The US pharmaceutical industry faces two important goals–which conflict with each other. One goal is to provide needed drugs at the lowest possible price. The other is to provide incentives for research and development of new drugs, which requires some form of compensation for the risks of undertaking such efforts. The US patent system allows inventors to have a temporary monopoly on their discovery, so that they can charge higher prices for a time. After the patent expires, it then becomes legal for others to produce generic equivalents. The result is a two-part market for US pharmaceuticals: expensive drugs still under patent and inexpensive generic drugs.

William S. Comanor layout some of the patterns in his essay, “Why Are (Some) U.S. Drug Prices So High?” which is subtitled, “The Hatch–Waxman Act promotes both pharmaceutical innovation and price competition, confounding simple comparisons of U.S. and foreign drug prices” (Regulation, Winter 2021/2022).

Here’s a table showing how the US pharmaceutical industry has evolved. Notice that about 90% of dispensed prescriptions are generics, accounting for about 20% of total invoice spending, while 10% of prescriptions are branded drugs, accounting for 80% of invoice spending.

A common complaint about the US pharma industry is that brand-name drugs sell for more in the United States than in other countries, which often impose price controls and other rules on drugs from US firms. What is less-heard is that prices for generic drugs are typically lower in the United States. Here’s a comparison from Comanor. When adjusted for manufacturer discounts (“net pricing correction”), branded drugs cost about twice as much in the US as in Japan, Germany, and the UK. However, generic drugs in the US cost about one-third less than Germany and the UK, and less than half as much as in Japan.

The bifurcated US approach to pharmaceuticals has led to the global dominance of US drug companies. Comanor reports:

As disclosed in the RAND report, the United States accounts for 58% of total pharmaceutical sales revenue among nations in the Organisation for Economic Co-Operation and Development, whereas the second and third highest counties, Japan and Germany, are 9% and 5% respectively. Moreover, because U.S. branded prices are higher than elsewhere, the United States accounts for approximately 78% of worldwide industry profits. All other countries, in aggregate, account for less than one-third of that amount. Put simply, U.S. profits incentivize global innovation.

Of course, one can imagine a variety of potentially useful ways to tweak the patent rules or the rules for drug regulation. It also seems to me that the goal of profit-seeking drug companies is to develop expensive drugs for extreme conditions that will generate high profits, along with in-demand drugs for conditions like hair loss. There’s an important rule here for government support of R&D to encourage innovating in a ways that the market might not reward very well: for example, a focus on the important but neglected health conditions; a focus on “orphan drugs” for health problems that affect only a few people and might not be very profitable; and a focus on versions of drugs with lower costs or fewer side effects. It would also be nice if the rest of the world would step up and pay a bigger part of the bill for developing new drugs, too. But in some broad sense, the bifurcated US drug market–an outcome of the Hatch-Waxman act passed back in 1984–has actually worked out pretty well.