Research Highlights Podcast
June 11, 2025
Understanding international approaches to drug pricing
Margaret Kyle discusses how different countries regulate the price of pharmaceuticals and lessons for the United States.
Source: LIGHTFIELD STUDIOS INC.
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Drug prices have become a hot-button issue in the United States, with across the agreeing that American consumers pay too much for prescription medications. But bringing down drug prices raises fundamental economic challenges that affect innovation, access, and healthcare costs worldwide.
In a paper in the Journal of Economic Perspectives, author examines how different countries approach pharmaceutical pricing regulation and the lessons to be learned from international experience. Her work reveals that while the United States does pay significantly higher prices for drugs, the story is more nuanced than a simple comparison suggests.
Kyle recently spoke with Tyler Smith about why economists generally support market solutions but make an exception for pharmaceuticals, how "pay-for-performance" contracts and subscription pricing models could bring down costs, and why simple solutions like copying other countries' prices might backfire.
The edited highlights of that conversation are below, and the full interview can be heard using the podcast player.
Tyler Smith: Economists tend to think that it’s best to leave markets alone. But that is not necessarily the case for pharmaceuticals. Why not let pharmaceutical markets set prices themselves?
Margaret Kyle: I think there are a number of special features of pharmaceuticals. One feature is that we use patents to create incentives for innovation. The idea here is that drug development is really expensive. It takes a long time. And if you come up with a product which is safe and effective and seems to do what we want it to do, in general, that product is relatively easy for other firms to imitate. The concern is that if a company faces that kind of imitation in a very short time period, then they don't expect profits that are high enough to justify that big investment. We try to assure them of those expected profits and at least give them the hope that they can make some money by promising exclusivity—so no direct competitors for some period of time. And we do that through the patent system. This creates a situation where, by construct, there's going to be market power for some period of time.
Another issue is that, in general, we have a market where patients with insurance are not paying the true price of the treatments that they're consuming. And so if you don't face the full price of what you're consuming in general, there's a temptation to consume more or consume more expensive treatments than you would if you were paying solely out of pocket yourself. So we have a situation where we have price-insensitive patients and also somebody helping to make their decisions about what to consume. That would be a doctor. And a doctor doesn't necessarily know or have any reason to be sensitive to the prices that patients or the insurance companies are paying. If you have market power and price-insensitive decision makers, like patients and doctors, then you have a recipe for runaway prices, which is why we see payers in both the US context and in other countries who push back on this and try and negotiate prices or come up with some other solution so that the prices are not entirely just set by a free market, at least not for innovator products.
Smith: Broadly speaking, what are the standard strategies that other countries are using to control drug prices and how do they work?
Kyle: Broadly speaking, you can think of them as acting very much like insurance companies or pharmacy benefit managers (PBMs) in the US context. They say they can't afford to pay this kind of price level for anyone who might be tempted to take this drug, so they take steps to try and limit consumption, either by putting in restrictions on who can have access to it or by negotiating a price. So some countries decide to actually fix the price paid directly to manufacturers. Others will have government insurance reimburse some amount. So, if the manufacturer asks for a price somewhat higher than that, then patients are going to end up being asked to pay that difference. Others will ask manufacturers what price they want and, based on that price, will decide whether they get reimbursed at all. There's a lot of different approaches to how it's implemented in practice and the kinds of criteria that go into negotiating the price or determining the reimbursement decision. They tend to look at things that you'd expect, such as the therapeutic value, substitutes, and the budget impact.
Smith: Beyond these standard approaches, are there any novel or more radical approaches to trying to control the cost of drug prices?
Kyle: I think that there are efforts to experiment with new approaches, because even in countries that do control prices to a larger extent than the United States does, I can assure you that patients and payers are not necessarily thrilled with the situation. So, even in countries that pay much lower prices, there are still concerns about drug budgets. In fact, if you look at the share of pharmaceuticals in the overall healthcare budget, the share of pharmaceuticals is much higher in the healthcare budgets of most European countries than it is in the US. I think that's a point that's a little underappreciated: that basically all prices are high in the US. The US pays much more for doctors and for nurses and for lots of other things in healthcare. Pharmaceuticals have actually been a pretty stable share of that total budget. It's a lower share than what you see in other countries. I think some of the lessons that we can learn from other countries in many situations are what doesn’t work so well, or what the tradeoffs are, or what’s really difficult to implement in practice.
One example would be the pay-for-performance kind of contract where a new drug comes to the market, and we know something about it from clinical trials, but we don't necessarily know how well it's going to work in practice. And unfortunately, right now, the way that pricing is done in many contexts, particularly when negotiated with governments, is to fix a price for some number of years, three or four years, say. All that negotiation is based on relatively little information. When a drug first comes to market, we don't know everything about it, but we're locking in the price despite that lack of information. So, a pay-for-performance contract might have some targets. For example, if you have a new diabetes treatment and it does a fantastic job controlling diabetes, you get a big reward as a pharmaceutical company. If it turns out not to work, maybe you don't get paid. I think that that's an example of a situation where economists can provide some value in thinking about how we can better align incentives, both for drug companies to develop things that are really going to work and to find the patients in whom those products are going to work rather than trying to sell to everybody regardless of whether it's appropriate.
Another example of a different kind of contract would be something like what’s called the Netflix model. If you have a situation where you think there's a large population of patients who might need a treatment, and it presents a huge budget issue or a lot of uncertainty, either for the manufacturer or for the payer, one approach is to give a fixed payment to the manufacturer in exchange for an essentially unlimited supply for anyone who needs it. We saw some experimentation with that kind of approach with some of the Hepatitis C drugs some years ago. That's not necessarily the right model for every drug, but I think that these kinds of approaches are changing the mindset that we just need to determine a price per pill that will be locked in for some fixed period of time.
We should be willing to pay for the breakthroughs but not pay so much for drugs that add only a little bit of extra value or have just minor benefits.
Margaret Kyle
Smith: Another layer of complication is that the pharmaceutical market is a global market. How should this fact affect the way that policymakers approach trying to bring down the cost of drugs?
Kyle: The concern in the US system is that because pharmaceuticals are a global product, other countries that aren't paying these high prices still get to benefit from that innovation. If you're a small, high-income country, you're not shifting global incentives for innovation very much because you're a very small part of the global market. It's not going to change the incentives if these small countries pay high prices. The problem is that when you have medium-sized countries and if all of them start doing this, then we do have a problem of not enough countries paying high enough prices to create the incentives that we want for innovation. I think this free riding is a legitimate concern. I think we should understand that it's not quite as extreme as some think, but it's also a difficult one to get around without a lot of international coordination or collaboration or discussion.
Smith: When it comes to bringing down the costs of drugs, do you think that the US has been heading in the right direction or is the problem getting worse?
Kyle: I think one thing we don't appreciate is that when we talk about the cost of drugs, we tend to focus on the branded products and we forget that generics are actually a big part of the market and are certainly a much higher share of prescriptions overall. But that's because generics are actually a really good deal in the US. They're cheaper in the US than they are in a lot of other markets. One point I'd like people to think about is that the US pays higher prices while the drug is still on patent, but then we benefit from really low prices once the drug loses its patent protection. We need to be careful about not killing those incentives for generics to come in and bring our prices down. I think also we pay too much attention to the average price level and not enough to the difference between high prices on a really effective drug and low prices on less effective drugs. I think we really need to work on paying for the really effective products. We should be willing to pay for the breakthroughs but not pay so much for drugs that add only a little bit of extra value or have just minor benefits.
In terms of policies that have been proposed, I think the “” approach, which is basically setting the US price to be similar to what we see in other countries, would be a big mistake. A lot of European countries do some version of this within Europe and sometimes referencing a few non-European countries, which is called external reference pricing. I think this is a situation where the US can learn from the European experience as to unintended consequences. That kind of approach tends to delay access or eliminate the incentive for companies to launch at all in the lowest-priced market. Because, if they launch in a really low-priced market, that will affect their prices in any country that references that low price. Maybe we think we don't really care what happens in other countries; we just want low prices ourselves. Well, the thing is that other countries and firms tend to be pretty smart about this as well. One likely response would be that they just hide the price. Just as insurers and PBMs don't ever reveal the true price that they pay, we have this notion of a list price for a drug, and then we know that it's rebated, but we don't know by how much. Basically, if you use a lot of external reference pricing, that's exactly the kind of situation that you're likely to create. Governments will officially pay the US price, but we're going to have a side deal with companies where we get a big rebate at the end of the year. So ultimately, I think the consequences for other countries would not be great, and I don't think that US prices would come down that much.
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“Lessons for the United States from Pharmaceutical Regulation Abroad” appears in the Spring 2025 issue of the Journal of Economic Perspectives. Music in the audio is by .