Bargaining and International Reference Pricing in the Pharmaceutical Industry

The United States spends twice as much per person on pharmaceuticals as European countries, in large part because prices are much higher in the US. This fact has led policymakers to consider legislation for price controls. This paper assesses the effects of a US reference pricing policy that would cap prices in US markets by those offered in reference countries as proposed in the H.R.3 Lower Drug Costs Now Act of 2019. We estimate a structural model of demand and supply for pharmaceuticals in the US and reference countries like Canada where prices are set through a negotiation process between pharmaceutical companies and the government. We then simulate the counterfactual international reference pricing equilibrium, allowing firms to internalize the cross-country externalities introduced by this policy. We find that such a policy results in a slight decrease in US prices and a substantial increase in reference countries prices. The magnitude of these effects depends on the number, size and market structure of references countries. Overall, we find modest consumer welfare gains in the US but substantial losses in reference countries suggesting that this policy may not be the bet way to introduce price controls in the US.