By John C. Goodman

Originally posted on Forbes, September 2015 

You probably saw the headlines. Daraprim is a small, white tablet that looks a lot like Aspirin. It was created 62 year ago and treats a parasitic infection called toxoplasmosis. Until recently is sold for $13.50. But then Turing Pharmaceuticals acquired the only company that manufacturers the drug and it hiked the price to $750 overnight – a 5,500 percent increase!

How can that happen? The drug went off patent years ago. Anyone can copy it and make a generic equivalent. So why don’t they? Turns out, the market is very thin. The New York Times estimates that between 8,000 and 12,000 prescriptions get filled annually.

That creates two problems. First the market is probably not large enough to support two competitors. One company supplying the entire market will likely have a lower average cost of production than two or three or four companies sharing the market. If so, you are likely to end up with a “natural monopoly,” under normal competition. Second, if another company entered the market, there is the problem of how price competition would take place. As health policy analyst Sarah Kliff explains:

Let’s say I decide to launch Sarah’s Generic Drug Company, and I’m pretty sure I can break even by slightly undercutting Turing and charging $700. What happens if Turing responds by dropping its price down to $500, or even back to $13.50? It will keep all its patients — and my nascent drug company is likely going bankrupt.

Kliff and many others think the solution to this problem is to have government do what governments do in just about every other country in the world: negotiate with the drug companies over prices. This apparently is the solution Hillary Clinton now prefers.

There are two problems here. First, as part of the effort to get the Affordable Care Act (Obamacare) passed, the Obama administration agreed with the drug industry not to negotiate prices – and Clinton was part of the administration at the time. Second, polls show that the American public is reluctant to see the government in the role of drug price fixer because of the negative effects this activity could have on future research and development.

There are good reasons for the public’s reluctance. As the Wall Street Journal editorial page explained recently, one out of every five R & D dollars in the United States is deployed by the drug industry. Other countries seem content to let us bear the cost of drug discovery and then pay only the marginal cost of producing the pills, once the discoveries are made. If we don’t do the innovating, who will?

Also, politicians are present oriented. Their incentive will be to squeeze the drug producers and pander to the voters today, while ignoring the future consequences of their actions. Since drug development has a long lead time, today’s representatives are likely to be retired from office long before the consequences of no R & D are felt.

What’s a better approach? Some time ago I made a suggestion in the Wall Street Journal on how Medicare could save a great deal of money: let providers come forward and offer to re-price and re-package the services they provide. Medicare should accept these offers so long as they promise to lower costs, raise quality and increase access to care.

The same principle should apply to generic drugs. Since the patents on these drugs have expired, there is no reason to worry about the effects on R & D. So why shouldn’t Medicare and every other health insurer be open to a better offer.

In this case, a drug manufacturer might offer to supply a generic equivalent of Daraprim for, say, $20 or $30, provided they get an exclusive contract. If the offer is accepted, Medicare would pay for the drug only if it is supplied by the drug company the agreement is made with. The same offer could be made to Blue Cross and other insurers. In fact, the insurers could actually organize a market in which many potential manufacturers could submit bids.

What’s the difference between this proposal and the negotiation over drug prices that Hillary Clinton and many on the left have advocated for years? The left wants take-it-or-leave-it demands from government, effectively dictating prices that do not allow the makers of brand name drugs to recover their R & D costs.

The proposal made here would allow many companies to compete to supply an entire market with drugs whose patents have expired. No insurer would be required to accept an offer and no drug company would be required to make one.

Just because one company can supply the entire market more cheaply than two or more companies, that is not a reason to pay monopoly prices. We could have dozens of companies vying to supply a large part of the market and they could be competing on price, quality and ease of access – to the benefit of patients everywhere.

This article was originally posted at Forbes on September 25, 2015.