Congress should keep this in mind in considering whether and how to make prescription drug benefits available to Medicare outpatients, advises Calfee, an economist who has studied the pharmaceutical industry for many years. Proposed by President Bill Clinton in 1999, the Medicare outpatient drug benefit is expected to be one of the high-visibility pieces of legislation Congress considers in this election year.

Observing that Medicare has a history of creeping price ceilings on health care services, Calfee cautions that if Congress wants to enact a prescription drug benefit for outpatients, it should take a limited and income-sensitive approach. Except where patients’ spending exceeds a "catastrophic" annual threshold, Medicare benefits should include "a substantial deductible and co-payment," Calfee says.

One way to keep the cost of outpatient drugs within budget and avoid price controls, Calfee proposes, would be a system of government vouchers that may be used toward the purchase of private insurance, as opposed to outright government insurance.

Calfee's study describes the ongoing revolution in pharmaceutical research, which has developed breakthrough therapies for heart disease, diabetes, osteoporosis, arthritis, and other illnesses. The latest revolution is as much market-driven as science-driven. Advances in biology have been combined with a new clinical trials industry, a biotechnology industry supported by venture capital and flexible labor markets, managed care with its massive data on drug therapy in practice, and aggressive marketing practices that bring new treatments to the attention of untreated patients and motivate further research on the benefits of pharmaceuticals.

The backbone of Calfee's analysis of pricing is the proposition that the profit motive is what drives pharmaceutical research. If manufacturers are in doubt that they can earn in the marketplace the revenues needed to pay for the costly development of approved drugs and for those that do not survive lab tests or clinical trials, they will curtail research. That business logic was evident in 1994 and 1995, when Congress debated the Clinton healthcare initiative, which would have set price ceilings on innovative drugs. In an atmosphere of uncertainty about the health care business, the pharmaceutical industry scaled back its annual increases in R&D spending to less than 4 percent, far below the average of 11 percent for 1981-1993. (The lowest annual increase during that span was 7 percent.) Research spending gains have returned to an average of nearly 12 percent annually since the Clinton plan was defeated.

Other countries have imposed controls on drug prices, Calfee notes. One result has been that "the locus of research has moved steadily to the United States, whose firms now produce the vast majority of the worldwide best-selling drugs."

Sometimes new drugs come to market at significantly higher prices than older ones, Calfee reports, but they also may confer substantial additional benefits--quicker recoveries, shorter hospital stays or none, reduced pain and suffering, and the alleviation of restricted lifestyles. What patients spend on new or improved drugs, they may save on forgone hospital bills and fewer visits to the doctor. Employers save money from reduced absenteeism.

"New drugs are usually of higher quality, sometimes much higher," Calfee asserts. Were price increases adjusted for quality gains--a difficult statistical exercise--effective price rises would be much smaller. Moreover, intense competition among the producers works to benefit patients as it brings to market still newer medicines that drive down the prices of those already on the market.