Once again the Ontario government is meddling with generic drug prices in a vain attempt to save a few bucks. Having dug itself into an enormous fiscal hole, the province just announced it will further lower the prices it pays for the 10 best-selling generic prescription medicines to 20 per cent of their brand-name equivalents, down from the current 25 per cent.

Fixing the price of generic drugs has been standard practice in Ontario for several years and other provinces have imitated this approach. While it is encouraging that provincial governments are attempting to pay down their deficits and recognize that taxpayers are paying among the highest prices in the world for cheaper generic alternatives, simply fixing prices through government regulation is not the solution.

The trend in ‘price fixing’ began in 1993 when the Ontario government introduced legislation which stipulated that new generic drugs covered by the province’s public drug plan could not cost more than 75 per cent of the original brand name product price.

While the objective was to create a price ‘ceiling’ for generic drugs purchased by the government, it instead created a price ‘floor.’ Since pharmacists knew well in advance what the government was willing to pay (75 per cent of the brand name equivalent), there was no incentive to lower the prices of those drugs.

The notion that this type of price fixing created ‘floors’ instead of ‘ceilings’ is made clear by how, subsequent to the original legislation, the Ontario government reduced the reimbursement rate to 70 per cent of the original brand name drug in 1998, 50 per cent in 2006, 25 per cent in 2010, and to 20 per cent today for certain drugs.

Although fixing generic drug prices has saved the province some money in the short-term, it has removed the essential market forces required to naturally set prices based on supply and demand.

Importantly, when governments are involved in setting arbitrary prices, they could also be setting prices too low, which could distort supply. Notably, some drugs are more expensive to produce than others and these price differentials are not reflected in government-set drug prices; only a competitive market can strike the right price as determined by supply and demand.

Regulators are mistaken if they assume that drug makers and pharmacy retailers will continue to supply drugs to the market at any price set by government. Prices must provide a competitive economic return to both drug producers and retailers, relative to alternate uses of invested capital. If they don’t, reduced pharmacy services and a more limited drug supply could be some of the negative consequences of further fixing generic drug prices – which is precisely the major concern of Ontario’s retail pharmacies.

One way to put downward pressure on generic drug prices without completely distorting the market is to lift the arbitrary price levels the government has imposed while introducing greater competition among retail pharmacies through price sensitivity for public drug plan recipients.

Ontario’s public drug plan users are only required to pay a small flat co-payment when they purchase prescription drugs. They are not required to pay the typical dispensing fee charged by the pharmacists. This is the case regardless of the price of the drug or the quantities prescribed. Because the total prescription cost does not affect the co-payment, and because the fixed co-payment is low, there is no incentive for consumers to shop around for the lowest price. The price is the same at every pharmacy, thus price sensitivity for those dependent on the public drug plan is non-existent.

In contrast, by charging drug plan recipients a percentage based co-payment up until a pre-determined means-tested threshold (deductible) has been met, and requiring them to pay the dispensing fee, consumers would care more about price and would be motivated to shop around. Not only would this remove the arbitrary government prices, it would create additional incentives for pharmacies to offer competitive prices and dispensing fees.

Providing suitable economic incentives for drug manufacturers and retail pharmacies while getting good value for money for taxpayers is a difficult balance to strike. However, allowing competition to determine the supply and prices of generic drugs is a better option than the status quo.

Consumers and taxpayers would benefit from increased choice and savings, while the most competitive drug makers and pharmacy retailers would win increased sales by competing on price.