Regulation and Market Power

In the United States the main regulatory agency for medicines is the Food and Drug Administration, a federal agency.  Other agencies that may get involved include OSHA, the CDC, and parts of the military.  The states have the legal authority to regulate medicines also, but we are not aware that this practice is widespread.

Other countries sometimes have agencies analogous to the US FDA.  The most important one, as far as the big pharmaceutical companies are concerned, is the European Medicines Agency.

The drug industry pays more attention to government regulation than most industries do, because new product introduction is so important to profits and regulators are a gateway to new product introduction.

Over the decades the regulatory philosophy is periodically updated, usually with the stated intent of making life better for consumers.  But so often these changes end up making industry incumbents more powerful.

Following a 1937 incident in which over a hundred people died from taking an antibiotic sold by the firm Massengill, Congress gave the FDA a new power.  Some drugs would be classified as “by prescription only”.  These were usually newer or more risky drugs, and the idea was that a competent doctor acting as a gate-keeper would ensure that these medicines were used only when the benefits outweighed the health risks.  Over-the-counter drugs were ones for which individuals could decide if they needed and when and how much they needed.  This gave us the two-tier drug system we have in the US today: prescription and over-the-counter.

When medical insurance became more prevalent it usually covered some or all of the cost of prescription drugs, but not the cost of over-the-counter medication.  This resulted in a system of “he who orders does not buy, and he who buys does not order” (Senator Estes Kefauver, 1960’s).  The prices of prescription medicines became inelastic in economic terms – patients and their families did not look at the costs.  The result was that prescription drugs became much more expensive than OTC ones.  Even today, pharmaceutical companies strive to keep the drugs they make – even generic ones with no patent protection – classified as prescription-only medicines.  If the FDA makes these drugs available over the counter, prices fall

During the period before 1960, the FDA had to approve new drugs and did so only if they were deemed safe.  The medicines did not actually have to work.  As long as they didn’t hurt people, the FDA allowed sale of the medicines.

In 1962, the FDA was given the authority and mandate to approve new medicines only if they were proven effective.  This meant expensive clinical trials, and further gave power to the incumbent pharmaceutical companies or to highly funded new companies.  Drugs were the opposite of electronics.  In electronics, and later computer software, a few individuals with little money could create and sell products that consumers wanted.  No medicines are developed in garages; it is too expensive and time-consuming for lone entrepreneurs to do so.

Today’s pharmaceutical industry is operated with a blockbuster mentality.  A few high-selling medicines can justify the research costs and the modest profits on low-selling medicines.  It is estimated that only one-third of eventually marketed drugs make more than enough to cover their development costs.