Intro. [Recording date: June 6, 2017.]
Russ Roberts: Robin Feldman's latest book, which is the topic of today's discussion is Drug Wars: How Big Pharma Raises Prices and Keeps Generics off the Market.... Before I read your book, I thought I understand patents and generics. I was a happier person, too. But after I read your book--let me give you the before. I would have said, 'Well, it's kind of straightforward. A drug company discovers an interesting drug. They get FDA (Food and Drug Administration) approval and patent it. And then they get a monopoly and they make a lot of money, if it's effective and safe and gets that FDA approval. And then, at some point, that expire. And generics come in; and the price plummets; and everybody gets cheaper drugs--which is great, but to encourage innovation they get a long time where they get to make a lot of money at the higher price.' And that's the end of the story. But, it turned out, the actual world is a lot more like, I don't know--Alice in Wonderland, Kafka's The Trial, maybe The Metamorphosis. I don't know. And it's a lot more depressing. So, let's start: we're going to go back to 1984 and the Hatch-Waxman Act. What problem was it trying to solve, and how did it try to achieve that solution?
Robin Feldman: So, the concept that you described of how pharmaceutical patents should operate is 100% correct. We love vigorous competition, but with patents we suspend that for a period of time, because research and development on pharmaceuticals takes a long time, is expensive. And so we want to create enough incentives so drug companies will invest in this research. So, we give them a period of time in which they should be able to block out competition, be the only one in the market, and have a strong, healthy return on their investment. That's supposed to end at the end of the patent term. The problem that was identified and described extensively in 1984 with the Hatch-Waxman Act is that that was not happening. We were supposed to see at the end of the patent term generics coming into the market, bringing the price down, and creating the vigorous competition that we love to see in markets. It wasn't happening for two reasons. One, because it takes so long to get approval for a drug, that the generic company would have to start their approval process when the patent ended, and so it would be years before they might get to the market. There was no guaranteed monopoly return for them at that point in the open market, so why would they go back and repeat everything the drug company had originally done to get approval? And then, lastly, there were a lot of weak patents in the market that a generic company might have to fight off to get its way there. So, for all of those reasons, we were not seeing a large number of generics in the market. And in fact, prior to Hatch-Waxman, approximately 13% of the prescriptions in this country were filled by generics. That's a very small number.
Russ Roberts: And it's now?
Robin Feldman: It's now 80-90%.
Russ Roberts: So, that's the glass half-full part of the story. Unfortunately, there's a lot of half-empty left. You said that there are problems with weak patents that make it harder for generics. Can you explain that?
Robin Feldman: Yes. This probably gets into the weeds that you were talking about. Under the Hatch-Waxman system, if I am a company that creates a new drug, I go to what's called the FDA Orange Book, and I list all the patents that I believe might relate to this drug. The generic company coming on has to then make certain representations about whether they might be infringing on one of these patents. Some of the patents that a company can put on the drug list could be very weak. But even before the generic drug system, the Hatch-Waxman system, came into place, if a drug company filed a weak patent, that might sit there and block out competition for a long period of time, even if it was relatively weak, because a would-be generic coming onto the market would have to risk trying to fight that off, but would have to make a choice about whether to do that even before it could get FDA approval.
Russ Roberts: Yeah--I don't understand that. It's the "weak" part that's confusing to me. And I just want to let listeners know that although this is a little bit complicated, it's really extraordinarily fascinating and weird, as we get into the implications of this. But, as a non-lawyer, a "weak patent" means it's kind of easily gotten around? Is that what a weak patent is?
Robin Feldman: Nooo. No. A weak patent means that it ought to be invalidated. A weak patent means it shouldn't have been granted in the first place.
Russ Roberts: Okay.
Robin Feldman: And it shouldn't be there.
Russ Roberts: All right.
Robin Feldman: So there are 2 million patents outstanding in the system today. Many of them, if they were tested, would not stand up in court. But it varies.
Russ Roberts: So, I develop a new drug. I patent it. And it may turn out that that patent is illegitimate. But, as a generic, I don't know that, a potential generic competitor, and it's costly to challenge it. Is that a good summary of the problem?
Robin Feldman: That's right. And I think--it's hard outside the patent system to understand why there are weak patents. Don't we have a Patent and Trademark Office? Doesn't it just put a stamp on when the patent is good? The problem is that the Patent Office is overwhelmed. And estimates are that it takes about two years for a patent to be approved. A patent agent will spend, across that two years, approximately two days' worth of time reading the patent. Pharmaceutical patents are very complex and difficult. There may be hundreds of claims in a single patent. And that's all the time you get. And the theory is, is that if the patent is significant enough, it will get fought out in court and we'll figure it out. But the reality is that there are a lot of very weak patents--patents that probably ought to be invalidated that are sitting out there on the books.
Russ Roberts: Okay. So, let's go back to Hatch-Waxman. The first problem was that--bizarrely, to me, of course, as an economist, or as a human being--the idea that once a drug had already been approved by the FDA, if I've got the exact same chemical, I now have got to get it re-approved, going through years of clinical trials, when in fact it's already been approved, is bizarre. But, that's one thing that Hatch-Waxman relaxed--which is a good idea. Right?
Robin Feldman: Yes. So, you are right. What seems perfectly obvious to you as an economist took our patent system much longer, and our regulatory system much longer, to come to u. So, for the first person to bring a drug to market--I'll refer to them as the Brand-name company--Brand-name company has to show safety and efficacy. The generic just has to show bio-equivalence. So, in simplified terms, the first company has to show that the drug is safe and works. The second company just has to say, 'I'm the same. Me, too.' All you have to show is that you have the same drug as the one that was already been proven to be safe and effective.
Russ Roberts: And that was Hatch-Waxman, that changed to that [?]--
Robin Feldman: That's what Hatch-Waxman did. Hatch-Waxman allowed the generic drug companies to rely on the safety and the efficacy status of the brand-name drug, the original trials that were done to prove that. That was a key implementation.
Russ Roberts: Now explain--
Robin Feldman: Now, the second--
Russ Roberts: Go ahead, sure--
Robin Feldman: So, a second, very important part of Hatch-Waxman was what's known as its 'Paragraph IV Certification.' If you live in the pharmaceutical patent world, it's all full of abbreviations and short forms. So, this is Paragraph IV. But the idea was to try to give an incentive for generic companies to do battle against the big guns--to fight off weak patents. So, the way the system worked--let me just step back one moment to explain something. It takes, there's a certain amount of time to get through approval at the FDA, even if you are just a generic company. Now, in order to do that, the company wants to be able to resolve the patent issues, the potential patent issues, before it goes to all the trouble of doing the things it's going to need for FDA approval. And so, the system allowed a way to accelerate that. Under patent, you are not allowed to--someone holds a patent, no one else is allowed to make, use, or sell the product during the patent term. So, if you can't make the product, you can't do the things you need to get FDA approval. And so, it's difficult to get the process started without opening yourself to a large amount of liability. So, Hatch-Waxman created an artificial system in which, on paper, someone could be infringing the drug: You could go to the court and battle out all of the patent issues. And the problem, get that all done so that as soon as the patent expires you can come into the market. That may be more complicated an answer than you wanted.
Russ Roberts: No. I think I need a more complicated answer. I could always do that. What did Hatch-Waxman add--I could always say, 'I don't think this is a good patent,' 5 years into the life of a drug. 'I'm going to challenge it in court.' Obviously you could lose. That's a big deterrent. It's a lot of expense. And so you might just wait till the patent expires. And certainly when the patent expires, you have an incentive to produce a generic. You've gotten rid of this clinical trial barrier, hurdle. But what Hatch-Waxman did was try to make that process more streamlined. Correct?
Robin Feldman: The process--it was a Paragraph IV Certification. I say to the FDA, 'I would like approval for this drug. And I certify one of two things: Either that my drug does not infringe the patent, or, that the patent is invalid.' And plunking that piece of paper down creates an artificial act of infringement. That gives the Brand-name company notice. And the Brand-name company then has a period of time to go to court and say, 'I disagree.' So, all of this can be worked out before the patent would have expired. So that the drug company--the generic company--gets its approval and is ready to hit the market, in theory, the second the patent expires.
Russ Roberts: So, basically--
Robin Feldman: And there's another kicker--
Russ Roberts: Yeah. Yeah. But basically it's a way to break the law. And of course, 'It's okay. Go ahead. Make the drug now. Challenge them. And that way you can hit the ground running, if it turns out that your patent that you are fighting is either, is invalid, or just expires and you'll be ready to go.' Is that right?
Robin Feldman: I think I put it the other way around. It's a way to say 'I've broken the law' when I haven't yet. So, that we can work out whether I would be breaking the law. And so we can decide this before I would be crushed by large amounts of damages, if I were to break the law--
Russ Roberts: Got it--
Robin Feldman: And then we resolve it. And if I'm not breaking the law, then the minute the patent expires, I'm good to go.
Russ Roberts: But there's that kicker. Go ahead.
Robin Feldman: And then there's the kicker. So, the kicker is, that, with the knowledge that there are a lot of weak patents out there, and hoping to entice generics to get into this expensive battling, Hatch-Waxman creates a system where the first generic to successfully challenge a patent gets 6 months of exclusivity as a generic. It's really a duopoly--a time when there will be two on the market. So, we have the original Brand-name company. We get the first filing generic, successful. And then Hatch-Waxman says, 'For 6 months, 2 of you will be the only ones on the market.' After 6 months, all the other generics can come rushing in as well.
Russ Roberts: And those generics that come rushing in--they all, I assume they do it--do they still have to show bio-equivalence? Or do they just, they can just start?
Robin Feldman: Everyone has to show bioequivalence.
Russ Roberts: No matter what.
Robin Feldman: No one can get on the market without FDA approval.
Russ Roberts: So, they still have to wait for that. But after that, all these extra, ideally multiple generics, will come in. The price will plummet.
Robin Feldman: And that is what happens across time. So, when the first generic filer comes in, the drug price--it makes it to market--the drug price can drop 15-20%. Over time, if multiple generics come in, the drug price can drop as much as 85%.
Russ Roberts: Now, the Brand-name company doesn't like this. Obviously. And, before we talk about what they do to get around this competition, which lowers their revenue dramatically from their previous discovery, talk about how much money is at stake for some of these drugs when a patent expires and your price is going to fall 15-20%; in 6 months, 80 or 90%.
Robin Feldman: A huge amount of revenue and profit are at stake. For a blockbuster drug, sales can be in the $1-2 billion dollars a year. So, to hold off generic competition even for 6 months in a blockbuster drug, that can be worth hundreds of millions of dollars, in unchallenged sales. By that I mean sales with no one else on the market. The dramatic price drops after generic drugs enter the market--those create incredible incentives to try to keep off competition as long as possible. It's in the economic interest of a pharmaceutical company to keep that from happening as long as possible.
Russ Roberts: So, in your book, you talk about 3 different generations of the ways that Branding-companies have worked to keep out that competition. So, let's start with the first one, the Pay-for-Delay.
Robin Feldman: So, I do want to be clear that I separate into 3 generations, but they don't fall neatly into time that way. So, over time, you'll see Generation 1 happening at the same time as from Generation 3 happening. But, there's 3 waves in which different types of strategies were developed. The first wave was called Pay for Delay. And it was fairly simple. The Brand-name company would pay the first-filing generic a certain amount of money. And the first-filing generic would agree not to come onto the market for a period of time. This would happen in the context of settling one of those Hatch-Waxman lawsuits. So, Hatch-Waxman set up a process of litigation between the branded company and the generic. The two companies would settle. The generic would agree to stay off the market a period of time. And the Brand-name company would pay them. In economic terms, the Brand-name company is sharing a part of its monopoly rent with the first-filing generic. And they are both happy. Who is not happy are the consumers and society in general, because the price stays higher for a longer period of time.
Russ Roberts: And then, of course, the weird part--and I think I understand this correctly, but it's so weird that I've got to ask. So, if I'm this generic company; I've gone through this legal process. I now have the right to produce the generic. I'm going to get a 6-month duopoly that holds off any other generic competitors. I'm going to make a lot of money. And the Brand-name company bribes me, effectively bribes me, not to come on the market yet. But the 6-month period doesn't start yet, until I've come on the market. Is that correct? So that the other generics can't come in until I finally enter? Which means that by paying this fee, I can deter a lot of competition, on the brand name. Is that right?
Robin Feldman: That's exactly right.
Russ Roberts: It's horrifying.
Robin Feldman: The two agree that--because the way the statute is written, no one else can come in until the generic has come on the market.
Russ Roberts: The first one.
Robin Feldman: So everything stays the same. The 6-month clock doesn't start running until the generic makes it to market. Congress have tinkered with that language across time, trying to keep this from happening. The companies have just been more nimble. And so it still works in the same manner.
Russ Roberts: That's just bizarre. Right? I mean, it's basically--you create this special legislation to encourage this generic competitor, and that creates the opportunity for the Brand-name to pay this single, challenging firm--that's been encouraged to challenge--it can get this duopoly. And then it keeps everybody else out anyway.
Robin Feldman: That is the effect. It's not the effect that was intended. But, the incentives are so great, because the dollar figures are so large.
Russ Roberts: So, that was eventually--well, first, some people defend that as an okay thing. Can you make the argument? I know you don't accept it--
Robin Feldman: no, no, no, no, no--
Russ Roberts: But, what's the argument people who think that Pay-for-Delay is a positive thing?
Robin Feldman: There are always arguments. So, the argument here is that Pay-for-Delay is simply a settlement; and in any settlement, one has to figure out the risks of going to litigation, the risks of coming from litigation what something is worth. And this is a just a rational reason to settle from both parties. There are reasons to be suspicious of that explanation. In settlements, generally one doesn't see the plaintiff paying the defendant. Usually it's the other way around.
Russ Roberts: Yeah.
Robin Feldman: So, there are things about these settlements that suggest strongly this has nothing to do with settling case. It has everything to do with protecting and extending an exclusivity you are not supposed to have.
Russ Roberts: Yeah. It seems kind of straightforward. Although I'm sure there are some ways to defend it, even from an economist's perspective. But, my first thought it is that's a bizarre, clever way to use the legislation to extend the patent. Period. You don't have to share the profits, of course. But still, it seems like a crazy thing. But the courts eventually do what?
Robin Feldman: The court eventually agrees with you.
Russ Roberts: Yeah; and what do they rule?
Robin Feldman: So, the Supreme Court in 2013, in a case called Actavis, eventually ruled that these types of settlements could be challenged as an Antitrust violation. That pronouncement in itself, although quite limited, was enough to allow the lower courts to begin pounding away at these. And, anticipation of these decisions has made companies begin to move away from Pay-for-Delay--just simple Pay-for-Delay settlements.
Russ Roberts: Do you remember what the vote was on the Supreme Court on Actavis?
Robin Feldman: I don't remember what the Actavis vote was.
Russ Roberts: Just curious. We'll put up a link to it. But I always wonder whether that was open and shut or not.
Russ Roberts: So, Pay-for-Delay was one technique. But now that the Courts--and, as you say, this happened before 2013--companies started to look for other ways. So, what was the, what you call the 2nd Generation kinds of ways that they could delay competition?
Robin Feldman: So, Second Generation looks much like the First. That is, settlements of these cases. But, the settlements are more complicated. Generation 2.0 are complex side view [?]. So, the generic stays off the market, but is paid not in strict cash but in some other type of benefit that's more difficult to detect. So, for example, you might see a number of cases between the parties settled. But if you tease each of the settlements apart, the major benefit is value flowing to the generic in exchange for staying off the market. Or, you see a settlement in which the Brand-name company pays the generic to do something for the Brand company that is economically irrational. So, a Brand-name company may pay a generic that's never existed and never done anything to market the Brand-name company for it. So, you are paying someone who has no experience and knows nothing to do something for you. Or, in one of the cases, the Brand-name company paid the generic to market--I'm sorry, to make the product, to manufacture the product. The generic company had no manufacturing ability. It just contracted out to a third party. So, the generic basically paid--so the Brand paid the generic a lot of money just to be a useless middleman. These are Generation 2.0. They are much harder to detect. They are harder to tease out. And more complicated under Antitrust law for the Courts to think about. But they reach the same result: Generic gets the benefits and agrees to stay off the market for a period of time.
Russ Roberts: These are classic examples, much more complicated, of course, but classic examples of other types of ways economists have looked at for decades in the evasion of price controls. So, if you put, say, a rent control on an apartment in New York--so the apartment is worth, say, $3000 a month, but the rent control is $1000, the landlord might charge in the old days--I think they've stopped this now but they might charge you, they charge you the $1000 because that was the rent-control price. But, to get the key, they charge you $6000, to have the key printed. Or, a booster of a university football team wants to make a payment to a potential high school recruit; hires them to work in their office to make photocopies; and pays them $20,000 a month for that month that they do that. And of course these are just ways that the regulations, which try to get in the way of these natural incentives, that have, in this case been created by a separate piece of legislation. So it's kind of complicated. But, these are ways that people get around these things. And then you have to, then, try to re-regulate. So, in the case of college sports, they make it illegal for a college athlete to have a job. And you think, 'How can they do that? It's unconstitional.' And it probably is. But, the way that that's justified is, 'Well, if we didn't do that, then there would be a way, easily to hide payments to athletes for coming to school.' Which is what they are trying to stop. So, it's beautiful example of that kind of hidden side-payment.
Robin Feldman: That's exactly right. And I do want to step back for a moment, because the example that you just went through hits a hot button for me, and that is: Complexity breeds opportunity. The key problem in the Hatch-Waxman system is its complexity. All of this system that we've come up with for the introduction of generic drugs breeds opportunities for manipulating it. And, as Congress has tried to make changes here and there to keep drug companies from exploiting it, that's just more complexity. And so we end up with other opportunities. But we're still fighting the same battle without making much ground.
Russ Roberts: Economists sometimes call this regulatory arbitrage. This whole complex web of regulation and response reminds me a lot of financial sector regulation, where, similarly, you'll say, 'Well, you can borrow money to finance activities if the stuff you're financing is really safe.' And, there's not enough safe stuff. So, they solve that by creating artificially safe stuff. It turns out, it's not so safe. Which was--a big part of the financial meltdown in 2008 was things that were called Triple A weren't Triple A, because there was an incentive for a variety of reasons to be riskier than they should have been. But it's the same phenomenon here. It's disturbing and depressing, but it's reality.
Robin Feldman: I like to call it death by tinkering.
Russ Roberts: That's a good phrase.
Robin Feldman: So, you change a little piece here and a piece there till the whole thing collapses of its own weight.
Russ Roberts: It's a great example of Hayek's quote, which my listeners, some of my listeners are tired of but I haven't said it in a while, which is, 'The curious task of economics is to demonstrate to men how little they know about what they imagine they can design.' And so, you design this little thing, 'I'm going to fix this problem; we need more engineers; oh, gosh, it didn't work; now I've got to fix that.' It just keeps going back and forth.
Russ Roberts: So, that's what you call Generation 2. Generation 3--why did Generation 2, these side-payments--why are they less likely to be seen now? And what's next?
Robin Feldman: So, one thing you have to understand about the pharmaceutical industry is that it is extraordinarily sophisticated, and takes a long view. Generation 2.0 is still quite active: side-deals are still occurring and becoming more complex and convoluted. However, companies have begun to anticipate the time when the courts may strike down these 2.0 side deals and say, 'Well, we're beginning to get decisions along those lines.' Hasn't been the Supreme Court yet, but where an Appellate Court has said, 'These side-deals should be treated the same way as a cash deal.' So, with that problem on the horizon, companies have turned to, or added on, a new layer of a new generation, Generation 3.0. Now, in Generation 1 and 2, the game was about collusion. Generation 3.0 is about obstruction: trying to exploit aspects of the regulatory system to block the generics out of the market, and to keep them out completely. These games generally come in a couple of different kinds of baskets. The two main baskets, one is still within the Hatch-Waxman system itself, using different ways to try to delay or block generics. And another basket is using an entirely separate system of non-patent exclusivities to create competition-free zones. I can describe whichever one in whichever order you would like.
Russ Roberts: Go ahead. Either one.
Robin Feldman: So, within Hatch-Waxman, there's certain types of games companies can play to keep the generic from getting to market. Some of these involve what are called 'evergreening' and 'product hopping.' That is, you try to make a minor modification to the drug's delivery or dosage or something else related to the system and then get a new patent on this new version, and then keep the generic from being able to come on, to get involved in the system. There are also a series of games that are played with what are called 'citizen petitions'--that is, petitions that a pharmaceutical company can file asking the FDA not to approve the generic, or not to approve this generic.
Russ Roberts: So bizarre. It reminds me of how new hospitals are required to get a certificate of need, and the existing hospitals are the ones that provide it. The idea that an existing Brand-name company could petition to keep a generic off the market and just obstruct the process for a while seems kind of cheating.
Robin Feldman: Well, putting that one aside for a minute, the example you came up with is actually precisely a different strategy that's played. And that has to do with denying the generic company the sample it needs to prove by equivalence. So, if you recall, the Brand-name company has to do all kinds of tests to show it's safe and effective. The generic just has to show it's the same. How do I show it's the same? I have to get a sample from the Brand-name company, so I can go the FDA and say, 'See. Mine is the same.' But if the Brand-name company won't sell me the sample, I can't do that.
Russ Roberts: Can't I just go buy it?
Robin Feldman: Ahhh. You would think. However, Brand-name companies have in some cases gone through extraordinary efforts to make sure that the generic company can't buy it at all. So, let me give you one example--
Russ Roberts: I can't say it's for a friend? The generic company--I knock on the door, 'Hey, it's not for me. It's for a friend.'
Robin Feldman: Yeah. I believe that would be called illegal transfer of drugs. But, so, some of this--in some cases you'll see companies that will only sell their drugs through limited distribution channels. They'll say, 'We'll only sell to certain pharmacies,' or 'We'll only sell to certain hospitals. You, the generic, aren't one of those. And so therefore we can't possibly in good conscience transfer.' There's a particular version of this that's under what's call the REMS (Risk Evaluation and Mitigation Strategy) system, and that is a system that's put in place for particularly dangerous drugs or drugs that are at risk of creating bad side-effects. This happened in response to--remember the Vioxx drug?
Russ Roberts: Yep.
Robin Feldman: So, Vioxx was pulled from the market after concerns were raised about heart complications. So, in response to that, the FDA set up a system, so there were certain types of drugs, you could have them on the market but you needed special warnings. Or, perhaps, limited distribution. But, some way to make sure that the drug was particularly safe. So, what you see in some of these cases is a drug that has a specialized plan like this: The generic comes to the drug company and says, 'I would like a sample of the drug to show bio-equivalence.' And the drug company says, 'Oh, I'm sorry. You're not a special hospital or one of our special providers. We just don't think you're safe enough. We can't give it to you.' And even when the FDA says, 'No, we think it's fine. Yes, you should transfer it to the generic so they can approve it, the company says, 'I'm sorry. Just wouldn't be prudent.' And then they're stuck in a standoff. So, that's one. Now, do you remember everybody's favorite whipping boy, Martin Shkreli?
Russ Roberts: Sure.
Robin Feldman: Okay. So that's how Martin Shkreli--Martin Shkreli used a version of this technique as a way to create a competition-free zone. So, remember, he bought a drug that was selling at $13.50 a tablet. And hiked the price to $750 a tablet. So, that's a huge, a huge price rise. It went from--let me see if I can remember what the annual amount was for that. I think it went from $400 a month to $20,000 a month, [?] system. Shocking. Normally, if you see that kind of a price rise, you will see competitors come in and enter the market--
Russ Roberts: Because it was off-patent at that point.
Robin Feldman: It's off-patent. The drug is off patent. There's nothing protecting it. So, the drug also was not protected by one of these REMS safety protocols. It was completely not a protected drug. So, Shkreli and his company declared that they would only distribute it through certain safety protocols and through certain types of distributors. The FDA hadn't even asked them: they simply declared, 'We're going to do this.' And then, of course, couldn't transfer something to a generic. And in fact, one of the executives of the company said, 'Well, we're certainly not going to make it easier for the generics to get the drug.'
Russ Roberts: Yeah. I can't help but remark that raising the price of a drug $750 is unlikely to be a profitable strategy unless you are getting someone else other than the customer to pay for it. And of course that's a whole separate issue--you talk about in the book in a number of places. But, one of the weird parts of this world, of course, is that the consumers, who are ultimately consuming these pharmaceuticals, aren't paying for them, typically, or aren't paying for them out of pocket. They are being covered either by government insurance or private insurance. And the people who have need, they are the ones who are really punished, relentlessly, by the system. And Shkreli is profiting at the expense of taxpayers, or premium holders, depending on which the case is. And it's ugly. But, for a while it was in his company's self interest. The separate issue, though, of the distribution channel is a whole 'nother piece of this complexity. It's not just the high price. And I think that's just a fascinating example of--within this regulatory framework you can get some things that would never happen within a normal market.
Robin Feldman: And that is the--it isn't, it isn't the type of market one would like to see. You have separation between the consumer and the party paying. You have different types of incentives, because when my health is at stake, I feel willing to pay much more. You have some extraordinary subsidization going on, at international levels as well. So, drugs that sell for $400 overseas in other countries, sell for $30,000 here. You have--an extraordinary difference between the drug pricing--American citizens essentially are subsidizing lower prices in foreign countries. It's a very complex market. And again, that breeds lots of opportunities for exploiting it.
Russ Roberts: I want to go back to Product Hopping, because again, as a non-insider, non-expert, this is kind of shocking. And you hear about it; and it never makes any sense. Now, I think I understand it, but it's still very depressing. So, I have a drug that's very effective; it goes off of patent. I know that's going to cause generics to come in and I'm worried about losing my monopoly profits. So, I re-package it. I--let's say, change the coding of the drug with the claim that it's going to make it easier, say, to digest it. Or, for it to be a little more effective in how quickly it's activated. And now I get to extend my patent? Because of that? That just seems absurd. How does that work? How does that work legally? I don't get it.
Robin Feldman: Product-copying is a wonderful strategy. Aspects of it are sometimes referred to as 'Evergreening'--as, 'May a patent be evergreen.'
Russ Roberts: It's a great color.
Robin Feldman: It requires three factors: timing, minor modifications such as in dosage and delivery, and then market blocking. So, you want to do this right about the time that your patent or other exclusivity is expiring. Then, make some modifications, like, to drug dosage and delivery. And then figure out a way to block the market. So, let me give you one of my all-time favorite examples, which is Asacol[?]. Asacol, actually, that's one where the product hop fails. And they did something slightly different. But I think it may have been the one you were referring to because of the way you described it. So, here, with Asacol you have a company approaching the patent cliff. It actually tried a product hop and failed. So, instead, it introduced a new product, which was the same drug except with an ineffective capsule around it. You cut the capsule, and the old drug just falls out. Even the FDA agreed that the two drugs were exactly the same. The capsule around it did absolutely nothing. However, the company got a shiny new patent on Delzicol. That was its new drug, with a capsule around it that did absolutely nothing at all. The company then removed the old version from the market entirely. So, when you do that, the doctor writes a prescription for the new drug. Sorry--sometimes it's hard to describe. It's so complicated for people to understand how remarkably clever it is. But, here's--one of two things will happen. The doctor will write a prescription for the old drug, Asacol. Goes to the pharmacist. Asacol is not on the market any more. So, the pharmacist can't fill it. There is a generic Asacol; but you can't fill the generic if there is no prescription for--if there is nothing there for the Brand Name. So, they may not be able to fill it at all. The doctor is not going to write on for Asacol anyway, because it's not on the market any more. They are going to write it for Delzicol: Take the Delzicol. The pharmacist looks at the Delzicol and says, 'Well, there is a generic, but I can't fill it with the generic because it's different.' The generic says--
Russ Roberts: Because it doesn't have the capsule around it.
Robin Feldman: Because it doesn't have the capsule around even though it does nothing. And the generic says, 'Okay, I'd like to put a capsule around mine,' but you've got a new patent, so you have to wait until the patent expires before you put the new capsule around it. So you can't do that. They've completely blocked the generic off the market. You could go to court and fight the patent as ineffective. And, when the generics fight the Brand-name patent in those paragraphs for certification, they win three-quarters of the time. But that takes money, and that takes time. And in the meantime, Asacol is sitting there and it still has a complete monopoly on the market.
Russ Roberts: It's so depressing. So, there's two parts--well, I understand both of them, I think, but I just want to clarify. The first part is that, I can't, as the generic--I can create my own fake capsule, but then I've got to do this process of challenging. So, that's expensive, and then time. So, the natural thing is just to tell doctors, 'Don't prescribe this stupid drug Delzicol that's got this ineffective capsule at x-times the price. Just do my generic.' And that, bizarrely, is not straightforward because of the incentives in the health care system that separate consumers, doctors, etc. And I am just going to ask you this question: it's kind of--I don't know if you can answer it on air. But the gist of it is: I go to my dermatologist; she prescribes a Valeant drug--which is one of these companies doing this creative distribution things. She says, 'Oh, by the way. You can't get it at your regular pharmacy. You have to go across the street. We have a special relationship with Walgreen's.' I say, 'Okay, who cares? That's fine.' And I get there and the drug is $1200. But, of course, I'm reassured it's covered by my health care insurance. But, the whole thing stinks. There's something really ugly about it. And it turns out, there's an over-the-counter solution that's $18. And I want to know why my dermatologist is playing along with this. Because it just seems like a way to exploit--is she getting a kickback? Is her practice just lobbied relentlessly by Valeant with pleasant gifts and things? Or, is it just, 'Well, it's a little better than the thing that's over the counter'? Because it's a minor condition that's not worth even spending $20 for. I decide [?] to do nothing. The whole thing is ugly.
Robin Feldman: There's a huge information gap. It's not that doctors are corrupt. It's that they don't have information. And, the way the generic system works is that in order to keep prices low, generics generally don't engage in the same type of extensive, direct-to-consumer advertising, or even as much advertising to doctors. The concept is supposed to be that the doctor prescribes the medication and then the pharmacist looks to see the least-expensive version and fills it. Doctors are not supposed to have to worry about all these things. Part of the problem goes back to advertising. The United States and New Zealand are the only countries in the world that allow direct-to-consumer advertising of prescription medication. That in itself is a powerful tool for not just advertising to the doctor but also advertising to the patient. The patient comes in and says, 'I've seen this new thing and I think it's going to help me,' so you've got a lot of pressure going in all kinds of directions. The doctor is busy trying to figure out how to treat you and is unlikely to have the time to go out and figure out who is charging more or less for exactly what is a little bit or a little less effective but won't matter. Nobody's watching the henhouse.
Russ Roberts: Well, there's one player that is, though, and that's the last piece of this puzzle. And that's the insurance company. So, my insurance company really wants me to be using that generic, in this particular case. They are going to be the ones--because, again, not everyone is covered by insurance, but for the people that are--you're right: I don't have any incentive; I want the brand name. I want the Delzicol or whatever it's called. I don't want that generic, because it's not coming out of my pocket, often. So, why don't the insurance companies, who are not fooled by that direct-to-consumer marketing, why aren't they making sure that when there are generics that are bio-equivalent to these fake, brand-name, new-patented things--why aren't they making sure that the generic is what gets prescribed?
Robin Feldman: The insurance companies do have an incentive to keep the cost down. There are several pieces that get in the way. Remember that the largest insurance company is the Federal government through its Medicare system. And we have a piece of legislation that says the Medicare--the government can't negotiate on prices: it's got to just take what it gets. So, that system is set up in an economically irrational fashion. Then, you're also assuming that the generic actually got to market. Some of these games that I talk about are keeping the generic from getting to market at all. So, there isn't an incentive. And, the pricing mechanisms can be done in a very clever way. If I get an insurance company or a large payer that's objecting, I can try to work out a special rebate or a special deal for that. If I'm getting heat from a certain patient advocacy group about indigent patients, I can give rebates in pricing there. So it takes the heat off in various places. As long as we don't have sunshine on pricing--as long as we can't see what's happening with all of these deals--you can move the shells around fairly effectively.
Russ Roberts: So, I want to make an observation about ideology here. And let you react to it. So, you mention in passing that legislation does not allow--restricts--the U.S. government from negotiating drug prices. And, I'm a free market guy. Hardcore. So, my first thought is, 'Yeah, that's right. They should just pay the market price. They shouldn't be able to use their market power as the largest buyer.' And I think they are a huge portion--it's not just they're the biggest; they're also huge. That's two separate points. It's not just they're the largest. They are also large. So, they could have a big impact on market price, and certainly on the tax revenue that has to be raised to fund Medicare and Medicaid drugs. And especially Medicare, because older people use more drugs, use more pharmaceuticals. So, the free market part of me says, 'The government shouldn't be interfering in the market price and using its weight. They should just pay the market price.' But, that is only true in a system where there is a market price already. And there isn't a market price here. It's a very distorted system because of all the incentives that we've been talking about. And I want to read a paragraph from your book which I thought was extraordinarily great. And, it illustrates this. But I want to add one footnote to it. You say,
Granted, one cannot fully blame companies for engaging in behavior that is strongly in their economic self-interests when regulation is unclear or riddled with loopholes. If society wishes its interests to prevail, then the legal system must bring the incentives of the players into proper alignment with the goals of society by creating either sufficient incentives or sufficient disincentives. We cannot expect the rats in the maze to run in the direction society wishes if the cheese is located at the other end. And, as the generic system in the United States currently operates, the cheese is poorly located.
I thought that was a brilliant paragraph. And again, I think free marketers have a very unfortunate tendency to say, 'Well, they are acting in their own self-interest; that's okay.' And, 'They are just responding to the legislation,---the loopholes that you mentioned. And I think that's the wrong thing for free marketers to argue in a system where it's not a free market. Because, the rats help write the legislation and put the cheese where it is. So, there's a reason that Medicare doesn't negotiate with pharmaceuticals, and it's because pharmaceutical companies are really powerful politically. It's not because 'Well, that's a great idea.' End of rant.
Robin Feldman: Thank you, by the way. That's one of my favorite paragraphs.
Russ Roberts: It's great.
Robin Feldman: It is what I deeply believe. It's not helpful to go around bashing companies and saying, 'Oh, they are these horrible people; they are acting in economic self-interest.' We have an obligation as a society to figure out a better system. And, we need to take that responsibility; and that includes members of Congress who are being extensively lobbied. It is possible to construct a better system, but we have to take that responsibility. You can't sit back and point fingers and say, 'Oh, it's the dreaded HMOs (Health Maintenance Organizations), the dreaded insurance companies, it's the horrible pharmaceutical companies.' There's plenty of blame to go around; but at the end of the day, if we care as a society, we have to have a better system that has the right incentives.
Robin Feldman: I would love to just talk for a second about the Citizen Petition area, because that is one of my favorite of the new and emerging games, and it's one that I've looked very closely at. So, if your time allows, I'd like to talk about that.
Russ Roberts: Yeah. Go ahead. And then we'll talk about reform, a little bit. We'll make sure we leave not too much time for that--so we don't have to put the burden on you of solving it all. So, go ahead.
Robin Feldman: So, it's easy to be an armchair--as an academic, I can solve anything in seconds. All right. So Citizen Petitions were started in the 1970s. The idea was to give citizens the ability to participate at regulatory agencies and to express their concerns. It was supposed to be 'Power to the Ordinary Citizen.' So, I looked at 12 years of FDA data of Citizens' Petitions filed at the Food and Drug Administration. And, I'm particularly proud of this data because it was published before the book in two different peer-reviewed journals--one at Stanford, and also at the New England Journal of Medicine. And, what I found in that data was just remarkable. The concerned citizen at the FDA is frequently a drug company who is raising questionable claims in a last-ditch effort to hold up competition. These petitions that I'm talking about are ones that seek to delay generic competitors. They doubled since 2003. So, this is what I talk about--Generation 3.0, a new wave of looking for obstructionist tactics. They may ask the FDA to do things that the FDA already does. They may ask for things that are impossible. They may ask for things that are silly. The FDA denies the petition and the action taken, 80% of the time. But, it still takes time. Citizen Petitions have become a major vehicle for pharmaceutical companies that want to block generic competition. And in this 12 years' of data that I looked at, in some years almost 1 out of every 5 Citizen Petitions filed at the FDA were related to delaying generic entry. So, that's looking at every topic--food, tobacco, devices, my favorite dietary supplements. If you look at all of those, in some years 1 out of every 5 was a company trying to block a generic from entering the market. It's a huge amount. Forty percent of these petitions were filed a year or less from the time the FDA approved the generic. In other words, they were probably last-ditch efforts to just hold off a little bit longer. And that can be worth hundreds of millions of dollars. So, the FDA has 5 months to respond to one of these petitions.
Russ Roberts: No hurry.
Robin Feldman: Even if it denies the petition, the company has gotten another 5 months of unchallenged sales. For a blockbuster drug that's got $500 million dollars' of sales during that period of time, that's a pretty good deal. It costs about $25,000 in legal fees to file one of these pieces of paper. And if you can get a few hundred millions of dollars in unchallenged sales, it's a pretty good deal.
Russ Roberts: It's crazy.
Russ Roberts: So, let me challenge your optimism; and then I'll let you respond with whatever optimism you have left. So, as an economist, as an outsider learning about this complexity for the first time in the detail that you've provided in the book and in our conversation, my general thought is that we have two really flawed institutions at the root of this problem. One is, we have this third-party payment system, that means that doctors and patients don't have an incentive to be fully informed about the cheapest alternatives. We have a gatekeeper, the FDA, that I think is a horrible institution. I'd get rid of it. That puts me in a very small group; that's not a very realistic policy proposal, so we'll put that, the realism of it aside. But the reality is that the FDA is a political organization by definition. It doesn't think of itself that way. But, for a long time--it just took very long--we don't allow European approval to fulfill the equivalent, the requirements even though there can be years' of data that would prove the safety and efficacy. So, there's a lot of things built into the system that make it really easy to be a large drug company. And I would argue that it's an example of what we call on this program, after Bruce Yandle's term 'Bootleggers and Baptists,' there are these attractive reasons: 'Oh, at the FDA; we have to have safe drugs,' but of course it gets manipulated in ways that tends to make large drug companies happy. And they of course advocate for it--because they want safe drugs, too, they'll tell you. But they also like the profits. So, I see two deeply flawed institutions, and attempts to fix that third-hand, fourth level of legislation strikes me as Quixotic. So, put on your Don Quixote hat and tell me why we might be able to improve it despite those underlying flaws.
Robin Feldman: Well, I am endlessly optimistic. And I do believe that even if we cannot solve everything--and we might be able to--we can certainly do much better than we are doing now. And I think there are a couple of key overview approaches. I can talk to you about weeds, but let me just talk to you more about the breadth and the overview. One is: Ruthless simplification. You have to have to much more simple systems that are not subject to the same types of complex manipulation as the system we have in place. I like to think about it as, to some extent, thinking about--I know no one loves the tax system, but there's a particular rule in the tax system I love, which is the Step Transaction Doctrine. And it says: Even if you have figured out how to, underneath the rules, manipulate it so you get to a good result, we're going to collapse it all and to say you can't do it anyway. Those types of standards-based approaches in addition to the rules are important. They are important for trying to cut through some of these things--that you really have to have a much--you really have to simplify the systems, much more so than we have. The second, and very important piece is--well, let me step back and give you one additional one that I don't think of. And it really depends on the audience you are talking to, but I feel free to say this in an EconTalk conversation on your show. You have to have functioning competitive markets. You have to think about incentives. You cannot imagine that you'll solve the problem by telling a pharmaceutical company what to charge, or by putting in a price control, or by any of the other types of market-manipulating mechanisms that get discussed. You have to understand that the bottom line is effective competition. And, even when you are in the odd position that you have companies saying, 'Please, please don't subject me to competition,' you have to ignore that. A functioning effective market is what we need. The third--and I think the third is really important--and that is Sunshine. Part of the reason that the types of games have been so effective in the pharmaceutical market is that they are complex. They are difficult for the public to understand. They are difficult for the policymakers to understand. And that makes it easier for those who are experts to manipulate it. But in a modern system where we have social media that can knock down legislation that comes up, when you have lots of different players in the system, nice, bright sunshine goes a long way. And so, whatever we can do to expose what the prices are, to expose what the games are, to translate them into terms that ordinary citizens can understand, those steps will go a huge way towards helping us find a more rational, competitive, and effective system.
Russ Roberts: And I like to believe--it's my Quixotic side--I like to believe that informing listeners through this kind of episode of EconTalk will maybe make people more aware what the issues are; and that I suppose is some solace and some help maybe down the road in the political process. I need to increase my audience a little bit, I think, to have a real impact, so, all of you out there, get a friend.
Russ Roberts: Le's close with a question about half-full and half-empty. So, we've talked a lot about regulatory arbitrage, death by tinkering. And yet, you could argue--and I think it might be true--that, for all of its flaws, the Hatch-Waxman Act in its current state has improved the competitive landscape of the pharmaceutical world. It's true that there are these horrible cases you've been depressing us with; but, there's lots of cases that are successful. There are a lot of generics out there. Hatch-Waxman made them easier. Again, I would emphasize that--we needed a legislation for that because of the weird way our system is organized and the way that patents and the FDA interact. But, put that to the side. Would you argue that Hatch-Waxman is a half-full story, or a half-empty--and you are just trying to get the level up a little bit more with these kind of reforms--if it's half full?
Robin Feldman: I view Hatch-Waxman as half-full. In fact, I'd say Hatch-Waxman has been miraculous, in moving us toward a system of generic drugs. The real miracle, however, will be if it continues to survive, as these new waves of game-playing unfold. That's our challenge. And if your listeners can be involved and appreciate the types of things you are saying, I think we have a good shot.