The Myths of Medical Monopoly and Monopsony

Published August 30, 2002

Two erroneous notions have long infected the debate about appropriate public policies for prescription drugs. The first is that patents protecting intellectual property grant monopoly power and keep prices higher than they otherwise would be. The second is that the government can prevent drug makers from gouging patients by forcing discounts through its purchasing power as a single buyer. This is monopsony, the mirror image of monopoly.

Defenders of government-controlled health care constantly tell us that health care is different: It cannot be sold like pizza or bicycles. So, let’s use a health care product that the government never took over to analyze these fallacies. In the 1910s, my grandfather dropped out of high school because he could not read the blackboard, and his family could not afford to buy eyeglasses for him.

Competing for Eyes

The history of the availability of eyeglasses to the common man is one of patented innovation. In 1804, the meniscus lens was patented. Patents for innovations to eyeglasses were still being granted in the twentieth century. The first corneal contact lens was patented after World War II, leading to countless papers and several new journals dedicated to the new technology.

Between 1910 and 1997, the number of optometrists in the United States multiplied more than eleven times, versus a doubling of the general population. The real price of high-quality glasses was dropping, making them widely available. Advertising supported competition in selling eyeglasses: a lesson for those who would prohibit it for prescription drugs. In 1963, prices of eyeglasses in American states that restricted their advertising were 25 percent higher than in states that allowed it.

Data series extracted from Statistics Canada’s CANSIM II database show that, between 1985 and 2001, the price of eye care in Canada dropped 23 percent relative to the Consumer Price Index. In 1998, Canadian households’ average expenditure on prescription eyeglasses was $113. In Canada and the United States, innovation and competition quickly brought eyeglasses to everyone.

Great Britain did it differently. The National Health Service (NHS) provided standard, wire framed, widely derided “granny glasses” to citizens. The generally ridiculed granny glasses show how bad the government is at buying health care goods for the individual. First, the government’s agents are not spending their own money. Therefore, they are not motivated to spend it as carefully as the individual is.

Second, there is “information asymmetry.” Even if it is acting in good faith, the government is incapable of knowing what value different individuals put on different aspects of health care. So the committee in charge of buying eyeglasses simply chooses a single product that it finds easiest to manage.

In 1986, the NHS wisely got out of this business by switching to vouchers that people could use t buy glasses of their choice.

Which Shall We Subsidize?

A current example of misguided monopsony is the Reference Drug Program of British Columbia’s Pharmacare, whereby a committee bundles drugs into classes that it believes are therapeutically equivalent. The committee decides which drugs are fully subsidized and which are not.

Pharmacare’s managers invested more than $2 million from various agencies for research into the effects of the Reference Drug Program. The results published so far are unable to say what the effect of the program has been.

The team research ACE inhibitors (used for hypertension and congestive heart failure) concluded: “Further research is needed on the overall health and economic effects of such policies.” Moreover, they wrote, “We could not directly measure all changes in the health status of patients but only changes that led to contact with health care professionals.”

Similarly, the team researching reference pricing of nitrates (used for angina) concluded: “Additional research into the ‘downstream’ consequences of reference-based pricing is therefore necessary to determine the overall effects of the policy.”

Only five drug classes are reference priced, but the committee must approve every subsidized drug. Pharmacare accounts for 53 percent of the province’s prescription drug expenditures. A policy that takes over half of patients’ pharmaceutical budgets and commits it entirely to drugs selected by the government is bound to lead to “granny glasses” style medicine.

The cost of spectacles and contact lenses has fallen dramatically, and quality and choice increased in the last century … not because of the state’s monopsony, but because manufacturers had to compete for every single customer. If governments got out of the prescription drug business, the results would be the same.

John R. Graham is director of pharmaceutical policy research at The Fraser Institute. This article, with extensive references not reprinted here, first appeared in the June 2002 issue of Fraser Forum, a publication of The Fraser Institute. Graham’s email address is [email protected].