Consider Walter. At seventy, he has a history of high blood pressure, heart trouble, high cholesterol, stomach pains, and seasonal allergies. He used to smoke but gave it up a while back. He is only moderately overweight. For his various ailments, Walter has a variety of prescriptions from his doctor. His real problem, however-as for 26 percent of his fellow Americans, particularly the elderly, those most in need of medications-is that Walter has no insurance coverage for his medications. Medicare does not provide it.

Drug coverage makes a real difference in people’s lives, for two reasons. Those who have it use prescriptions at a 50-percent higher rate than those without it, presumably to their benefit; and people without it spend on average $220 more per year for the few drugs they do get. Combine these facts and you have a recipe for not only moral but political outrage. Hence the increased attention being paid to a drug benefit for those on Medicare.

Yet there is something else at work here. Only eleven years ago, the percentage of Americans with no drug coverage was almost twice as high (48 percent) as it is today. By most measures of equity, then, things have gotten better: more people have coverage, and-for advocates of smaller government, something even more positive-this improvement has come about through private health insurance.

So why has drug coverage become a national issue? In 1999, $100 billion was spent on prescription drugs in the United States-8.3 percent of the total health-care ticket. By 2010, that figure is expected to rise to $366 billion (14 percent of total expenses). This works out to a predicted average annual growth rate of 11.3 percent for the next nine years-more than twice the growth rate of the country’s economy as a whole. (Last year alone, spending for prescription drugs rose a stunning 18.8 percent.) The real problem we are facing, therefore, is providing not simply prescription-drug coverage but the total bill for such expenses. And this reality is finally registering with American consumers, previously shielded from the real costs of such services. Naturally, the first to feel it are uninsured, high utilizers-namely, the elderly.

Every drama needs its shadowy character, and in this story the pharmaceutical industry is ripe for the role. Under increasing scrutiny, "big pharma" is reaping what it has sown. Through the 1990s, it grew at an average of 12.5 percent per year-two and one-half times the rate of the economy as a whole-and posted profits between 15 and 20 percent, making it one of the most profitable businesses around. The industry achieved this growth by delivering new hope to people, by securing political protection for itself, and by exploiting the vulnerabilities of both patients and an insurance-based payment system that inured customers to price sensitivity.

How much can Americans afford to pay for their medications? Who benefits from the growth of the prescription-drug industry? Might consumers trade slower pharmaceutical innovation for lower costs and broader coverage? To explore these issues, let’s return to Walter, our chronically unwell subject.

The accompanying table illustrates the range Walter might pay for his drug regime, depending on the drugs prescribed and his insurance coverage. The table also serves to illustrate the difficulties associated with resource allocation in health care, particularly how to balance social benefit and individual need.

The table is based on generally accessible and accurate (but hardly definitive) information on drug pricing estimates, as they relate to the theoretical treatment of Walter’s particular symptoms. Depending on insurance coverage, Walter could end up paying as little as nothing, or as much as $911 for his ninety-day course of drugs. The "system costs" (that is, the revenues to the drug companies) could range from $239 to $911, based on what is prescribed and who pays. A look at the table also indicates that there are few other markets for goods and services where product pricing varies so significantly, and largely to the benefit of the seller. Nonuniversal, third-party coverage compounds this issue by exposing some people to full costs while insulating other consumers from any sort of price sensitivity.

There are six elements at play in the pharmaceutical industry which contribute not only to its growth but also to the pressures it puts on the financing and delivery of health care in general.

• Product Development The key to growth in the pharmaceutical industry is the introduction of new products. Drug companies are masters at creating such innovations. They spent $25 billion in 1999-a whopping 25 percent of sales-on research and development. Their production pipeline is full of future products targeted for widespread chronic conditions like Walter’s-heart disease, depression, and arthritis-where utilization will be high and sustained. It is estimated that 46 percent of the rate of increase in prescription-drug spending each year comes from the introduction of new products. Companies search for blockbuster drugs that will deliver new benefits to patients and that will sustain their research and development programs. Of the $21 billion increase in spending for prescription drugs from 1999 to 2000, one-half was due to increased sales of just twenty-three individual drugs.

• Marketing Once a drug is developed, it is marketed intensively to differentiate it from its competition. In 1999, pharmaceutical companies spent more than $10 billion on marketing activities. Over 80 percent of this outlay was directed at physicians, trying to get them to recognize when to prescribe, and then to recommend a particular brand of drug. Company "detailers" (sales people) aggressively court doctors with information and entertainment. And marketing works. Between 1993 and 1998, sales of the ten most heavily marketed drugs contributed to more than one-fifth of the total increase in drug expenditures.

Yet the benefits of these blockbuster drugs are often overstated. Four out of five of Walter’s conditions can be treated with much cheaper regimens of generally similar efficacy. There is, however, little incentive in the health system for doctors not to prescribe the latest thing, once it is proven safe and effective. Furthermore, today’s fastest-growing marketing effort is direct-to-consumer advertising-getting patients to ask a physician for Claritin for a runny nose because they saw Joan Lunden recommend it on television. First permitted on television four years ago, consumer advertising was a $2.5 billion ticket in the year 2000. Such advertising campaigns offer only partial information about the products to the consumer, yet he or she can exert effective pressure on a physician to write a particular prescription.

• Differential Pricing and Cost Responsibility In a typical market, price is based on the consumer’s perceived value of a particular good or service. But in pharmaceuticals, the consumer is not the only purchaser. His or her insurance plan also plays a part, and this has had the unintended consequence of contributing significantly to price insensitivity for pharmaceuticals-all the while enhancing the industry’s profits. As Walter’s table indicates, third-party insurance coverage has created significant opportunities for differential pricing by the industry, again resulting in increased revenues. By law, Medicaid gets the lowest price, but uninsured individual consumers may end up paying a retail price typically almost twice that of Medicaid.

If the market can’t arrive at a fair or consistent price, is there some other workable mechanism? Efforts at price controls, common in Canada and Europe, are anathema in the United States. Every other major developed country employs some form of aggressive price and utilization control in its pharmaceutical program-whether as the provider of national health insurance or as a matter of industrial policy. (These include individual or product-group price controls, profit caps, monitoring the prescribing patterns of doctors, establishing national formularies, and patient cost sharing). The results are significant: per capita spending for prescription drugs in other major developed countries is 70 percent of the U.S. total-and growing at a slower rate. No wonder stories abound about Americans making shopping trips to Canada to purchase cheaper medicines. The U.S. pharmaceutical industry maintains that price controls in other countries force U.S. consumers to shoulder a disproportionate share of future product and development costs. But the industry is silent when it comes to whether Americans pay a greater share of its profits. The global reach of the industry may present an occasion for a global trade and industry policy.

• Patent Protections After a blockbuster drug is invented, marketed, and priced, a company works hard to protect its privileged position. Patent law exists to encourage innovation by preserving exclusivity and its benefits to the innovator for some time. The profits which accrue to the pharmaceutical industry, however, are truly extraordinary. Through diligent legislative activity, the industry has been able to more than double the potential effective patent life of a new drug, from 8.1 years in 1984 to 18.4 years in 2000. While not all drugs enjoy 18 years of exclusivity, the benefits of even six months of additional protection are considerable for a manufacturer, for once generic competition arrives on the market, prices can drop from 75 to 90 percent.

• Political Spending The pharmaceutical industry spent some $74 million for lobbying activities in 1998. The result? In addition to the patent protections noted above, federal tax credits for research resulted in the industry’s massive profits being taxed at only 15 percent, almost half of the average corporate tax rate. In the recent presidential election, the industry contributed more than $6 million to the Bush campaign, and coughed up another $1.7 million for Bush’s inaugural. Perhaps it is no surprise that an industry executive was named director of the Office of Management and Budget, or that three industry representatives served on the Department of Health and Human Services transition team-important positions from which to preserve current advantages and ensure that, for instance, a Medicare prescription-drug benefit proposal would steer away from governmental price controls.

• The Technological Imperative The last piece at work is probably the most difficult to harness: our collective desire for science to make our lives easier and to save us from our fears. The most important things Walter can do to help himself is to eat correctly, stay away from cigarettes, and get plenty of exercise and sleep. But these habits are hard to build and maintain. Virtue often loses to the quick fix promised by a pill, especially when it is cleverly marketed and the user does not directly pay for its full cost. Ultimately, of course, even good habits are no match for disease, let alone death. On the other hand, the benefits of medication, while not permanent, are incontestable. Still, we are guilty of a collective deceit when we let our faith in technology supplant a healthy respect for our bodies, both their strengths and their limitations. This deceit cannot be treated with a pill, and its results may be just as corrosive to the human spirit as any disease.

None of this helps Walter directly when he is trying to figure out how to pay for Lescol so he can lower his cholesterol and reduce the risk of a heart attack. And though it may make sense for him to pay a share of his costs, few of us would be comfortable with the idea that access to an effective drug should be rationed based on the ability to pay, let alone proof of a person’s exercise habits. How, then, do we get ourselves out of this mess?

The focus on prescription-drug coverage for the elderly is the best place to begin thinking about costs and coverage, for clearly the needs are real and, finally, it is federal policy that shapes the market for health care.

Currently, the only prescription-drug coverage options available for the elderly are retiree coverage for the lucky few; small state-based, sliding-scale programs; and Medicaid (for the impoverished). If actuarial estimates are correct, however, simply adding a full benefit for the elderly could raise program costs by 25 percent, an untenable prospect. How then do we close this gap between the real and growing needs of an aging population, and our ability to pay for those needs? Prescription drugs for the elderly thus become a more focused version of the larger dilemma raised by advocates of universal health insurance.

Current proposals break down less over the size of federal participation than over how allocation decisions get made; that is, the extent to which one believes the private market can and should work. The Bush administration’s original "Immediate Helping Hand Program" called for an annual block grant of $12 billion to the states. This would provide for means-tested subsidies to the needy elderly for purchasing necessary drugs-augmenting what some states already have in place. After a period of denial over the need for any federal role, the pharmaceutical industry has embraced this approach as the least intrusive of potential evils. It is easily administrable and is philosophically compatible with a limited and preferably state-based governmental role. It also lets the private sector take care of health, starts to create a lower tier of care and financing for the elderly, and does nothing to address the fact that prescription-drug costs are driving the system as a whole.

For their part, advocates of a broader Medicare prescription-drug coverage have a hard time making the numbers work. Means testing for any Medicare benefit would reduce the cost burden, but is politically difficult, given Medicare is a universal entitlement. Some proposals call for a separate, privately administered prescription insurance program. Medicare enrollees could use a voucher to buy into different types of coverage in a newly created "market" of privately administered, government-certified drug benefit programs. These policy administrators would hammer out their best deals for enrollees with the manufacturers. But advocates for these private-sector purchasing techniques conveniently overlook the fact that it is the private health-insurance sector that has produced the 15-20 percent per year growth rates that now threaten the whole system.

Installing greater patient cost-sharing mechanisms to foster price sensitivity is one potential means of lowering medical expenditures. But such a program would have to be carefully administered, lest people forgo needed drugs because of the expense. Finally, reducing costs by limiting the extent of the benefit becomes dicey. Just imagine the reaction when the first elderly patient with the need for an excluded medicine shows up on the nightly news.

Reform of the present system, therefore, will require money and real political will. Still, almost anything would represent an improvement over what is currently in place for the elderly. Medicare prescription drug plans should follow some of the time-tested patterns already established by Medicare.

• First, coverage rules should apply to all. A safety-net type of program would represent a break from Medicare’s commitment to equitable treatment. Medicare, along with Social Security, is the strongest example of social solidarity we have in the United States. It must be preserved.

• Second, we must get as comprehensive a benefit plan as we can afford. Half a loaf is better than none, but we have to make sure everyone gets it. Let those who can afford it buy a bigger loaf.

• Third, program operations must address the factors that have landed us in this fix. Federal purchasing or price controls for prescriptions should be instituted, as is already done for hospitals and physicians under the Medicare program. Admittedly, such price setting is ugly and inelegant, but it has worked for thirty-five years. For all their antimarket appearances, Medicare’s physician and hospital fees are the standard reference metrics used throughout the private health-care industry. In addition, let Medicare recipients buy those drugs not covered under Medicare for the same price Medicaid pays. The industry will howl in protest, but it will adjust.

• Fourth, a Medicare prescription drug program should install effective and means-tested patient cost sharing at the point of consumption. This will encourage more price sensitivity. Patients need a limited incentive to weigh the costs and benefits of various treatments. For example, in Germany the first $20 of the cost of any prescription is covered by public insurance, but all costs above that are privately financed.

• Finally, we should acknowledge that pharmacy costs-the fastest-rising element in health care-are emblematic of our infatuation with the technological fix and unlimited choices. Proposals for prescription-drug coverage-and any other health-care coverage-must address a fundamental tectonic force at work: the proliferation of products and technologies that push costs upward. Particularly at a time when health-care utilization is likely to increase as the population ages and diagnostic technologies, often gene-based, improve, we should recognize that the industry has no need for the protections it has been afforded legislatively in the form of excessive patent protection and tax credits. Furthermore, no credible argument has been made that direct-to-consumer advertising for drugs does anything more than increase costs and create unrealistic and partially informed demands on physicians by patients.

In the end, health care is a supply-driven business: The more options our friend Walter has, the more he will use. The unchallenged assumption is that the more we use, the better off we are. That assumption must be questioned. But the prescription drug industry has embraced that paradigm and profited immensely from it. At the same time, the commercial insurance sector has failed to control prescription costs, assuming, as we all have, that the benefits provided are worth the expense. How much different would our lives be, however, if lower industry profits and fewer legislative protections meant less capital for research and slower product development cycles? Can the American public learn to love last year’s antihistamine if it means that Walter can get most of his medication paid for?