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Prices of biopharmaceuticals in the United States exceed the prices of the same drugs negotiated by foreign governments, which, in turn, exceed their marginal costs of production. We present a model that accounts for these stylized facts and use it to predict the consequences of three policies proposed to reduce domestic drug prices: (1) facilitating drug imports from Canada and Western Europe; (2) requiring that Medicare pay the same prices for drugs as foreign governments; and (3) reducing the profit of downstream channel players (wholesalers, insurance companies, pharmacy benefit managers, and pharmacies) by promoting competition downstream. If not offset, all but the last of these price-reducing policies would eventually depress drug innovation. We conclude by discussing the least expensive way of restoring innovation while maintaining lower domestic prices. Although the model described here is conceptual and its results qualitative, it is the centerpiece of a calibrated simulation model (code to be made available on request) that can be used to quantify the effects of the alternative policies. We will describe the simulation model in a companion paper.
