What Does "Negotiate" Mean in this Context?

Via Hit and Run:

As part of their 100 hours, the House plans to pass legislation that
would enable the federal government to negotiate Medicare Part D drug
prices.

My experience is that when the government "negotiates" prices via their standard procurement processes, they end up paying higher prices than a private firm might (see "$6000 hammer").  I am not a very experienced political observer who understands all the insider-speak, so maybe someone out there can tell me.  In this context, does "negotiate" actually mean "use the government's fiat power to demand that prices be set at whatever hell level they want?"

If it is the latter, then does anyone really believe that with populist political pressures, prices are going to be set anywhere near high enough to continue to justify intense drug R&D?  Already most of the world pays just above marginal cost for drugs, such that we in America pay for most all the drug R&D that occurs  (a form of charity we never get credit for).  If the US government "negotiates" US drug prices down to marginal cost, who will be funding the new life extension therapies I will be needing in about 20 years?

Update: One clarification based on the comments.  There is nothing wrong per se with American drug companies selling pharmaceuticals outside the US near marginal cost.  Profit is where you find it.  However, the issue is that US politicians tend to use these international drug prices as a benchmark, as in "US customers should get the same low price foreigners are getting."  The result is all the drug re-importation battles we have from time to time.  (By the way, its funny that politicians who support drug re-importation to reduce the US drug price differential vs. other countries never seem to apply the same solution to the entirely parallel situation of other countries having much lower labor costs than ours -- in fact in these cases they actively resist labor re-importation, which we also call immigration or outsourcing.)

A second point I want to make is that we cannot say for certain whether US customers are getting a good value or a bad value at current drug prices, though both supporters and opponents of the current health care system try to draw conclusions about the "fairness" of drug prices.  This is an odd situation to be in.  In other situations when people challenge the "fairness" of pricing, say gasoline prices, we libertarians can always retort "Well, buyers and suppliers both agreed to the transaction at X price, so X price was fair for both."   

But we can't do this with drug prices.  The reason we can't determine whether individuals are getting a good value is that, as I wrote at length in this post, our health care system is not structured in a way where individuals make cost-benefit tradeoffs for themselves.  Our employer's insurance company, via their coverage policies, or the US Government, via its rule-making and tort law, make these trade-offs for us.  Some drugs you might never pay for yourself, but you take because your insurance company pays for them.  Some drugs (e.g. Vioxx) you might dearly love to take, but the American litigation mess effectively precludes your access to it.  My suspicion is that, given the value I put on my life, prices for many US drugs are still a bargain for me, but who knows what trade-offs other people would make in a free society?  At the end of the day, we don't know what the real market price for pharmaceuticals is.  All we can say with confidence is that whatever price the government "negotiates," it will most likely be wrong.

  • If the drug price negotiations work the same way as provider negotiations, Medicare will demand the "lowest" price for a given drug, which means it will be a crime for any private payer to obtain an even lower price. Regulators will then use the regulated price as the "market" standard and bring price fixing lawsuits against any drug producer that tries to negotiate prices with private payers that are too high above the Medicare "negotiated" price. This is what has already happened with physicians.

    This isn't like the $6,000 hammer. The government doesn't care what private firms are paying for similar hammers. Here, the objective is to control all prices within the market.

  • Matt

    The government passes laws against selling to nongovernmental buyers at a price below what the government pays...the $6000 hammer-type incidents happen because nobody but the military would buy a MilSpec hammer, and a hammer that doesn't meet the contract specifications is not considered to be the same product.

    So I'd bet against Medicare paying more for drugs than people who buy them with non-stolen money. But that _would_ almost certainly lead to the race-to-marginal-cost that any sane person is worried about.

    The only plausible good outcome is that the wave of stagnation and insolvency the changes will cause could lead to some other government barriers to the pharmaceutical business (such as the baroque FDA approval process and our insane tort system) being removed as an emergency measure.

  • Valens342

    Finally someone notes the fact that all these 'successful' socialist medical plans have been able to continue along (albeit rather poorly if the facts be exposed) because the U.S. has been subsidizing them... Oh, and we also provide all the actually effective defense spending for them as well in the form of the U.S. military. Socialism: The Road to Serfdom (though it may take a bit longer if you can continue to suck off the United States' economy. Haven't any of these left wing brainiacs learned that price fixing (as noted in the first comment above) has the reverse effect intended with disatrous ripple effects throughout the economy?

  • Don Lloyd

    Warren,

    "...Already most of the world pays just above marginal cost for drugs, such that we in America pay for most all the drug R&D that occurs (a form of charity we never get credit for)..."

    True, but contrary to popular belief this doesn't represent an economic injury to Americans, only an increase in blood pressure to those who read about it and don't understand it. As long as Congress doesn't mandate drug re-importation and destroy beneficial price discrimination, it's a small plus, given that we have little chance of convincing other countries (or even ourselves) that markets outperform price controls over the long run.

    Regards, Don

  • Ian Random

    Actually, the $600 hammer cost $15, to ease the accounting they allocated overhead evenly. So cheap things were expensive and expensive things were less so. Kinda like other things in accounting where you use the last price for something, no matter how much lower or higher it is compared to inventory you bought earlier. I do think there is room for more competition in contracts, by lowering the regulation bar, so smaller firms without fulltime redtape staffs can bid.

    As for the drugs, yes it will be a fiasco, look at the role of government prices for flu vaccine and how they are produced in England now. They looked at $1/dose versus $1,000,000's in liability and made a decision to discontinue. I am so close to losing sympathy for older folks, it is hard not to see SOME as greedier than a stockbroker with a filing cabinet of failure to delivers.

    A Hammer Story:
    http://www.govexec.com/dailyfed/1298/120798t1.htm

    A Vaccine Story:
    http://www.weeklystandard.com/Content/Public/Articles/000/000/004/793dgqvs.asp

    Ian Random

  • DaveJ

    Another thing to consider about drug prices in the US vs Germany is the relative probability of a $100,000,000 judgement (or 1000 of them) in each country. The drug price has to cover the liability insurance.

    The first time Pfizer has to pay that kind of money to a reimported drug user in the US, foreign patients in the reexporting country are going to start paying more for drugs. We'll be exporting our wonderful liability laws.