Did you hear the one about the socialist republic established in the middle of the Sahara Desert? Three years in, they began importing sand.
It's funny because it's true. Shortages are a hallmark of left-wing economic policy, from bread lines in 1930s USSR to gas lines in 1970s USA to starving citizens in today's Venezuela.
The explanation is basic economic theory. Price controls reduce profits below "normal" economic levels, the margins that people consider worth the work required to produce a good. This, in turn, prompts firms to exit the market, reducing supply. Prices stay at the government-set limit, so there's no incentive for others to pick up the slack. Voila, a shortage is born!
Those who don't learn from history are doomed to repeat it, we are told. (Told enough times for it to become trite). But we are apparently doomed still, because included in a 2015 budget agreement signed by President Obama (most Republicans voted no, but GOP leaders ushered it through anyway to raise the debt ceiling), were aggressive new price controls on generic drugs.
In the world of health care, generic drugs are like sand in the middle of the Sahara Desert. They're plentiful and cheap. It's one part of the deeply dysfunctional health care sector that generally resembles a functioning market, with robust competition, quality increasing and prices decreasing over time.
Get ready to start importing sand.
A study from Bates White Economic Consulting analyzes the impact of the 2015 changes, finding "these price regulations may have precisely the opposite of their intended effect."
The new rules, the study continues, are "likely to reduce competition in generic drug markets, lead to fewer companies competing in the market, and increase the likelihood of shortages."
Broadly speaking, the changes in the 2015 law require generic drug manufacturers to provide rebates if their prices rise faster than inflation.
The problem is, these are already mature, robustly competitive markets. If costs from any part of the supply chain increase faster than inflation, this would naturally be reflected in prices that increase faster than inflation. But in this instance, costs would rise while profit margins fall. Firms will exit the market, and shortages will result.
When applied to historical examples in recent years, the new penalties would significantly reduce margins just at the moment that cost increases are driving temporary price spikes. In some instances, these new penalties will reduce the effective price to zero! Even Bernie Sanders would have to admit that's not exactly sustainable.
Temporary input cost spikes in a complicated supply chain happen all the time. Inflation is an average; its constituent parts are higher and lower.
Normally, higher prices quickly bring these spikes back to equilibrium, because the higher price carries with it the increased incentive to remedy whatever is driving the higher costs. This is the inverse: reducing the profits at the worst possible moment.
It's frustrating because this is such a well-known and studied phenomenon, yet left-wing politicians keep trying the same thing over and over again, always with the same end result. The goal is to increase supply, decrease prices, especially to help poor people. But the result decreases supply, increases price, and hurts the poor most of all.
Congress should move quickly to rescind this Obama-era relic. With President Trump in the White House, the new rules can be reversed before they do any more damage to the competitiveness of the generic drug market.
James Lowe, is a two decade radio industry veteran and now host of his own nationally syndicated radio show based in Kansas and carried on the Iheartradio App. Find out more at jiggyjaguar.com
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