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Preventing Price Gouging in the Pharmaceutical Industry: A Comprehensive Policy Approach

March 16, 2018
Pharmaceutical drug price hikes have now become a common feature in American news. From Martin Shkreli’s infamous Daraprim price hike that saw a $737 increase to the chemotherapy drug Cosmogen that currently sells for $1,400 in the U.S. compared to $20-30 overseas, the problem is clearly systemic [1]. Many important cancer drugs, including Gilead’s Sovaldi, Merck’s Keytruda, and Vertex’ Kalydeco all cost over $80,000 for a course of treatment [2]. Often prices increase are unrelated to any new research and development done. There is a clear need to address such drastic drug price increases in order to prevent these dramatic hikes and create a more stable biopharmaceutical market.


The biopharmaceutical industry is one of the largest in the United States, with sales exceeding $850 billion per year [3]. Furthermore, drug prices are significantly higher in the United States than in the rest of the developed world [4]. The current method for drug production uses a pipeline system, which essentially means that companies begin developing a large portfolio of potential compounds. Through the production process, companies successively eliminate products that are not viable for reasons such as adverse effects or low potency. The rationale for this system is that a large number of potential candidates optimizes the likelihood of creating a fiscally rewarding drug. However, this system results in a high cost associated with drug production. The price of creating a new drug and bringing it to market has been estimated to be as high as $2.6 billion [5]. The cost of a drug does not solely stem from the production of the individual finished product, but also from the cost of the failed drugs within the pipeline. Pharmaceutical research and development productivity has declined due to the high rate of failure of drugs at later stages of development, which has caused an increase in the price of creating and distributing a viable drug in the market [6].

A price hike occurs when a large biopharmaceutical company can increase prices either over a span of time, or in some cases, overnight, due to a single entity controlling much the market share. Soon after, other companies with similar drugs follow suit, creating a kind of “Shkreli effect,” named after the infamous CEO of Turing Pharmaceuticals, who was responsible for the Daraprim price increase. Price gouging occurs because of pharmaceutical company abuse of patent laws and the current model for drug discovery and development previously mentioned. Although patent protections were created to incentivize innovation, patents actually create “quasi-monopolies” in the pharmaceutical sector by allowing companies loopholes to delay selling to competitors that produce generic drugs. The prevalence of price hikes exemplifies the need to reform the biopharmaceutical market, without disincentivizing innovation or risk-taking in research.

Market Control

Pharmaceutical companies, in many instances, perpetuate their control over specific molecules by blocking generics from entering the market. This is done through a variety of means, including restricting access to their compound to delay bio-equivalence testing and “pay for delay” agreements, when a brand company pays a generics producer to delay sale of a version of their product. In 2017, the biopharmaceutical company, Amgen, even attempted to thwart generics producers by transferring their patent to the St. Regis Mohawk tribe and subsequently leasing it back [7]. These monopolies, in turn, have the ability to make autonomous decisions regarding drug pricing, creating a situation where prices do not respond to supply and demand market economics [8].

Generics manufacturers are also blocked from entering the market by tactics such as “product hopping” and manipulation of the Risk Evaluation and Mitigation Strategies as mandated by the FDA [9]. “Product hopping” takes advantage of the patent system by slightly modifying old products nearing patent expiry and remarketing the drug as a new product [10]. At this point, competitors have already begun development of a generic version but must restart their development in order to have their drug be a generic version of the newest product [11]. The REMS are a way in which the FDA places restrictions on drugs identified as dangerous, sometimes limiting the availability of the drug [12]. Drug companies say that due to this limitation, they are not able to sell the drug to competitors, thereby eliminating the ability for competition and solidifying their quasi-monopoly on the product [13]. Tactics such as these effectively prevent new competitors from being able to sell a generic version of the product, and thus allow pharmaceutical companies to hike their prices and maintain quasi-monopolies.


There are multiple policy approaches that could potentially stabilize the biopharmaceutical market and in turn protect the consumer. Many states, such as Maryland and California, have already enacted policy meant to create legal challenges for pharmaceutical companies looking to raise prices. However, for such a policy to be effective and protect the majority of consumer stakeholders, it must be Federal law.


The “import relief” law created by the Medicare Modernization Act in 2003 is a provision that allows the FDA to import pharmaceuticals from trusted nations at lower prices when they are deemed safe and can save Americans money. However, the government systematically prevents the import of drugs from countries such as Canada because of intense lobbying and alleged safety fears [14]. To illustrate this disparity, American consumers paid approximately $79 for a Proventil asthma inhaler; meanwhile, Canadian consumers paid just $21 for it [15]. The FDA currently regulates imported drugs in order to alleviate shortages, and a possible policy solution is simply increasing imports of such pharmaceuticals. However, a report by the American Enterprise Institute states that even if Congress were to pass a law permitting free importation of pharmaceuticals, US prices would not be reduced [16]. Part of the problem is that the Canadian market is much smaller than the American one-their revenues are less than 5% of the US market [17]. Moreover, imports would cause the US market to be influenced by foreign price controls, and pharmaceutical companies would face nearly unlimited demand because of those historically low-priced markets. As the US continues to import drugs, Canada would likely lose its drug supply unless its government relaxes its control, which would send Canada’s prices surging instead [18]. While this would make richer nations, such as Canada and Germany, bear more of the cost of research and development to which the US historically contributes the largest share (50%), it would also disadvantage poorer nations because they would no longer be able to afford their own drugs [19]. So, while this could lower prices to an extent, it does not seem like the best method of doing so.

(Image: Drug Price Hikes, December 2014 to January 2016. Source: Bloomberg)(Image: Drug Price Hikes, December 2014 to January 2016. Source: Bloomberg)

Upstream Regulation

Future public policy should require bio-pharmaceutical companies choosing to divest from the production of a particular drug to include a price ceiling in the transfer agreement. Price hikes are, in part, facilitated by the original companies’ lack of involvement in the future of a compound when they cease production. Often when the patent life of a drug expires, the parent manufacturer will often cease manufacturing the molecule or biologic. They often give up their rights to no longer profitable ventures to other companies, transferring manufacturing knowledge, marketing rights, and even trademarked names [20]. In principle, when a company gives up manufacturing privileges, it should open the market by introducing competition, thereby reducing prices and consequently increase access. However, in many cases, the opposite occurs because companies transfer patents to a single entity, which then has sole control over the drug pricing. For example, Eli Lilly offloaded the rights to produce the antibiotic cycloserine to Purdue University’s Chao Center, who soon thereafter, transferred the drug to the company Rodelis in 2015. Rodelis unexpectedly increased the price of the drug twenty-fold. Amidst heavy public scrutiny, Chao regained the manufacturing rights from Rodelis and reduced the price, but the price remained double the original price [21]. However, in the United States, patents are transferable goods because this allows for flexibility in research and manufacturing and recognizes the fact that a creator may not be the entity to bring a product to market [22]. Making patent transfers more regimented may consequently make it more difficult to ensure the continued production of a compound.

Currently, bio-pharmaceutical companies in the United States are already required to provide notice of plans to discontinue the production of a potentially life-saving drug [23]. The addition of price ceiling in transfer agreements will result in more mindful and calculated transfer of drugs, which can confer stability to the market in the future. It will legally preempt price hikes in the industry.

Transparency Bills

At the crux of the American pharmaceutical pricing controversy is the issue of transparency. In October of 2017, California Governor Jerry Brown signed a drug transparency bill [24]. The legislation requires that all bio-pharmaceutical companies notify both the Office of Statewide Health Planning and insurance companies if they plan to increase the price of a drug greater than 16% in a span of two years and provide a rationale for the price increase. The notification must be given 60 days prior to the beginning of projected price increase [25][26]. Such policy makes companies projecting a price hike subject to scrutiny from both the government and the public, which have been effective in pressuring companies to keep prices low in the past [27]. A similar policy on a national level would increase government influence over the biopharmaceutical industry without directly imposing price ceilings, regulating mergers, or manipulating patent law. A national bio-pharmaceutical transparency bill would increase the dialogue regarding price hikes and result in increased accountability on the part of large manufacturers, which would work to prevent price gouging on a national level. However, drug companies have sued California over this law because they believe that it holds pharmaceutical companies solely culpable for price gouging while ignoring other entities, like suppliers and distributors. They believe that this new regulation will lead to drug stockpiling and reduced competition [28]. Therefore, while transparency is beneficial in the pharmaceutical industry from a consumer perspective, it can also lead to decreased efficiency and innovation. 

Government Negotiations

An alternative to federal regulation in the pharmaceutical market is to allow the Secretary of Health and Human Services to negotiate pharmaceutical prices for Medicare patients, which accounts for 29% of national retail spending in the pharmaceutical industry. This is currently prohibited by federal law under the Medicare Modernization Act’s non-interference clause. Currently, Medicare Part D is run through private insurers, which cover different drugs at different prices and negotiate independently, allowing Medicare enrollees to switch between these plans depending on which plans optimize access according to their individual needs. Proponents of this policy highlight that the government may have the power to significantly reduce the prices of drugs by virtue of the size of the Medicare market as well as decrease prices in drug markets with little competition, such as those for rare diseases [29]. Opponents of this policy believe that the Secretary would not be able to obtain better prices than the individual plans [30]. The Congressional Budget Office has stated that increasing the scope of government regulation in Medicare Part D would have a “negligible effect” on curbing pharmaceutical prices. Additionally, opponents of such policy contend that direct government involvement could discourage innovation and discovery in the industry [31]. In summary, government negotiations regarding Medicare will likely not affect pharmaceutical prices in a meaningful way.

Maryland’s Price Gouging Law

Lawmakers in Maryland have approached this problem in a different way: their new law authorizes the state’s attorney general to prosecute firms that engage in dramatic price increases for generic drugs. Since this law only targets off-brand drugs, it will not affect pharmaceutical companies that claim they need high prices in order to recoup innovation costs. Maryland bases this on contract law, declaring that “a relationship between buyer and seller is deemed unconscionable if it is based on terms so tilted toward the party with superior bargaining power that no reasonable person would freely agree to them” [32]. However, this law has its own issues. Maryland specifically targets price increases of 50% or more in a given year for drugs that cost more than $80 per 30-day course, For instance, a pharmaceutical company could simply raise the price of a generic drug by 49% each year if a 50% increase per year were set as a threshold for price gouging [33]. Despite this, it is still a step forward from the current status quo.


The recent price gouging trend in the United States underscores the biopharmaceutical market failure and the consequent pricing controversy that arises when drug manufacturers have near monopolies over certain drugs. However, stringent price ceilings disincentivize much needed innovation in healthcare. Thus, a multifaceted policy approach, which alters the way international trade, internal regulation, private-public communication, and legal actions occur in the pharmaceutical industry is needed to provide stability in the bio-pharmaceutical market and prevent unfounded price hikes in the industry.

Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.


  [1] https://www.nytimes.com/2017/04/20/opinion/how-to-stop-drug-price-gouging.html
  [2] https://www.forbes.com/sites/matthewherper/2014/10/23/could-high-drug-prices-be-bad-for-innovation/#40dd17f05a80
  [3] http://journals.plos.org/plosone/article?id=10.1371/journal.pone.0113894#pone.0113894-IMS1
  [4] http://apps.who.int/medicinedocs/documents/s19834en/s19834en.pdf
  [5] http://csdd.tufts.edu/files/uploads/cost_study_backgrounder.pdf
  [6] https://www.nature.com/articles/nrd3078
  [11] Ibid.
  [12] Ibid.
  [13] Ibid.
  [14] https://www.nytimes.com/2017/04/20/opinion/how-to-stop-drug-price-gouging.html
  [15] https://www.pbs.org/newshour/health/u-s-make-easier-import-prescription-drugs
  [16] http://www.aei.org/publication/the-grim-economics-of-pharmaceutical-importation/
  [17] Ibid.
  [18] Ibid.
  [19] Ibid.
  [20] http://www.lillyglobalhealth.com/en/media/pdfs/mdr-tb-technology-transfer.pdf
  [21] https://joppp.biomedcentral.com/articles/10.1186/s40545-016-0064-8
  [22] http://www.economist.com/node/5014990
  [23] https://www.gpo.gov/fdsys/granule/USCODE-2012-title21/USCODE-2012-title21-chap9-subchapV-partA-sec356c

  [24] https://www.npr.org/sections/health-shots/2017/10/10/556896668/california-governor-signs-law-to-make-drug-pricing-more-transparent
  [25] Ibid.
  [26] https://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180SB17
  [27] https://www.npr.org/sections/health-shots/2017/10/10/556896668/california-governor-signs-law-to-make-drug-pricing-more-transparent
  [28] https://www.mercurynews.com/2017/12/08/drug-companies-sue-california-over-drug-pricing-transparency-law/
  [29] https://www.healthaffairs.org/do/10.1377/hblog20160919.056632/full/
  [30] https://www.kff.org/medicare/issue-brief/searching-for-savings-in-medicare-drug-price-negotiations/
  [31] https://www.cbo.gov/sites/default/files/110th-congress-2007-2008/reports/drugpricenegotiation.pdf
  [32] https://catalyst.nejm.org/marylands-anti-price-gouging-law/
  [33] http://thehill.com/opinion/healthcare/364297-keep-big-government-out-of-medicare-drug-pricing-negotiations


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