Mad at the market? Turn your ire toward Washington

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Article Highlights

  • The real villain of drug scarcity? Federal price controls.

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  • Banks must still make up for the government-mandated haircut; so don’t be surprised to find new, higher fees tied to services.

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  • The federal government is a powerful entity, but try as it might it cannot repeal the laws of supply and demand.

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When customers are unhappy with developments in the marketplace, their natural instinct is to blame the companies involved. Reed Hastings learned this the hard way when his plan to change the way Netflix services its customers prompted a customer revolt. That was a boneheaded business decision and a lesson learned the hard way.

But sometimes there’s more going on than meets the eye. Consider two recent episodes: the alarming drug shortages now reported by hospitals, doctors, and pharmacies, and the decision by large banks to charge customers fees for their checking accounts. These seemingly unrelated events have something in common – government price controls have played a central role.

"The federal government is a powerful entity, but try as it might it cannot repeal the laws of supply and demand." --Nick SchulzLet’s start with the drug scarcity. Several essential, injectable medicines have been in short supply in recent months. Oncologists and other medical specialists have been unable to access critical generic medicines when needed. The media has reported that erratic foreign supply of basic ingredients and the small number of competent drug manufacturers are among the causes.

But the real villain here is federal price controls. The Food and Drug Administration has insisted on manufacturing plant safety upgrades in recent years, but price controls have limited the ability of drug makers to recover the costs of the upgrades.

My American Enterprise Institute colleague Scott Gottlieb, a practicing physician, recently explained:

The bigger problem is that manufacturers can’t easily raise prices to meet the resulting increased costs of production. A 2003 law fixes the price Medicare will pay for injected drugs to an ‘average sales price’ that is at least six months old at any given time. This flawed concept means even if a generic firm raises its price to reflect increased production costs, the new price won’t get paid by Medicare—meaning purchasers would be losing money for months at a time. The result is that generic prices can’t rise to reflect changing demand or the need for bigger investments in manufacturing.

Branded drugs have faced similar production (and FDA) issues, and they are paid for under the same flawed scheme. But they have larger profit margins to offset the cost of plant upgrades. Among the generics makers—whose much smaller profits have been eroded away by production costs—more and more are choosing to exit product lines rather than invest money to meet steadily higher standards.

History is repeating itself. In the late 1970s, when federal price controls prompted gasoline shortages and long lines at the pump, Milton Friedman said: "We economists don’t know much, but we do know how to create a shortage. If you want to create a shortage of tomatoes, for example, just pass a law that retailers can’t sell tomatoes for more than two cents per pound. Instantly you’ll have a tomato shortage. It’s the same with oil or gas." It’s the same with life-saving medicines, too.

Now let’s turn to the financial sector. When several large banks, including Bank of America, announced earlier this year that they would charge fees on customer checking accounts, the public reaction was swift and furious. How could the banks be raising fees on customers when unemployment was high and so many Americans were hurting? Senator Richard Durbin of Illinois went so far as to encourage a bank run to punish the firms initiating the fees.

But dig a little deeper and here, too, is an example of government price controls in action.

The landmark Dodd-Frank financial reform law included a price cap on so-called "swipe fees" for debit cards. These are the fees merchants pay to banks when customers use their debit cards to make purchases. Merchants don’t like paying the fees and so they lobbied Congress to cap the prices they have to pay. Durbin was eager to champion their cause.

When the bill was being debated, banks told legislators that if price caps were imposed they would need to make up the revenue elsewhere, including by possibly imposing fees for checking accounts. Sen. Durbin and others were unmoved and went ahead with the price caps. So no one should be surprised, least of all Sen. Durbin, that the banks later raised fees in another area of their business to make up for the lost revenue.

While the public reaction to the checking account fees was so fierce it prompted the banks to relent, in the end banks must still find a way to make up for the government-mandated haircut; so don’t be surprised to find new or higher fees tied to other services, or a reduction in the supply of services provided by banks.

The federal government is a powerful entity, but try as it might it cannot repeal the laws of supply and demand. So don’t blame the drug makers or the banks; blame the politicians in Washington and their inability to see that price "controls" can’t control the larger market.

Nick Schulz is the DeWitt Wallace Fellow at AEI.

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