The Council of Economic Advisers

February 2018

September 29, 2017

Reforming Biopharmaceutical 

Pricing at Home and Abroad
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 1

Executive Summary

February 2018

The affordability of healthcare and biopharmaceutical drugs is a top concern for Americans. It 

is often asserted that promoting innovation and affordable drugs are conflicting goals. New 

innovations, however, often provide improved health that was not previously available at any 

price or obviate the need for more costly care. They thereby lower the effective price of health 

down to the price of the patented drugs, and later down to the price of generic drugs. Federal 

policies that affect drug pricing should satisfy two goals. First, domestic drug prices paid by 

Americans should be reduced. Second, the price of better health in the future should also be 

reduced by spurring medical innovation. This report considers policy options to 

simultaneously advance these two seemingly conflicting goals. 

Reducing drug prices that Americans pay means recognizing that many artificially high prices 

result from government policies that prevent, rather than foster, healthy price competition. 

Drug prices, for example, are sometimes artificially high due to government regulations that 

raise prices. This report discusses changes to the Medicare and Medicaid programs that could 

help lower domestic prices, as well as reforms to the Food and Drug Administration (FDA) that 

could encourage more robust price competition.

Preserving incentives for biopharmaceutical innovation can be achieved while still promoting 

lower prices for Americans. Global financial returns from product development drive 

innovation. But those returns are unfairly low today. This is because most foreign 

governments, which are the primary buyers in their respective pharmaceutical markets, force 

drug manufacturers to comply with pricing rules to gain market access. Through this leverage, 

foreign governments are able to set drug prices below those that prevail in the United States 

and erode the returns to innovation manufacturers might otherwise see from selling in their 

markets. Among members of the Organization for Economic Co-operation and Development 

(OECD), CEA estimates that Americans pay more than 70 percent of patented 

biopharmaceutical profits, despite the fact that the United States accounts for only 34 percent 

of OECD GDP at Purchasing Power Parity (PPP). In short, pharmaceutical innovators—and 

foreign governments—across the world rely on America’s patients and taxpayers to finance 

critical research and development.

The objective of government in biopharmaceutical policy is to ensure that the private sector 

competes and invests in meaningful innovations that lower the price of health, rather than 

incentivizing market exclusivity and high prices on products. The two goals of reducing 

American prices and stimulating innovation are consistent, but can be achieved through a 

combined strategy that corrects government policies that hinder price-competition at home, 

while at the same time limiting free-riding abroad. 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 2

1. Introduction

According to recent polling of American adults, lowering prescription drug prices is one of the 

most important public issues, regardless of party (Figure 1). Americans are understandably 

concerned about a reduction in affordability, the disparity between U.S. drug prices and prices 

overseas, and well-publicized episodes of price manipulation.

Figure 1: Politico/Harvard Polling on Americans' Top Priorities for Congress, 2017

(Percent Responding Extremely Important)

Source: Politico/Harvard, Americans' Top Priorities for Congress through the End of CY 2017

Note: Poll of U.S. Adults open Aug 30 to Sept 3, 2017 

Concerns about affordability have been magnified by the high price of many newly approved 

drugs. Table 1 provides a range of annual per-patient costs for treating a condition with some 

of these high-priced drugs. As an extreme example, the annual cost of drugs that treat genetic 

diseases can reach almost $800,000 for a single patient (AHIP 2016). 

0

10

20

30

40

50

60

Total Democratic Republican Independent

Lower prescription drug prices Raising federal minimum wage

Reducing budget deficit and federal spending Repealing and replacing ACA
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 3

Table 1: Summary of Annual Per-Patient Drug Expenditures

Condition

Range of Annual PerPatient Expenditures

Low ($) High ($)

Genetic Diseases (including hereditary hypercholesterolemia) 73,431 793,632

Cancer, hematological malignancies 12,897 540,648

Immune System Disorders (including Multiple Sclerosis) 12,586 462,384

Cystic Fibrosis 40,546 368,688

Infectious Diseases 13,440 226,800

Cancer, solid tumors 27,144 220,320

Pulmonary Arterial Hypertension 103,464 196,560

Hereditary Angioedema 14,292 98,040

Cancer, supportive care agents 14,183 41,576

Growth Hormone Deficiency 30,064 38,944

Organ Transplant 15,528 38,765

Ophthalmic Disorders 13,320 29,256

Source: AHIP 2016. “High-Priced Drugs: Estimates of Annual Per-Patient Expenditures for 150 Specialty Medications.”

It is misleading, however, to consider only the prices of these new drugs without evaluating the 

well-being of patients before the drug became available. It is important to separate the price 

of healthcare, such as drugs, from the effective price of better health, such as how costly it is to 

live longer. Innovations such as new drugs often reduce the price of health even when the new 

drug is very expensive relative to other goods. Consider the example of a patient diagnosed 

with HIV in the early 1990s. Before new breakthrough therapies for HIV emerged, the price of a 

longer life was prohibitively high because a longer life could not be bought at any price 

anywhere in the world. Once new HIV drugs were developed and marketed in 1996, the price 

of a longer and healthier life for HIV-positive individuals decreased dramatically: it reached the 

equivalent of the price of the new, patented drugs. Generally, the price of better health falls

further as competing drugs enter the market, then fall even further to competitive price levels 

upon patent expiration when cheaper generics become available. The example of innovative

HIV drugs makes the essential point that even though the price of the drug was considerable

and drug spending rose, the effective price of better health declined.

Preserving incentives to innovate will ensure that the effective price of health can continue to 

decrease over time. This is important to high- and low-income populations, as they all will use 

generic or biosimilar versions of today’s high priced drugs in the future1. Indeed, the vast 

majority of the World Health Organization’s (WHO) Essential Drugs today are off-patent.

 1 For biologics, no generics exist. FDA has the authority to approve follow-on biologics that are “interchangeable,” 

but it has not yet used this authority partly because of the difficulty of ascertaining sameness in complicated, very 

large protein molecules.
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 4

The U.S. government and biopharmaceutical industry have been the central engines in 

lowering the price of better health for patients worldwide by being both the world leaders in 

biopharmaceutical innovation as well as the source of innovative returns to those investing in 

such innovations. The U.S. market makes up 46 percent of OECD sales of brand name 

innovative drugs, funds about 44 percent of world medical R&D, invests 75 percent of global 

medical venture capital, and holds the intellectual property rights for most new medicines (BMI

2017; Moses et al. 2015; TEC 2017). Furthermore, publicly funded medical research in the 

United States has produced two-thirds of the top-cited medical articles in 2009, underlying the 

university research that often leads to medical breakthroughs (Moses et al. 2015).

U.S. patients and taxpayers alike have mainly financed the returns on R&D investments to 

innovators. Unlike other developed countries with single payer systems, which nearly all 

impose some sort of price controls on pharmaceuticals, the U.S. drug market is less financed 

by the public sector and more open to private market forces. In a free market, prices of 

products reflect their value as opposed to prices in government-controlled markets, which

reflect political tradeoffs. CEA estimates that because of the American market system, more 

than 70 percent of OECD patented pharmaceutical profits come from sales to U.S. patients

even though the United States only represents 34 percent of OECD GDP at Purchasing Power 

Parity (OECD 2016). Thus, innovators across the world rely heavily on Americans paying market 

prices to underwrite the returns on investments into products that improve their health

because governments abroad use their monopsony power to set prices below market-levels.

The United States both conducts and finances much of the biopharmaceutical innovation that 

the world depends on, allowing foreign governments to enjoy bargain prices for such 

innovations. This indicates that our current policies are neither wise nor just. Simply put, other 

nations are free-riding, or taking unfair advantage of the United States’ progress in this area. In 

addition, prices paid by Americans for many drugs are too high, particularly so when paid for 

in government programs. This is the result of poorly designed reimbursement policies and 

regulations that inhibit price competition, and it is therefore a poor use of taxpayer money.

In light of these problems, reforms to U.S. biopharmaceutical policy may consider two 

simultaneous goals. First, American drug prices today should be reduced. Second, the price 

of health in the future should be reduced by lowering the costs and increasing the rewards of 

innovation.
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 5

Biopharmaceutical Drug Reform Goals

Goal 1: 

 Reduce the prices Americans pay now for biopharmaceutical products 

Goal 2:

Reduce the price of health by raising innovation incentives for products in the future

The first goal can be addressed by reforms that reduce overpricing by promoting competition 

and reforming public reimbursement policies. The second goal can be addressed by reforms 

that cut the cost and raise the rewards to innovation through domestic reforms and limiting 

underpricing of drugs, particularly through free-riding abroad. These reforms should occur in 

conjunction so that both objectives are met. For example, only lowering prices in the United 

States will enable the first objective but not the second as it makes better health costlier in the 

future by curtailing innovation. Likewise, just eliminating underpricing abroad will mainly 

enable the second objective but not address the first. The key point is that the two seemingly 

inconsistent goals of reducing American prices and stimulating innovation can be achieved 

only by a combined strategy that eliminates overpricing at home while at the same time 

reducing free-riding abroad. This report provides a menu of potential combined reform options

that may usefully achieve both objectives. 

2. Americans Pay High Prices for Biopharmaceutical Products

In a well-functioning competitive market, the price of a good is driven down to the cost of 

production of the firms producing it. This principle applies to all markets including the market 

for pharmaceutical drugs. However, various factors often preclude competition from driving 

down prices in U.S. pharmaceutical markets.2 In the case of patent-protected new drugs, the 

temporary exercise of exclusivity preserve incentives for innovation. What has been less 

emphasized is that government policies or public insurance programs have unintended 

consequences that prevent, rather than foster, healthy price competition and induce 

artificially high prices. 

 2 It should be noted that there are various prices of pharmaceutical drugs, including the manufacturer price, pharmacy sales 

prices, and patient price. Even within these categories, prices can vary depending on rebates, markups and insurance 

coverage. Each price is important, and we focus on these different prices throughout this section.
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 6

2.1 Reduce High Prices Induced by Medicare and Medicaid Reimbursement 

Policy 

To promote patient welfare, government policy should induce price competition. In the two 

primary U.S. insurance programs, Medicaid and Medicare, current policies dampen price 

competition, thereby artificially raising prices. 

Medicaid

Manufacturers that choose to enter the Medicaid Drug Rebate Program are required to offer 

state Medicaid programs their prescription medications at a price that either includes a 

minimum rebate of 23.1 percent of the average manufacturer price (AMP – the average price 

paid to manufacturers by wholesalers and retail pharmacies that buy direct net of prompt pay 

discounts) for brand drugs or, if lower, the “best price” the manufacturers offer to any other 

purchaser (“Medicaid Drug Rebate Program”). In exchange for these discounted rates, states 

are then required to cover the manufacturer's drugs in their Medicaid programs. In fiscal year 

2014, Medicaid programs spent $42 billion on prescription drugs and collected about $20 

billion back in rebates so that net expenditures equaled about $22 billion (Baghdadi et al.

2017). The practice of mimicking public relative prices to private relative prices is partly 

beneficial because it allows the private market rather than bureaucrats to determine relative 

prices based on patient value.

While this basic approach of using market prices is sound, as currently implemented, the 

Medicaid Best Price program can create artificially high prices in the private sector under 

certain conditions. If a large share of a given drug’s market is enrolled in Medicaid (e.g., for HIV 

or mental health drugs), a pharmaceutical firm has an incentive to inflate prices in the private 

sector so that it can collect higher post-rebate prices from its large Medicaid customer base. 

Similarly, the mandated price discrimination implicit in this program prevents price discounts

to lower-income patients in the private sector. Lower-income, private patient populations 

cannot be charged low prices as that jeopardizes the Medicaid price. Reforms could help

prevent the inflated private sector prices the program induces while at the same time allowing 

the government to use pricing information from the private sector to determine value. 

While CMS rules require that best prices be determined on a unit basis, Medicaid statutes do 

not (42 C.F.R. 477.506(e)(2)) (Sachs et al. 2017). CMS could revise rules to specify how 

manufacturers calculate best prices determined after the sale and the patient’s recovery. This 

may encourage competition and lower prices. It would also incentivize better adherence 

regimens and lower the risk to the government that it pays money for something that turns out 

to be less effective than expected. CMS could also provide more guidance on how value-based 

contracts and price reporting would affect other price regulations. This would encourage drug 

purchasers to negotiate, thus increasing competition and lowering prices.
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 7

Medicare

Medicare Part B Physician Administered Drugs 

Medicare Part B drugs are those administered by physicians in their outpatient clinics to 

Medicare recipients. From 2006 through 2013, twenty-eight percent of this spending was for 

newly approved drugs that were concentrated among a small number of conditions, such as 

cancer, blood diseases, and ophthalmology (GAO 2015). According to the GAO, over time, 

expensive specialty drugs and biologics approved through expedited pathways have come to 

represent a higher proportion of newly approved drugs that are administered by physicians.

In the Medicare Part B program, through which many specialty drugs are reimbursed, drugs 

administered in physicians’ offices and hospital outpatient departments are reimbursed based 

on a 6 percent markup (now 4.3 percent due to the sequester) above the Average Sales Price 

(ASP), that manufacturers receive net of any price discounts. For example, with a 6 percent 

markup above ASP the doctor receives $600 for administering a $10,000 drug and $60 for a 

$1,000 drug. As is true in any cost-plus reimbursement environment, this leads to a lack of 

incentive to control costs and instead an incentive to raise costs. The current policy mutes the 

incentives for doctors to prescribe cheaper drugs and therefore for manufacturers to engage 

in price competition. While there may be larger costs to providers for prescribing more 

expensive drugs, such as storing expensive drugs and the lower probability of collecting 

reimbursement or copays, these costs are routinely handled in other healthcare markets 

without resorting to distorted cost-plus reimbursements. While some private payers have 

responded to this type of perverse incentive problem through alternative reimbursement 

procedures for drugs delivered in clinics, similar reforms have not been made for the Medicare 

Part B program. 

The Medicare Payment Advisory Commission (MedPAC), the Government Accountability Office 

(GAO), the Department of Health and Human Services (HHS) Office of the Inspector General 

(OIG), and others have all proposed solutions for how Medicare could remove perverse 

incentives for prescribing higher-priced drugs and instead provide an incentive for doctors to 

prescribe cheaper drugs, putting competitive pressure on manufacturers to reduce their 

prices. Options for reform include:

i. Introducing physician reimbursement that is not tied to drug prices, 

ii. Moving Medicare Part B drug coverage into Medicare Part D, where price-competition 

over drug prices is better structured, and 

iii. Changing how pricing data is reported to increase transparency. 

By moving Part B coverage into Part D, the 71 percent of Medicare beneficiaries who participate 

in Part D would receive prescriptions that they would fill and their physicians would administer,

thereby removing any economic incentive from prescribing decisions. There are additional 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 8

reforms to consider that increase price transparency and reduce incentives for more spending.

First, require better and more accurate sales data from drugs that are older than six months 

since launch. This is important because drug makers have an incentive to exclude discount 

prices from the sales price they report, since the higher the average sales price, the more they 

are paid. Second, for new drugs that do not have much sales data, cut the doctor’s payment. 

This removes the incentive of prescribing a high-priced drug when physicians write 

prescriptions, and elevates clinical competition as a decision-making factor. 

Medicare Part D Outpatient Drugs

Medicare Part D reimburses outpatient drugs, and the program has several provisions that 

artificially raise costs for patients. The Social Security Act requires Medicare Part D plan 

formularies to include drugs within each category and class of covered drugs. CMS has 

previously interpreted the Social Security Act’s requirement to include drugs within each 

therapeutic category and class to mean the inclusion of at least two non-therapeutically 

equivalent drugs. This requirement eliminates the ability of Part D sponsors to negotiate for 

lower prices when there are only two drugs on the market since drug manufacturers know that 

CMS must cover both. The two-drug requirement leads to more spending.

Another problem resulting from Medicare Part D is the overpricing of low value drugs. The 

Social Security Act §1860D-14A stipulates cost-sharing amounts for low-income subsidy 

enrollees that vary by income and are adjusted by projected program cost growth. The use of 

formulary tier-based cost-sharing is prohibited, which eliminates the ability of sponsor plans 

to price and discount drugs according to value for patients. Low-income subsidy enrollees and 

sponsor plans should have incentives to use high value drugs. The Medicare Payment Advisory 

Commission (MedPAC 2016) has highlighted this problem by reporting that 17.3 percent of lowincome subsidy enrollees are high-cost compared to just 2.8 percent of other enrollees.

The Medicare Part D Coverage Gap Discount Program requires drug manufacturers to provide 

a 50 percent discount to enrollees while in the coverage gap. The 50 percent discount is then 

counted toward the calculation of an enrollee’s true out-of-pocket cost, accelerating them 

through the coverage gap into the catastrophic phase of benefit where Medicare pays 80 

percent of all drug costs and the sponsor and enrollee are responsible for the remaining 15 and 

5 percent, respectively. With such discounts, enrollees may have an incentive to use brand 

drugs and reference biologics when less expensive generics and biosimilars are available, since 

the large discounted payment counts toward the true out-of-pocket cost. The overall Part D 

benefit structure creates perverse incentives for plan sponsors and pharmacy benefit 

managers (PBMs) to generate formularies that favor high-price, high-rebate drugs that speeds 

patients through the early phases of the benefit structure where plans are most liable for costs. 

The Medicare Part D program has unintended consequences that have resulted in higher drug 

prices for consumers. MedPAC and OIG, among others, have each produced various policy 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 9

options to address these misaligned incentives within the program. Solutions to overcome 

these problems could include:

i. Requiring plans to share drug manufacturer discounts with patients.;

ii. Allowing plans to manage formularies to negotiate better prices for patients;

iii. Lowering co-pays for generic drugs for patients; and

iv. Discouraging plan formulary design that speeds patients to the catastrophic coverage 

phase of benefit and increases overall spending.

2.2 Cut the Duration of High Prices Induced by Price Manipulation 

Prices for new and therapeutically advantageous drugs may often be higher than for existing, 

less effective drugs, particularly for innovative drugs that treat severe diseases with priceinsensitive demand. Having exclusive rights to sell a new and therapeutically advantageous 

drug allows the supplier to set pricing sufficient to recoup considerable investments in 

innovation. But potentially higher pricing is not confined to branded, patent protected drugs.

Several recent episodes have illustrated the ability of firms to legally take advantage of their 

position as the sole source for old but important drugs by rapidly increasing prices. 

Unlike most markets where new products can enter easily to cut prices, in the 

biopharmaceuticals market, the Food and Drug Administration (FDA) acts as a strict 

government gatekeeper for new pharmaceutical products. The evidence is clear that generic 

drug competition rapidly drives down the cost of drugs. After the 1984 Hatch-Waxman Act went 

into effect, researchers found that market entry of generic manufacturers resulted in generic 

prices falling to between 17 and 25 percent of the pre-expiry patented price within 24 months 

(Caves et al. 1991; Grabowski and Vernon 1992). A more recent paper by Berndt and Aitken 

(2011) estimates that U.S. generic prices fell to 6 percent of patented prices after 24 months of 

generic entry. Olson and Wendling (2013) account for endogenous entry of new generic 

competitors and find even larger decreases in drug prices after two and three competitors

enter the market.

A valuable policy option might be changing the criteria for expedited review to include new 

molecular entities that are second or third in a class, or second or third for a given indication 

for which there are no generics. This would serve as a new pro-competition pathway that would 

enhance therapeutic price-competition by providing expedited entry into monopoly 

markets. To avoid imposing policies retroactively on the industry, this policy change could be 

phased in slowly so that current drug manufacturers of single-source drugs would retain the 

value of their efforts to be the first in a given therapeutic space.

In later sections we discuss FDA reforms that may enhance faster drug price competition. The 

FDA Reauthorization Act of 2017 (FDARA) currently authorizes the FDA to designate a drug as a 

“competitive generic therapy” upon request by an applicant when there is “inadequate generic 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 10

competition” i.e., when there is no more than one approved abbreviated new drug application 

(ANDA) for the patented reference product (not including discontinued products).

3 This 

designation allows for improved communication with and advice from the FDA and a 180-day 

exclusivity period with no additional ANDA approvals available for other applicants. 

2.3 Enhance Price Competition in the Pharmacy Benefit Manager Market 

Pricing in the pharmaceutical drug market suffers from high market concentration in the 

pharmaceutical distribution system and a lack of transparency. Pharmacy benefit managers 

(PBMs) act as buying intermediaries between drug manufacturers and health insurance plans 

and their beneficiaries. They negotiate rebates off manufacturers’ list prices and then pass on 

some of the benefit to health insurance plans and beneficiaries. However, the PBM market is 

highly concentrated. Three PBMs account for 85 percent of the market, which allows them to 

exercise undue market power against manufacturers and against the health plans and 

beneficiaries they are supposed to be representing, thus generating outsized profits for 

themselves (Sood et al. 2017). Over 20 percent of spending on prescription drugs was taken in 

as profit by the pharmaceutical distribution system (Sood et al. 2017). The size of manufacturer 

rebates and the percentage of the rebate passed on to health plans and patients are secret. 

The system encourages manufacturers to set artificially high list prices, which are reduced via 

manufacturers’ rebates but leave uninsured individuals facing high drug prices (Sood et al. 

2017). Policies to decrease concentration in the PBM market and other segments of the supply 

chain (i.e., wholesalers and pharmacies) can increase competition and further reduce the price 

of drugs paid by consumers (Sood et al. 2017).

3. Raising Innovation Incentives Reduces the Price of Better Health 

in the Future

It is important to continue cutting the price of health by encouraging innovation. That could be 

accomplished by increasing the reward to innovation by limiting underpricing in foreign 

countries and at home, and by decreasing the cost of R&D through FDA policy. 

3.1 Limiting Under-Pricing of Drugs in Foreign Countries 

Worldwide profits drive innovation incentives, but when worldwide profits are partially 

determined by centralized pricing of governments, this induces unique free-riding issues (Egan 

and Philipson 2013). While drug prices in the United States are less publicly financed than in

other countries, government procedures and price controls set prices in most foreign 

countries. It is in each country’s interest to have other countries provide the returns to fund 

 3 ANDA’s or generic drug applications generally do not have to include preclinical and clinical data to become approved. A 

generic drug is one that is comparable to a novel drug product in intended use and effectiveness. 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 11

innovation by generous reimbursement. Smaller markets that do not significantly affect world 

returns have an incentive to set low prices without a discernible impact on the flow of new 

products their citizens enjoy. The problem is that in aggregate, these free-riding actions of 

many small countries have a substantial negative impact on worldwide profits. Put simply, 

providing innovative returns is a global public goods problem that leads to classic underprovision through government free-riding. Government payers from larger economies such as 

the United States face less of an incentive to free-ride as they make up a larger share of world 

returns and therefore enjoy less innovation from free-riding. 

The United States is the engine of worldwide pharmaceutical innovation, accounting for an 

estimated 46 percent of OECD patented pharmaceutical sales. Figure 2 shows patented 

pharmaceutical sales by country. The U.S. market for pharmaceuticals is about three times 

larger than the second largest country for both total sales (China) and patented sales (Japan). 

While the U.S. market provides a disproportionally large share of OECD pharmaceutical sales, 

it accounts for an even larger share of OECD pharmaceutical profits because profit margins are 

much larger in the United States. CEA estimates that the share of OECD patented 

pharmaceutical profits earned in the United States was approximately 78 percent in 2016, 

despite the fact that the United States made up only 34 percent of OECD GDP at PPP during 

that year (OECD 2016).

Figure 2. OECD Patented Pharmaceutical Sales by Country, 2016

(Percent of Sales)

Sources: Commerce, BMI
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 12

One method of estimating profit margin is to observe the decline in prices among patented 

drugs when patents expire and generic manufacturers compete prices down to the marginal 

cost of production (Caves et al. 1991; Grabowski and Vernon 1992; Berndt and Aitken 2011). 

Prices declined by an average of 84 percent across three studies implementing this method, 

implying that marginal costs were 16 percent of the patent-protected price. Using data from 

Danzon and Furukawa (2011), CEA estimates that foreign variable profit margins are 20 percent 

among patented drugs (see Appendix).

The U.S. Department of Commerce estimates that U.S. patented pharmaceutical sales totaled 

$270 billion in 2016, with sales in the rest of the OECD totaling $316 billion. To estimate the U.S. 

share of OECD profits, we assume that economic profits are zero (i.e., that accounting profits 

equal a normal rate of return in the economy)for generic drugs since patent expiration of brand 

name drugs allows for competition that drives price to marginal cost.4

 Thus, profits in a given 

country are equal to the sales of patented drugs multiplied by the profit margin for patented 

drugs. Dividing U.S. profits by foreign OECD and U.S. profits produces the U.S. profit share. 

UUUU PPPPPPPPPPPP haa aa = MM MM MMUUUU ∗ SS SSUUUU

MM MM MMFFFFFFFFFFFFFF ∗ SS SSFF + MM MM MMUUUU ∗ SS SSUUUU

= 84% ∗ $270bb

20% ∗ $316bb + 84% ∗ $270bb = 78%

Vernon (2003) derives profit margins for patented pharmaceuticals using another method with 

novel firm-level data that reflects margins of the world’s top 20 firms for products sold in the 

United States and the rest of world. The drugs sold in the United States had pre-tax, operating 

profit margins that were, on average, four times those of the more regulated markets of France, 

Italy, Germany, Japan, and the United Kingdom. When this alternative profit margin ratio is 

applied to the formula above, we estimate that the United States has a 77 percent share of 

OECD profits. This alternatively estimated ratio of U.S. to foreign profits of patented 

pharmaceuticals confirms the primary estimate. In addition, Goldman and Lakdawalla (2018) 

report, using a different methodology, a mid-range of 71 percent of world profits, as opposed 

to OECD profits. The fact that this world share estimate is only modestly smaller than the OECD 

share estimate estimated by CEA may potentially be due to the fact that OECD countries make 

up almost all world profits. Taken together, these studies all suggest a conservative profit share 

in the United States among OECD countries above 70 percent. 

 4 While accounting profit (the difference between revenue and explicit costs) is positive in competitive industries, economic 

profit is zero. That is because economic profit includes the opportunity cost of investment on top of explicit costs. Since this 

analysis examines variable profit, we consider economic profit because we are concerned what the companies will do with 

the next dollar. Companies will enter a competitive market until economic profit goes to zero (at marginal cost of 

production).
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 13

While U.S. consumers and taxpayers finance over 70 percent of estimated OECD profits on 

patented biopharmaceuticals during a single year, this does not account for the fact that these 

drugs are often sold in the United States before other markets. Drug manufacturers usually 

pursue market access in the United States before other markets due to the higher prices in the 

United States. Danzon, Wang, and Wang (2005) find evidence that the United States gains 

access to drugs sooner and has earlier drug launches compared to other developed countries. 

For example, the United States had several times more drug launches than Japan in the 1990s, 

and those launches that occurred in the United States occurred on average 19 months earlier.

The expected net present value (NPV) of a drug’s earnings drives the level of R&D investments 

undertaken to achieve it. This implies that if the U.S. government pays for the initial years of 

sales (i.e., those discounted across fewer periods and therefore producing a higher present 

value), an even larger share of the return on innovation is paid for by the United States. This 

suggests that our estimates understate the share of NPV earnings paid for by the United States.

Figure 3 provides an estimated share of NPV profits paid by the United States that varies by the 

number of years foreign countries delay approval for a drug. This analysis is of a hypothetical 

new drug sold in the United States and other OECD markets, assuming that each market would 

purchase the same proportion of other patented drug sales in 2016. For example, in 2016, the 

United States accounted for 46 percent of all patented drug sales. For a baseline analysis, we 

use the previously discussed profit margins of 84 percent in the United States and 20 percent 

in the rest of the OECD. While future sales and profits remain at 2016 levels, these are 

discounted at 10 percent to account for the time value of money and cost of capital for 

pharmaceutical firms.

5 As one would expect, the longer the delay by foreign markets, the larger 

the U.S. share of NPV profits paid to drug manufacturers. Even if the U.S. profit margins are only 

40 percent, or twice the foreign profit margin, the United States still pays two-thirds or more of 

profits on drugs in the developed world.6

 5 DiMasi, Grabowski, and Hansen (2016) estimate that the real cost of capital for pharmaceutical firms is about 10 percent. 6 Goldman and Lakdawalla (2018) provide a conservative estimate by assuming profit margins paid by the U.S. are about 

twice the average foreign profit margins.
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 14

Figure 3. Hypothetical Net Present Value of U.S. Share of OECD Patented 

Pharmaceutical Profits

(Percent of OECD Profits)

Source: CEA calculations. Note: Assumes 20 percent profit margin in foreign OECD markets.

Since smaller OECD countries do not face a tradeoff between prices and innovation given that 

innovation is not substantially affected by their pricing, most OECD nations employ price 

controls in an attempt to constrain the cost of novel biopharmaceutical products, e.g. through 

cost-effectiveness or reference pricing policies. In essence, in price negotiations with 

manufacturers, foreign governments with centralized pricing exploit the fact that once a drug 

is already produced, the firm is always better off selling at a price above the marginal cost of 

production and making a profit, regardless of how small, than not selling at all. Thus, the 

foreign government can insist on a price that covers the marginal production cost—but not the 

far greater sunk costs from years of research and development—and firms will continue to sell 

to that country.

Meaningful reforms could address the free-riding that takes unfair advantage of American 

innovation, whether through enhanced trade policy or policies that tie public reimbursements 

in the United States to prices paid by foreign governments that free-ride or other methods. 

Meaningful reforms would address the root of the problem: foreign, developed nations, that 

can afford to pay for novel drugs, free-ride by setting drug prices at unfairly low levels, leaving 

American patients to pay for the innovation that foreign patients enjoy. Since these nations 

benefit from the innovations regardless of the costs to Americans, they currently have no 

reason to raise their own prices and exploit the fact that novel drugs are already invented. If 

the United States had adopted the centralized drug pricing policy in other developed nations 

twenty years ago, then the world may not have highly valuable treatments for diseases that 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 15

required significant investment. The United States could take actions that change the 

incentives for these countries to price drugs at levels that appropriately reward innovation, 

rather than disproportionately putting that burden on American patients and taxpayers. As in 

other cases of under-provision of public goods, increased provision towards the public good 

would be desirable from free-riding parties.

3.2 Limiting Under-Pricing Domestically 

Reducing arbitrary underpricing domestically could help to realign incentives for 

pharmaceutical firms to innovate. The Medicaid Drug Rebate Program, discussed above, had 

the unintended consequence of far fewer voluntary discounts from drug manufacturers to 

certain safety net health providers since the discounted price would become the “best price” 

for all remaining Medicaid patients. Congress created the 340B Drug Pricing Program, in part, 

to exempt discounts to safety net health providers from the Medicaid best price formula. 

The 340B Drug Pricing Program requires manufacturers who want to have their drugs covered 

under Medicaid to provide “covered outpatient drugs” (prescription drugs and biologics other 

than vaccines) to certain hospitals and certain clinics receiving federal grants to serve 

vulnerable populations (“covered entities”) at or below a discounted “ceiling price.” The 

ceiling price is calculated the same way as Medicaid prices (AMP minus a unit rebate) resulting 

in a price that approximates the net price paid by Medicaid programs after rebates (Baer 2015). 

Manufacturers participate to qualify for federal funds for the covered outpatient drugs sold to

Medicaid. Most covered entities save even more by participating in the Prime Vendor Program,

which provides average savings of 10 percent below the ceiling price. Covered entities saved 

an estimated $3.8 billion on outpatient drugs in 2013 (MedPAC 2015).

The 340B program has expanded dramatically in recent years. Safety-net providers and their 

affiliated sites spent more than $16 billion to purchase 340B drugs in 2016, six times the 

amount spent in 2005, and the number of hospital organizations participating grew from 583 

in 2005 to 2,140 in 2014 (Vandervelde and Blalock 2017; MedPAC 2015). 

Two significant problems have emerged in the 340B program. First, the imprecise eligibility 

criteria has allowed for significant program growth beyond the intended purpose of the 

program. Second, providers earn significant profits from qualifying for the program, which can 

be used to fund other forms of care or shareholders’ dividends rather than provide care forlowincome patients. These large incentives distort provider organizations’ decisions in attempts

to qualify for the program, which is simply a form of rent seeking.

An unintended consequence of the 340B program has been that covered entities receive 

guaranteed profits while low-income patients who are the purported target of the program 

may receive little to no benefit (Conti and Bach 2014; Baer 2015). Covered entities can purchase 

drugs at discounted 340B prices for all their patients and sell them to patients with Medicare 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 16

and private insurance at far higher prices (Figure 4). The 340B statute does not dictate how 

covered entities use the revenue. They are not obligated to pass the discount savings onto 

patients nor are they required to report how they served low-income or vulnerable populations 

(Baer 2015).Drug-reimbursement could be restricted under the program to cover only uses the 

purchased drugs are intended to treat. Such a limitation would constrain the ability of 

providers to use 340B to cross-subsidize other care the provider may offer or use 340B as a 

source of profits to provider shareholders.

Figure 4. Drug Markup Disparities for Providers Under 340B

(Dollars)

Source: CEA. Note: Markups and prices are hypothetical.

The current eligibility criteria allow many hospitals to qualify as covered entities even though 

they may not serve significant numbers of low-income patients through charity care. Forty-five 

percent of 340B hospitals qualify through the disproportionate share (DSH) program by 

demonstrating that a certain percentage of their inpatients are low-income given that they are 

insured by either Medicaid or Medicare Part A, along with Supplemental Security Income 

benefits. Yet, 340B is a program to provide outpatient drugs. Hospital affiliated outpatient sites 

do not affect the hospital’s DSH percentage regardless of the income or insurance of the 

patients they treat. The other major category of 340B hospitals (44 percent) is critical access 

hospitals (CAHs) – small hospitals that provide essential services to remote, rural communities. 

CAHs do not have to demonstrate any DSH percentage to qualify for 340B. Nearly two-thirds of 

340B CAHs provide less charity care than the national average for all short-term, acute care 

hospitals. Thirty-seven percent of 340B DSHs provide charity care that represents less than 1 

percent of their total patient costs (AIR 2016). Eligibility of lower priced drugs could be 

340B 

Acquisition 

Price

340B 

Acquisition 

Price

Markup

Markup

Medicaid/Uninsured Patients

Reimbursement Price

Privately Insured

Reimbursement Price

Reimbursement Price = Acquisition Cost + Markup

Acquisition Cost 

Negotiated by 

Private Insurer
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 17

restricted to the intended poor patient populations, to ensure better use of government 

resources.

Regulatory changes that prevent profiting from the 340B program in Medicare Part B are 

currently under way. Prior to 2018, Medicare Part B paid the same amount for drugs to 340B 

entities and non-340B entities even though the 340B entities purchase the drugs at a steep 

discount. Hospitals in the 340B program accounted for 48 percent of Medicare Part B spending 

at acute care hospitals in 2013. It is estimated that 340B hospitals receive, on average, a 

minimum discount of 22.5 percent of the average sales price (ASP) while Part B pays ASP plus 

6 percent for outpatient drugs (MedPAC 2015). On November 1, 2017 CMS issued the Hospital 

Outpatient Prospective Payment System (OPPS) and Ambulatory Surgical Center (ASC) 

Payment System final rule, which starting January 2018, will reduce the amount Medicare pays 

hospitals for drugs acquired through the 340B Drug Pricing Program to ASP minus 22.5 percent 

rather than the current ASP plus 6 percent (CMS 2017a). These reforms will reduce 

overutilization of the 340B program and thus require hospitals to pay market prices for drugs 

for ineligible populations. It will also lower Medicare beneficiaries’ coinsurance liability, saving 

them an estimated $3.2 billion over the next decade (CMS 2017b).

The goal of the 340B Drug Pricing Program is to provide benefits to low-income patients, not 

to pay economic rents to hospitals. More precise eligibility criteria could help meet the primary 

goals of the program in the future. Beyond these immediate changes to the existing program,

a single agency could set prices at which the eligible providers can buy drugs. Such an agency 

would require better guidance for how reduced eligibility and profiteering can be implemented 

going forward. 

3.3 Reducing the Cost of Innovation through change at FDA 

The fixed costs of developing and bringing a drug to market are typically large compared to the 

small marginal costs of producing additional pills or doses. Thus, the incentive to innovate is 

driven by whether expected profits exceed these fixed R&D costs, and government policies 

have a major influence on the size of these fixed costs.

It is widely accepted that the fixed cost of bringing a new, patented drug to market has risen 

rapidly over time (Figure 5). The Tufts Center for the Study of Drug Development estimated that 

the average pre-tax, industry cost in 2013 dollars per new prescription drug approval (inclusive 

of failures and capital costs) is about $2.6 billion (DiMasi et al. 2014; 2016). Moderating this cost 

growth requires an understanding of the drug development process.
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 18

Figure 5. Growth in Capitalized R&D Cost per Approved New Compound

(Millions of Dollars, 2013)

Source: DiMasi et al. (2016)

Drug development starts with basic research to understand disease processes and identify 

molecular targets for new drugs.7 This research is done in academic settings, in governmentfunded settings (NHI, NCI), and by industry. Following basic research, there are five remaining 

steps primarily conducted by industry: (i) drug discovery and development; (ii) pre-clinical 

testing with non-human subjects; (iii) clinical trials with human subjects; (iv) FDA review and 

approval; and (v) post approval research and monitoring. Altogether, these steps take over 10 

years to complete, on average (FDA 2015; Chakravarthy et al. 2015). There are very few markets 

outside of biopharmaceutical in which it takes more than a decade, on average, from idea to 

market. Scientific uncertainty, government regulatory review, and firms’ increasing interest to 

avoid litigation over failure to warn all contribute to the increased timespan compared to other 

markets.

The most time-intensive steps are clinical trials involving human subjects (80.8 months) and 

FDA review (16 months), which has fallen with each reauthorization of the Prescription Drug 

User Fee Act (PDUFA)8. Clinical trials with human subjects are broken down into three phases: 

Phase 1 typically includes fewer than 100 human subjects to study drug safety and how the 

drug is absorbed, metabolized, and eliminated from the body; Phase II may include as many as

 7 These mandated development costs are fixed costs that have to be undertaken by innovators before they market 

their products, and therefore lower returns on innovation. This is different from voluntary variable costs, such as 

sales and marketing, which presumably raise profits and innovative returns. 8 PDUFA, reauthorized in 2017, allowed the FDA to collect fees from manufacturers during fiscal years 2018-2022 

in order to fund the new drug approval process. 

0

500

1,000

1,500

2,000

2,500

3,000

1970s 1980s 1990s-early 2000s 2000s-early 2010s

Pre-human Clinical Total
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 19

100 to 500 subjects to assess safety and efficacy with different strengths and dosing schedules 

of the drug; and Phase III includes potentially thousands of patients across multiple study sites 

to determine if the drug is safe and effective. Not surprisingly, Phase III accounts for the largest 

component of development costs.

Because clinical trials and FDA review are the most time- and resource-intensive steps, reforms 

that significantly reduce the fixed costs of entry could address these areas. Although FDA drug 

review and approval times have always been shorter than those of regulatory agencies in other 

countries, the FDA has over the years attempted to speed up the process (Downing et al. 2012;

CIRS 2014). In particular, the FDA has four separate programs to expedite the development and 

approval process for drugs that address an unmet medical need in the treatment of a serious 

or life-threatening condition:

• Priority Review shortens the usual 10-month initial FDA review of new submissions to 

6 months.

• Accelerated Approval allows the FDA to approve new drugs before full testing is 

completed for patients with serious conditions and limited treatment options. Since 

the program started in the early 1990s, over 90 new drugs and biologics have been 

approved. 

• Fast Track designation provides for more frequent communication between the FDA 

and the manufacturer during development and eligibility for accelerated approval and 

priority review. This includes rolling reviews of results without waiting for the approval 

application to be complete. 

• Breakthrough Therapy designation is available when preliminary clinical evidence 

indicates a new drug for serious conditions may demonstrate substantial 

improvement over currently available therapies. The FDA commits to intensively guide 

development beginning as early as Phase I. Between 2012 (when the program began) 

and 2015, 74 drugs received this designation.

While these programs have been put in place to speed up the entry for therapeutic drugs, there 

is still room for improvement — an average time of development and entry of new drugs of 

more than a decade is too long. The FDA could continue to facilitate the validation and 

qualification of new drug development tools that allow sponsors to demonstrate safety and 

efficacy more efficiently and earlier. 

Furthermore, these pathways are not ideally suitable to use for defining pathways (discussed 

above) based on economic, as opposed to clinical, relief. The Breakthrough Therapy

designation has been instrumental in bringing innovative drugs to market more quickly, with 

major benefits for patients who are provided new treatment options. However, the 

Breakthrough Therapy designation may no longer be available for new but similar drugs 

because they cannot demonstrate significant clinical improvement over the initial 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 20

Breakthrough Therapy drug. Moreover, Accelerated Approval and Fast Track are only available 

to fill “an unmet medical need,” which has already been met by the initial drug. 

The government has also aided drug development utilizing biomarkers and surrogate 

endpoints. Biomarkers are molecular or clinical features that can be used as targets for drug 

treatments. Identifying patients who are likely to respond to specific treatments can shorten 

the time necessary to see positive results and make it easier and faster to recruit subjects who 

are more anxious to participate in trials. In the past three years, the FDA Center for Drug 

Evaluation and Research has approved more than 25 new drugs targeted at specific 

biomarkers. Surrogate markers that predict clinical endpoints can also shorten trials by 

identifying drug efficacy sooner. The 21st Century Cures Act has encouraged utilization of 

surrogate markers but more scientifically validated markers need to be discovered.

The problem is that there is currently no way originators of biomarkers and surrogate 

endpoints can capture the value of their innovation to other manufacturers using it after it has 

been developed. Once a biomarker or endpoint is published, it can be difficult for originators

to capture the value of their innovation to other manufacturers using it. Rewarding firms that 

invest in the pooling, curating, and validating of potential biomarkers and surrogate endpoints 

that can shorten clinical trials could create appropriate incentives for more high quality 

research. 

3.4 Reforms Reducing the Cost of Innovation Raise Price Competition

Drug development reforms should aim to lower the cost of entry and enhance price 

competition of new innovations. Reforms that lower prices after patents expire are also 

important. Generic drugs have been highly successful in driving down drug prices—as more 

generics come to market, prices drop rapidly to nearly half after just the second generic 

introduction. Faster generic drug approvals could decrease the cost of entry and thus decrease 

drug prices even further. The current approval process for generic drugs is based on the 1984 

Drug Price Competition and Patent Term Restoration Act (also known as the Hatch-Waxman 

Act). Generic drugs go through an abbreviated approval process in which applicants are only 

required to prove bioequivalence (showing that the active ingredient is absorbed at the same 

rate and to the same extent as the patented drug) to an already approved drug. Tests to prove 

bioequivalence are much less costly than tests to prove safety and efficacy. In addition, the 

Hatch-Waxman Act allows applicants to start clinical testing before the patent on the original 

drug expires. The result was that after the Hatch-Waxman Act took effect, the lag between 

patent expiration and generic entry for top selling drugs dropped from more than three years 

to less than three months (CBO 1998). Nevertheless, the time until approval (and associated 

cost) for most generic drugs is far greater. The FDA is undertaking regulatory actions to 

streamline and speed up the process by which generics are approved. Gaming of the 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 21

regulations that distort the industry away from the intended goals of the regulations of

lowering drug prices for patients can be further reduced. 

In August 2017, President Trump signed the Food and Drug Administration Reauthorization Act 

(FDARA) into law, reauthorizing the Generic Drug User Fee Amendments (GDUFA) to empower 

the FDA to collect user fees for generic drug applications and consistently process applications 

in a timely manner. In November 2017, the FDA completed more final approvals and tentative 

approvals of generic drugs (107 in total) than any prior month in the agency’s history. 

The Trump Administration has prioritized the approval of more generic drugs to bring down 

the cost of pharmaceuticals (FDA 2018). Last year, the FDA announced the Drug Competition 

Action Plan (DCAP) to expand access to safe and effective generic drugs. Efforts have focused 

on three key priorities to encourage generic drug competition: (i) preventing branded 

companies from keeping generics out of the market, (ii) mitigating scientific and regulatory 

obstacles in gaining approval, and (iii) streamlining its generic review process. The FDA has 

already released guidance that outlines to companies and FDA staff specific steps to reduce 

the number of review cycles and shorten the approval process. Some of the actions that the 

FDA has taken under the DCAP include:

i. New policies to expedite review of ANDAs where there are limited approved 

generics for a given product;

ii. Publication of a “List of Off-Patent, Off-Exclusivity Drugs without an Approved 

Generic,” which will receive expedited review if an ANDA for the product is 

submitted;

iii. New guidance for industry on submitting ANDAs;

iv. Product specific guidance to support generic development of small-molecule 

complex generics; and 

v. Guidance for industry for evaluating the abuse deterrence of generic solid oral 

opioid drug products.

Biosimilar competition 

Biologics—large, protein based, complex drugs made in living cells and which are typically very 

expensive—have become increasingly important; however, they present particular scientific 

and regulatory challenges. Despite being used by only 2 percent of the U.S. population, they 

have come to comprise between 27 percent and 40 percent of U.S. drug spending (Morton and

Boller 2017; Carroll 2013; Purvis and Kuntz 2016). The Biologics Price Competition and 

Innovation Act (BPCIA) created an abbreviated licensure pathway for biological products 

(aBLA) that are demonstrated to be biosimilar to or interchangeable with an FDA-approved 

biological product. It is believed that biosimilars could be cheaper than their reference 

products and save $44 billion over 10 years (Mulcahy et al. 2014). 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 22

Biosimilar applicants must demonstrate to the FDA that there is no clinically meaningful 

differences in safety, purity, and potency (safety and effectiveness) compared to the reference 

biologic. The standards are even stricter for approval as “interchangeable”—a biosimilar must 

be able to be switched for the reference biologic without risk of an adverse event—so that they 

can be substituted for their reference biologic without a doctor’s specific permission. 

Nevertheless, approvals have taken time—there are only nine FDA approved biosimilars and 

none are considered interchangeable (FDA 2017).

Lack of competition for biologics, including those with expired patents and data exclusivity 

periods, is one potential reason prices remain high. Eighteen of the top 30 selling biologics 

were first licensed in 2004 or earlier suggesting that prices have remained high despite relevant 

patent expirations (Morton and Boller 2017). This is in contrast to what happens after patent 

expiration of small molecule drugs where generic competition rapidly brings prices down. 

Developing and gaining approval for biosimilars is far more expensive than bringing typical 

generics to market. Small molecule generics rely on easily replicated chemical ingredients and 

can be approved on the basis of relatively small and inexpensive studies to prove 

bioequivalence. In contrast, biosimilars and biologics are highly sensitive to the living systems 

used to manufacture them. Production is difficult and requires significant scientific expertise 

(Palmer 2013). Biosimilars can take 8-10 years and hundreds of millions of dollars to gain 

approval (FTC 2009). 

The cost of bringing biosimilars to market, as well as the complexity of manufacturing biologics 

and biosimilars, make it likely that large, well-established companies will dominate the 

biosimilars market, which would limit the number of entrants (Blackstone and Fuhr 2013). 

Since most biosimilars will not be interchangeable with the reference biologic, competition 

will be more like therapeutic competition between patented products rather than typical 

generic competition. CMS recently announced it will institute separate payment codes for each 

new biosimilar rather than have a single payment code as is done for all the versions of small 

molecule drugs, including all the generic versions and the original patented drug. The 

reference biologic could maintain significant market share among patients and physicians 

concerned about potential differences between the reference biologic and its biosimilars, 

limiting downward price pressure. In addition, the complex and costly manufacturing process 

means that cost savings from biosimilars will be smaller than savings from small molecule 

generics because of the substantially higher ongoing costs of production. 

Regulatory uncertainty, driven in part by concerns over safety, has also impeded biosimilar 

development. Final guidelines for demonstrating biosimilarity were only finalized in 2015, five 

years after passage of the BPCIA, in part reflecting the complexity of this problem. The FDA has 

indicated it will not finalize guidelines on demonstrating biosimilar interchangeability for 

another two years or more. Speeding up the issuance of final guidelines could add certainty 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 23

and attract additional biosimilar applicants. If these guidelines are relatively easy and 

inexpensive to adhere to, it could spur interchangeable applications and approvals, which 

could result in more effective competition with the reference biosimilar and lower prices.

4. Conclusion

The two seemingly inconsistent goals of reducing American prices and stimulating innovation 

can be achieved only by a combined strategy to reduce artificially high prices at home while at 

the same time reducing free-riding abroad. 

The objective of government in biopharmaceutical policy is to ensure that firms invest in 

meaningful innovations that lower the price of health, rather than provide incentives that 

dampen rather than promote competition between innovations. Additionally, it is also the role 

of government to help solve international problems such as global free-riding on drug 

innovation, which harms U.S. citizens. Bad government policies or insurance programs that 

prevent, rather than foster, healthy price competition often induce artificially high prices in the 

United States. The U.S. biopharmaceutical industry is the engine of worldwide 

biopharmaceutical innovation and an important part of our economy. Preserving this industry 

and encouraging it to innovate while making drugs more available and affordable for all 

Americans is an attainable goal.
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 24

Appendix

This analysis uses operating margin, or variable profit margin, the pre-tax operating income 

divided by net sales. 

One method of estimating profit margins is to observe the decline in prices among patented 

drugs when patents expire and generic manufacturers compete down prices to the marginal 

cost of production (Caves et al. 1991; Grabowski and Vernon 1992; Berndt and Aitken 2011). 

Prices declined by an average of 84 percent across all three studies, implying that this was the 

U.S. profit margin for manufacturing and distributing patented drugs before patents expired 

and that variable costs were 16 percent.

To derive profit margins for the rest of the world, we use 2009 patented, retail sales and 

quantity data from Danzon and Furukawa (2011). Patented, retail drug sales for nine other 

major markets (the United Kingdom, Canada, France, Germany, Italy, Spain, Japan, Brazil and 

Mexico) were an estimated $86 billion, compared to $120 billion in the United States.

Multiplying the U.S. profit margin of 84 percent by U.S. patented retail sales results in an 

estimated $101 billion in profit in 2009. 

Table 1: Derived Foreign Profit Margins

Danzon and Furukawa (2009 Data)

Market Estimate U.S.

Nine Foreign 

Markets

Patent Share of Retail Sales 75% 67%

Patent Share of Retail Quantity 25% 39%

Patent Retail Sales ($ Billions) $ 120 $ 86

Patent Retail Quantity (Millions of Doses) 42 151

Price /Dose $ 2.84 $ 0.57

Variable Cost /Dose $ 0.45 $ 0.45

Profit Margin 84% 20%

Patent Retail Profit ($ Billions) $ 101 $ 17

To derive foreign market profits, we assume no advertising costs and that these markets have 

the same variable cost of manufacturing and distribution as in the United States. The implied 

price per dose (sales divided by quantity) in the foreign markets is $0.57 compared to $2.84 in 

the United States. The variable cost of manufacturing and distribution in the United States (16 

percent) times the price per dose is $0.45. The profit per dose in foreign markets is $0.12, which 

represents a 20 percent profit margin. We assume that the share of patented sales and quantity 

in the entire market (e.g., over the counter, inpatient), is the same as the retail market. 
CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 25

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CEA • Reforming Biopharmaceutical Pricing at Home and Abroad 28

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