a better health insurance market, either.

These are all ideas worth considering. But the point here is simply that, in order to coherently think through which solutions are best, we have to first admit something much more basic: That we don't have true "markets" in drugs and we probably never will. And just move on from there.

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Jeff Spross

Jeff Spross was the economics and business correspondent at TheWeek.com. He was previously a reporter at ThinkProgress.