In "The Prescriptions or the Rent?" [op-ed, Aug. 3], Reps. Tim Johnson and Tom Allen are rightly worried about seniors' access to prescription drugs. But their argument is based on an economically unsound premise -- that variation in drug prices should be eliminated. Also, they should be much more careful with the "discrimination" rhetoric they use to talk about drug manufacturers' pricing practices.
Their bill, whether intentionally or not, would eliminate drug discounting, thus benefiting neither those who now pay "too much" nor those, such as hospital patients and HMO enrollees, who now benefit from drug discounting. When everybody gets a discount, it becomes too costly for drug companies and thus nobody gets a discount.
The congressmen say their studies "confirmed a clear pattern of price discrimination by the pharmaceutical industry." This is undoubtedly correct, and it confirms what the Congressional Budget Office (CBO) said last year: Different purchasers pay different prices for brand name prescription drugs.
This practice, however, is no more nefarious than an airline charging a business passenger more for the same seat than it charges a leisure passenger who is willing to stay over a Saturday night. The pricing is based on people's willingness to pay.
"Price discrimination" is an economic term simply meaning charging different prices to different purchasers. It is referenced in a federal antitrust law known as the Robinson-Patman Act, which prohibits price discrimination when it has the potential to be anti-competitive.
Because most price discrimination is, in fact, a response to competitive pressure, this law is rarely invoked successfully. Indeed, the Federal Trade Commission has repeatedly found that discounts are pro-competitive, not anti-competitive, and benefit consumers.
The Supreme Court anticipated the congressmen's rhetorical confusion in 1960 when it said that "there are no overtones of business buccaneering in the . . . phrase `discriminate in price.' Rather, a price discrimination . . . is merely a price difference." In other words, price discrimination has a purely economic meaning, different from notions of race, sex, disability, age, sexual orientation or other pernicious forms of bias that Reps. Johnson and Allen suggest.
Airline price discrimination reflects differences in "price sensitivity" among purchasers. Leisure passengers are more price-sensitive than business passengers, and the airlines segment their markets with the Saturday night stay requirement. This does a better job of maximizing their profit than pricing all seats the same.
The CBO pointed out that drug makers, too, are profit maximizers. Those who have the ability to be prudent purchasers (usually HMOs and hospitals) pay less because they make the competitive market work when it can. They tell the drug companies they won't buy if the price isn't right.
Notably in the prescription drug market, when there are no therapeutic competitors, there tend not to be discounts. Further, according to the Congressional Budget Office, "according to standard economic theory, no purchaser pays a higher price to make up for the discounts offered to somebody else. Instead, each pays the price dictated by his or her price sensitivity."
Contrary to the congressmen's claim that their proposal would not be a "price control," eliminating price discrimination is a more destructive form of price control than the "price setting" that the drug industry is worried about. Banning (or creating an incentive to eliminate) discounts would not make manufacturers any less "profit maximizers." They would simply change their practices to accommodate the new rules by raising prices across the board.
Rather than criticizing price discrimination, Congress should find ways to make seniors part of drug benefit plans such as those offered by HMOs that are able to create and benefit from competition. Ultimately, such benefit plans are more likely to be sustainable than those under the single-price regime their proposal would create.
The writer is a professor of public and private management at Stanford University's Graduate School of Business.