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Government plans to control generic drug prices are doomed to failure

Appeared in the New Glasgow News
Release Date: October 28, 2010
For too long, Canadians have been paying almost double what Americans pay for identical generic prescription drugs. And while several provincial governments have announced plans to reduce generic drug prices, these efforts will ultimately be futile because they fail to deal with the underlying problem: the lack of market forces that would normally cause prices to fall.

According to the Fraser Institute study, Canada’s Drug Price Paradox 2010, average generic drug prices in Canada were 90 per cent more than American prices for the same drugs in 2008. Although previous editions of the study found that generic prescription drug prices in Canada were an average of 112 per cent more than U.S. prices in 2007 and 115 per cent more in 2006, indicating that generic drug prices in Canada have been slightly declining relative to American prices, Canadians are still paying way too much for generic drugs.

So why the price discrepancy?

The problem lies in two primary government policies that distort the generic drug market. Both policies are associated with the way in which prescription drugs are reimbursed by provincial public drug programs.

Public drug programs direct the reimbursement of prescriptions to pharmacies instead of consumers. This insulates consumers from cost and removes incentives for comparative shopping that would put downward pressure on prices.

Public drug programs also reimburse generic prescription drugs at a fixed percentage of the brand name original drug. Under this policy there is no price competition because the buyer (the government) offers every seller the same price, and the price is known in advance.

Large established generic companies exploit this reimbursement system to offer rebates to pharmacies that are bundled across many products in exchange for exclusive distribution rights. Because pharmacies are reimbursed directly, discounts are not passed on to consumers.

Recent attempts to reduce generic drug prices in Ontario, British Columbia, and Quebec have all taken a misguided approach. Instead of allowing competition to determine generic drug prices, they are further distorting the market by setting drug prices at a lower ‘fixed-percentage’ of the brand name original. The changes introduced to provincial drug plans fail to address the underlying problem, the total absence of competition among retailers and incentives for customers to comparison shop.

Canadians would be much better off if governments just repealed public policies that distort the market for prescription drugs. That would lead to lower prices and greater voluntary use of generics, which is currently taking place in the United States.

In 2006, Wal-Mart introduced an innovative prescription drug retail program in the United States that allows customers to purchase a 30-day supply of prescriptions drugs for only $4, or a 90-day supply for $10. The program includes more than 300 generic products, and according to Wal-Mart, has saved more than $3 billion since 2006. In response to Wal-Mart’s in-store drug plan, most other U.S. pharmacy chains now offer similar drug programs. This intense competition has enabled Americans to take advantage of low cost generic drugs which, unlike in Canada, are a fraction of their brand-name equivalent.

In 2008, average retail prices for generic drugs in Canada were 73 per cent of the price of their brand-name equivalents, compared with just 17 per cent of the price of their brand-name equivalents in the United States.

As the American experience shows, price incentives in a free competitive market encourage efficient substitution of generics for brand name drugs when appropriate while preserving consumer choice.

While Canadian governments defend their intrusion in pharmaceutical markets by claiming their policies reduce the costs of prescription drugs for consumers, Canadians are paying much more than they should for generic drugs because government policies are distorting the market.

Alternatively, if public drug programs reimbursed consumers directly at a flat percentage of the price of any prescribed drug and prices were not set as a ‘fixed-percentage’ of the brand-name original, consumers would be sensitive to price, and all drug sales would be subject to market forces that would put downward pressure on generic drug prices.

In the absence of government interference, consumer preferences and price sensitivities would encourage the efficient substitution of generics for brand name drugs. The resulting health savings would be significant.