The reason government pricing is toxic

There is much political rhetoric these days calling for government to “negotiate prescription drug prices.”

These words lead people to think two things: • the government is another customer, and • the government can negotiate just like another customer. Both of these assumptions are incorrect.

The free market customer negotiates for the most of amount of value for the least amount of cost. This negotiation necessarily includes inherent uncertainty over whether or not a transaction will occur.

The government is not just another customer in the economy which means those factors do not have the same affect on the government as they do on the free market customer.

When a government entity offers to pay a particular price, there is much less uncertainty about the transaction. Even when using the same criteria, government determines value differently than individuals.

For elected government officials, value is political—projecting responsibility for positive perception. When the government goes beyond its primary purposes, politicians may speak of providing “services,” but it is really only a buyer.

For instance, government is not a doctor. When a person gets sick, he doesn't look for the nearest politician or bureaucrat. He goes and finds a doctor. If he finds a doctor at a public health clinic, this returns us to our point: government is buying the services of the doctor to “provide that service” to the public.

Pharmaceutical companies spend a lot on research and development. There is no guarantee of a successful product. That uncertainty produces a risk product development may fail. When they do succeed, the initial price may be high to continue development, bring a product to market. Later that price point may come down to appeal to a broader pool of customers. Product competition accelerates these processes.

If the government comes along and decides it will be the sole payer for prescription drugs and caps how much it will pay for said drugs, one better hope they like what's available in the market at that time because it will likely stay that way for some time. Government can be a reliable and stable customer; that can become a liability for product development.

Product developers would then have a choice between selling a known product for a set price, and incurring high cost to develop an unknown product for the same price. Guess which one they will choose. No one takes on a high risk with no potential for high reward. This is the toxic effect of government pricing on innovation.