"[W]e conclude that the Bureau of Labor Statistics’ (BLS) CPI Prescription Drug Index (CPI-Rx) is the best available summary measure of the price changes of prescription drugs. According to this measure, not only are drug prices increasing more slowly than general price inflation; in the most recent period, drug prices have been decreasing. From the peak in June 2018 through August 2019, the CPI-Rx has declined by 1.9 percent. Figure 1 plots the year-over-year percentage change in the CPI-Rx. Through August 2019, the year-over-year change in the index has now been negative for 8 of the previous 9 months."
So reports the White House Council of Economic Advisers in "Measuring Prescription Drug Prices: A Primer on the CPI Prescription Drug Index" (October 2019). The report offers a useful explanation of why it's hard to measure an overall change in prescription drug prices, the key choices made by the Bureau of Labor Statistics in doing so, and the basis for news stories which claim that prescription drug prices have been rising quickly.
As a starter, here's the Consumer Price Index for Prescription Drugs as calculated by the US Bureau of Labor Statistics:
A price index is of course an average over all prices. In addition, it's a weighted average, where those items on which many people spend a lot get more weight than those items where only a few people spend.
Thus, if the price of an anti-cancer prescription drug used by a few thousand people rises by 100%, but but at the same time generic substitutes for some other prescription drug used by 20 million people become available at a fraction of the brand-name price, the overall price index for prescription drugs is likely to fall. The CEA report explains how the entry of generic equivalents into the prescription drug market are treated in this way:
The FDA approves generics if, among other things, the active ingredient is the same as the branded drug and the generic drug is bioequivalent to the brand name drug. As a result, generic drugs are considered substitutable (in fact, almost a perfect substitute) for the branded version but typically have a lower price, and many consumers switch from the branded version to the generic version shortly after the generic version becomes available. This switch is a price decline (lower price for an identical product) that is not captured by tracking the branded drug or the generic drug’s price over time. The CPI-Rx accounts for generic substitution by tracking the initial entry of a generic drug. After roughly 6 months after patent expiration (enough time for the generic to establish market share), the branded drug is randomly replaced with the generic drug, with a probability equal to the generic’s market share, and the price difference is recorded as a price decrease.
In addition, prescription drugs often have both a "list price" and an actual "transaction price," which results from a negotiation between drug manufacturers, health insurance companies, pharmaceutical benefit managers, as well as in some cases direct rebates to consumers. The BLS price index is based on the transaction price, not the list price. As the CEA report notes: "Express Scripts, one of the largest pharmacy benefit managers, reported that even though list prices increased in 2018, the prices paid by their clients fell. Some drug companies have themselves warned investors that increased discounts and rebates would offset any list price increases and that net prices would either be flat or fall in 2019 ..."
In addition, there is reason to believe that the prescription drug price index calculated by the BLS overstates the actual rise in prices because of a standard problem sometimes called the "quality" or "new goods" bias. Say that an old drug is replaced by a new drug, which works better and has fewer side effects, but sells for the same price. In this hypothetical, you are getting more for your money with the new drug; in fact, even if you paid a little more for the new drug, you might be better off. But while a perfect price index would presumably hold constant the quality and variety of drugs available, the practical reals-world price index doesn't do this, and for that reason will tend to estimate a higher rise in prices.
So why do so many news stories give the impression that prescription drug prices overall are rising quickly? Each news story has its own hook, of course, and the CEA report runs through a number of examples. In some cases, the news story might be focusing on a particular drug or small group of drugs. In other cases, the news story might focus only the average price increase for prescription drugs where the price rose, leaving out others. In other cases, the news story might count up how many drugs has price increase compared to how many did not, leaving out the issue of how much each of the actual drugs is used.
Of course, the CPI measure of changes in prescription drug prices has practical problems, as do all price indexes. It's based on a sample of prescription drugs, not all of them, and less-prescribed drugs are more likely to be left out. It is based retail prescription drugs, and so it doesn't include prices for hospital- and doctor-administered drugs. Figuring out transaction prices and gathering information on rebates to consumers is imperfect. If you personally need a certain drug, where they aren't good substitutes, and the price of that drug goes up, it's perhaps not very comforting to read about what is happening with an overall price index of drugs that includes all the ones you are not taking.
But if our society is going to address issues like the out-of-pocket cost of many prescription drugs, it's important to see the overall issue clearly. And the overall evidence is that the price index for prescription drugs has fallen in the last year or so.
A version of this article first appeared on Conversable Economist.
Timothy Taylor is an American economist. He is managing editor of the Journal of Economic Perspectives, a quarterly academic journal produced at Macalester College and published by the American Economic Association. Taylor received his Bachelor of Arts degree from Haverford College and a master's degree in economics from Stanford University. At Stanford, he was winner of the award for excellent teaching in a large class (more than 30 students) given by the Associated Students of Stanford University. At Minnesota, he was named a Distinguished Lecturer by the Department of Economics and voted Teacher of the Year by the master's degree students at the Hubert H. Humphrey Institute of Public Affairs. Taylor has been a guest speaker for groups of teachers of high school economics, visiting diplomats from eastern Europe, talk-radio shows, and community groups. From 1989 to 1997, Professor Taylor wrote an economics opinion column for the San Jose Mercury-News. He has published multiple lectures on economics through The Teaching Company. With Rudolph Penner and Isabel Sawhill, he is co-author of Updating America's Social Contract (2000), whose first chapter provided an early radical centrist perspective, "An Agenda for the Radical Middle". Taylor is also the author of The Instant Economist: Everything You Need to Know About How the Economy Works, published by the Penguin Group in 2012. The fourth edition of Taylor's Principles of Economics textbook was published by Textbook Media in 2017.