Cheaper medicines now!

The Australian Pharmaceutical benefit scheme is a monopsony buy-in arrangement for medicines run by ministries. It currently costs tax payers about ten billion dollars per year (see page 3 here), up from a paltry 149,000 pounds in its first year of operation, 1948! The upward trend was worrying enough to lead the Treasury to flag it as a real problem in its Intergenerational report, and Phillip Clarke in particular has been vigorously arguing that it is poorly designed and that we overpay for our medicines, especially generic medicines. A recent report by Stephen Duckett has increased pressure for reform by claiming that the taxpayers are being fleeced to the tune of 1.3 billion a year.

Both Clarke and Duckett point to what others pay to convince their audience. Phillip Clarke, in a recent letter to the editor of the Medical Journal of Australia points out that several other countries, such as New Zealand, pays much lower prices for the same medicines and that just on statins alone, a 260 million savings could be made by going to the low price. Duckett points out that even within Australia, several entities pay much less for the same medicines than the commonwealth does to pay for medicines-at-home. Hospitals for instance pay much less for the same medicines which they buy in bulk. Applying the lowest-cost price all round would in his estimation save around 1.3 billion. In short, we pay too much.

The deeper question is how to reform the pharmaceutical benefit scheme so that we get the incentives right to avoid paying too much. The problem hitherto has been that the decisions have become political, leading to a huge amount of lobbying by the pharamaceutical industry of both the ministers via media manipulations, and via repeated (and successful!) attempts at influencing the composition and work methods of the current scheme, forever expanding its budget.

Duckett has now started calling for a more independent monopsony scheme that would be allocated a fixed budget to buy in medicines for patients in Australia and that would hence regularly have to add and remove medicines in order to stay within the budget yet allow new and useful drugs into the system. Politicians would still determine the budget beforehand and appoint a director, after which the independent institute decides what to fund and what not. By fixing the budget beforehand one thereby removes a lot of the incentives for pharmaceutical companies to coordinate on political pressure as it puts the various companies in more direct competition with each other for the available dollars.

Buckett helpfully supplies a whole timeline for how the thing can be set up. Interestingly, what he proposes is almost a carbon copy of the first ‘piece of advise’ I gave to this government in March 2012 (see here where I call for an “independent Medicine Procurement Authority”), although his plan clearly pre-dates mine and is far more worked out.

I applaud Clarke and Duckett’s attempts at helping the nation get lower prices for our medicines and I wish them favourable political winds!

Author: paulfrijters

Professor of Wellbeing and Economics at the London School of Economics, Centre for Economic Performance

14 thoughts on “Cheaper medicines now!”

  1. Maybe I’m not understanding this particular situation, but does the government even have the right information and incentives to set the prices of medicine at a rate that both maximize consumer surplus and retain the incentive for pharmaceutical companies to develop new drugs?


    1. Research incentives are irrelevant from an Australian point of view: these companies are overwhelmingly foreign and we are a small fish in the global pond. We should free-ride and have as low prices as possible, letting the bigger fish worry about research incentives.

      Besides, R&D is a surprisingly small part of the budget of big Pharma. They mainly do marketing, including 40,000 meetings with groups of doctors and nurses in Australia alone. Yes, that is right, over 100 times per day pharmaceutical companies run workshops and conferences for groups of nurses and doctors who are wined and dined whilst being told they should prescribe X rather than Y. Its a lot of effort for simply ‘disseminating information’, is it not? The ‘research’ defense that is made to justify big Pharma profits is quite bogus, but unpicking that one is an issue for another day.


  2. I haven’t read the report yet, and there may be some really poor prices that exist in the PBS. However, this post doesn’t relate to particulars, it’s more focused on generalities. I think there are a couple of issues that aren’t fully fleshed out here:

    1. Paying for drug R&D is a collective action problem similar to carbon emissions. You can believe that global warming won’t be a problem, or that drug companies will be similarly innovative even if monopsonist national funders aren’t willing to pay patent profits. However if you do think either of those things will happen each country faces 2 choices: free ride, and hope that others will do what is economically painful for your benefit, or be a good global citizen, and suffer some economic disutility ‘for the greater good’. Other than convenience, what rationale does Australia have for choosing to be in the first group?

    2. It’s rational for each jurisdiction, but entirely unhelpful on the whole, for individual decisionmakers to decide to pay “at or below the average” of other countries. Someone has to be above average. That’s what makes it an average. Picking out X drugs, and saying that you’re paying above the average on Y of them is data mining. You could easily be below average on (X-Y).

    3. Australia should probably pay more than NZ (or India or Kenya) for patented drugs. It’s a richer country, and whether we’re considering individual willingness to pay for health benefits, the social value of improved population health, or the marginal productivity of the healthcare system, it’s hard to see why Australia “should” have a lower willingness to pay for the same incremental impact on population health. Just because you can pay less for a good with high fixed costs and minimal marginal costs of production doesn’t mean the current price isn’t justified by consumer WTP.


  3. Thanks Dr. Frijters for your response.
    Apple similarly spends a much larger percentage of their revenue on marketing rather than research, has high profit margins and price discriminates globally. I just don’t quite see how this justifies the government setting prices. Do pricing signals not indicate how much investment in medical innovation the market will bear? Would a price ceiling be beneficial for electronics? Sorry, I’m not trying to be difficult, just to understand.


  4. Ravi,

    its the other market distortions that give a role for monopsony purchases: governments give pharamceuticals patents meaning they guarantee them a monopoly, plus the ultimate consumers of these goods (patients) dont actually pay for them as their insurance pays. This means you dont have proper incentives on the side of patients and doctors to worry about value-for-money and thus get cost blow-outs unless you set up a government intermediary as the purchaser of medicines.


    what you are essentially arguing is that we should pay more because we can afford it and want the goods more badly. Call me a market economist, but when i see a lower price for the same product I want the lower price and enjoy more consumer surplus. If you want the pharmaceuticals to have more profits out of you, you can always just send them a cheque!


  5. “what you are essentially arguing is that we should pay more because we can afford it and want the goods more badly. Call me a market economist, but when i see a lower price for the same product I want the lower price and enjoy more consumer surplus. If you want the pharmaceuticals to have more profits out of you, you can always just send them a cheque!”

    As a market economist, you should know that we don’t know ex ante what will happen if a monopolist loses the ability to price discriminate between jurisdictions. It could mean that Australia gets cheaper drugs. It could also mean that NZ (or India or Kenya or Bulgaria, or whatever countries you think should be included in the comparison) loses the ability to get cheap drugs as every jurisdiction is forced to pay the global profit maximizing price or go without.

    Maybe you’re okay with that, but I think there’s an element of global justice to price discrimination in drugs, and I’d hate to see people in poorer countries lose access to effective interventions because high income jurisdictions decide to act solely out of self interest.


  6. I haven’t read the Duckett report – just commentary on it. As a regular user of the PBS, due to a heart attack and quadrupal bypass in 2007, I have regular experience with the PBS.

    What I can’t find in the commentary is any reference to the existing scheme whereby the PBS pays pharmacists $1.50 per script if they dispense a cheaper generic version of a prescribed drug. As a patient you don’t have to accept this and some doctors are reluctant do recommend that you do so. Nevertheless my pharmacist has always asked the question, and being a scientist with a major in Chemistry, I have been happy to do so, given that in most cases the only difference chemically is the metal salt used in the generic cf with the brand. This means that I get some of my drugs at a significant discount to the brand.

    The situation with the statins is particularly complex however. Atorvastatin (lipitor) is one of the most commonly prescribed statins, and as far as I am aware, there is not a generic equivalent available in Australia. This may simply be due to copyright. There are other cheaper statins, but they differ chemically and therefore have a range of different side affects. I wonder whether or not Duckett considered this in his paper? Do you know if he did?


    1. Both Duckett and Clarke have long ancestry in these debates. Clarke started writing on this at least 5 years ago with multiple papers and Duckett did a stint at Queensland health and followed health debates a long time.


  7. Dr. Frijters,

    I understand your argument that lowering pharmaceutical prices is the consumer surplus maximizing decision for Australia given the institutions currently in place. However, I think another appropriate solution would be to reform intellectual property law and the health care system to become more price sensitive (maybe universal catastrophic care with health savings accounts)? Isn’t decreasing the role of third-party payers and the market distortions that they bring a more efficient proposal in the long-run?


    1. The complexity of the health system is such that it is hard to say what can be done about the overall design. We tend to change things incrementally and follow successful examples. Have you got a worked out plan in mind regarding health accounts?


  8. The idea of a fixed budget is absolutely crazy. What happens if the budget is used up before the end of the year and people then miss out on needed drugs – after all the prescribing of drugs is a very atomistic and decentralised process? In the UK, GP practices are allocated fixed quantums of different drugs and if they overshoot, then bad luck for the patient. The complete antithesis of patient centred practice.

    Having just spent some time in NZ, the public is very unhappy with the health system there, which is very heavily rationed. In any case, with per capita income 30 per cent below Australia, you would expect them to get much cheaper drugs, which are distributed through Australia and are effectively sold at marginal cost. No lesson for Australia there.

    Actually, the PBS has been seen as a world leader in terms of getting value for money, when the analysis is undertaken carefully (see PC research on this).


    1. Once upon a time, the PBS was indeed world leading. I could use it as a proud example in lectures on public economics. Simply put, the rest of the world has become better at it whilst we got worse so that we are now somewhere in the middle if the pack. The argument that richer consumers should pay more for the same may sound logical but it is not from the point of view of the richer person who buys from the same store!
      Yes, a fixed budget system needs careful thinking about the limits. Same is already true now: no program is truly open-ended.


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