For months, I've been hearing about shortages of drugs--ADHD drugs, cancer drugs, various other generics. The shortages have been variously attributed--crappy Chinese links in the supply chain are a perennial favorite--but Ezekial Emmanuel had an op-ed in the New York Times this weekend which offered those most compelling explanation I've yet seen for the phenomenon. 

The underlying reason for this is that cancer patients do not buy chemotherapy drugs from their local pharmacies the way they buy asthma inhalers or insulin. Instead, it is their oncologists who buy the drugs, administer them and then bill Medicare and insurance companies for the costs.

Historically, this "buy and bill" system was quite lucrative; drug companies charged Medicare and insurance companies inflated, essentially made-up "average wholesale prices." The Medicare Prescription Drug, Improvement and Modernization Act of 2003, signed by President George W. Bush, put an end to this arrangement. It required Medicare to pay the physicians who prescribed the drugs based on a drug's actual average selling price, plus 6 percent for handling. And indirectly -- because of the time it takes drug companies to compile actual sales data and the government to revise the average selling price -- it restricted the price from increasing by more than 6 percent every six months.

The act had an unintended consequence. In the first two or three years after a cancer drug goes generic, its price can drop by as much as 90 percent as manufacturers compete for market share. But if a shortage develops, the drug's price should be able to increase again to attract more manufacturers. Because the 2003 act effectively limits drug price increases, it prevents this from happening. The low profit margins mean that manufacturers face a hard choice: lose money producing a lifesaving drug or switch limited production capacity to a more lucrative drug.

The result is clear: in 2004 there were 58 new drug shortages, but by 2010 the number had steadily increased to 211. (These numbers include noncancer drugs as well. )

Things like this are the root of my skepticism about technocratic rule-making.  I have no doubt that the earnest people who drafted this rule spent a lot of time thinking about whether the allowed price increase should be 5% or 7%.  But they somehow overlooked a rather significant feature of the market they were regulating, and the effect that their rule would have when it interacted with market reality.  The more complex your system of rules is, the harder it is to keep track of these potential unwanted side effects.


This is why it is so unwise to simply assume that you can identify excess profits in the health care system, and wring out those profits with a well chosen set of rules.  The odds are good that you don't understand the market quite as well as you think.  And even if you did . . . in this case there seems to be a quite clear tradeoff between paying providers too much, or giving up inexpensive cancer drugs.  You can't have less of one without more of the other--I'm sure this rule is saving the government money on some drugs, even as it forces others off the market.  (Though of course, to the extent that the government is now paying for more expensive brand names, this may be a windfall for pharma, and a net loss to the government.)

What's happening now is, by the way, exactly what many conservatives have predicted: crude rationing of needed care.  Generally, they've been met by accusations of alarmism, if not indignant condemnation for giving aid and comfort to the "Death Panels" meme. With all that waste in the medical system, how could it not be possible to make things better if you put some really smart people in charge of identifying what works, and making smart rules about pricing and provision?  

The administration always seemed to believe that there was a magic pot of money out there that did not come attached to an angry interest group, or any real costs to human welfare.  And I see that they are apparently still convinced that the health care system is a world without tradeoffs. When the debt deal was struck, the White House was careful to make it clear that any potential Medicare cuts wouldn't affect Medicare patients:

Nevertheless, Obama administration officials are quietely trying to sell those cuts by arguing that beneficiaries won't even notice them: Politico reports that "the White House said the cuts would be limited to providers and beneficiaries would be 'protected.'" Bloomberg is reporting that the cuts "would only affect provider reimbursements, not benefits."

It's certainly true that there is unnecessary treatment out there, and excessive profits for some providers.  But I don't understand how the administration can be so confident that they--and there partners in congress--will be able to identify the exact right price for medical services, such that the only people affected will be greedy providers who charge too much.  Since I doubt that even the providers are that certain about their profit margins, labor elasticity, and downside risks, I don't know how the administration could possibly have such information.


Which is why I expect to see more of these problems as Obamacare is implemented.  Of course, you might well think that the dislocations will be worth it (as long as you don't have cancer, anyway.)  But it's looking less and less reasonable to assume that there won't be any disclocations.