Dramatic increases in the price of generic drugs have focused the attention of policymakers and the public on the limitations of marketplace economics as a means of managing drug costs and access. In recent years, prices have increased sharply for established products that have been in use for 50 years or more. These include colchicine for gout (50-fold), digoxin for heart failure (6-fold), and isoproterenol for heart rhythm abnormalities (5-fold).

In one prominent example, Turing Pharmaceutical raised the cost of pyrimethamine (Daraprim), a 62-year old treatment for toxoplasmosis by over 5,000 percent, from $13 to $750 per tablet. Meaningful intellectual property ownership for these older medications expired decades ago and they are now subject to massive price increases or severe shortages. This need not be the case, and there are remedies to address these problems.

Market Failure And Generic Drugs

The 1984 Hatch-Waxman Act, which gave rise to the modern generic drug industry, was intended to create competition in the production of older, non-patent-protected prescription drugs by providing a shortened pathway for generic manufacturers to obtain Food and Drug Administration (FDA) approval. Instead of requiring companies to conduct expensive clinical trials to prove that their generic versions of old drugs are safe and effective, the 1984 law changed the rules to merely require proof that a generic product is bioequivalent, which usually involves in vitro studies and straightforward pharmacokinetic and pharmacodynamic testing in smaller numbers of patients.

Soon after the passage of the Hatch-Waxman Act, many older drugs attracted generic competition from multiple sources through this relatively inexpensive, abbreviated pathway. Aided by state drug product selection laws facilitating or requiring pharmacies’ automatic substitution of generic for bioequivalent brand-name versions, the price of generic drugs plummeted, reaching as low as 10 percent or less of the price of the original brand-name product once 10 or more companies entered the market. But this trend has recently reversed for some older drugs for which the number of suppliers has dwindled. When fewer suppliers participate in a market, they are able to extract exorbitant prices for a product.

Several factors help to explain this market failure. In the three decades since the enactment of Hatch-Waxman, robust competition in the sale of generic drugs lowered their prices and at the same time severely reduced profits for generic manufacturers, forcing weaker competitors out of business. The growth of chain drug stores and the weakening of independent pharmacies and wholesalers led to consolidation in the distribution of pharmaceuticals and reduced the number of entities that buy generic drugs. This left some generic manufacturers with few, if any, customers even at low prices.

Stronger generic manufacturers such as Teva absorbed numerous competitors. Its 2015 acquisition of Allergan’s generic drug business gave Teva control of 20 percent of the world’s supply of generic drugs, further reducing the number of generic manufacturers serving the US market. At the same time, the requirement for FDA approval of a company’s manufacturing practices for each generic product, often a slow process, raised barriers for new entrants, especially for less commonly used older products.

For many drugs—including staples such as injectable saline solutions—a combination of supply chain disruptions, manufacturing problems, FDA compliance problems, and business failures further reduced the small number of suppliers. As a result, a number of generic products were left with only two or three active suppliers—and some with only one—creating a natural monopoly.

This reduction created a precarious situation that has led to increasingly common episodes of outright shortages of some older generic products. The number of shortages has reached alarming rates in recent years, affecting hundreds of older drugs and leading President Obama to issue an Executive Order in 2011 directing the FDA to take steps to alleviate “a serious and growing threat to public health.” While some progress has been made, shortages continue to exist for many drugs, including older sterile injectable products, such as simple salt solutions vital for the routine care of hospitalized patients.

As a result, while generic drugs overall are still substantially less costly than brand-name drugs, one recent study showed that in 2013, one-third of generic drugs had an annual price increase, with about 10 percent of generic drugs posting an increase of 50 percent or more. Since generic drugs account for more than 85 percent of all prescriptions filled in the US, the economic consequences of even small increases in price across the board are serious for the average consumer and the health care system.

Additionally, the emergence of companies with predatory pricing strategies such as Turing and Valeant illustrates the growth of a new business model in which a company performs no research but simply acquires the rights to an old drug with a natural monopoly and then raises its price to extreme levels. No legislation prohibits these companies from taking advantage of the situation and of the laws of supply and demand.

Unfortunately, there is also no hope of a quick market response. Chronic underfunding of the FDA Office of Generic Drugs has led to a three year-long queue—or more—to review and approve an application to manufacture a generic drug, or to obtain an FDA determination that a factory follows good manufacturing practices. This prolonged delay serves as a powerful deterrent to potential new generic manufacturers, since the time to market and thus the opportunity to recover the cost of approval and earn a profit might be long gone before the FDA approves any competitive product.

A Global Solution To High Generic Drug Prices

Many of the drugs in short supply in the US are currently available at reasonable prices in other industrialized countries, produced by reputable companies that have received approval from regulatory authorities that enforce quality standards comparable to those of the FDA. For example, pyrimethamine, Turing’s $750 drug, costs only about $1 in Canada, Australia, and the UK; isoproterenol injection, Valeant’s $1,347 drug, is about $14 per vial. But those drugs cannot be sold in the US because there is no regulatory mechanism for the FDA to approve a product based on approval in another jurisdiction with comparable standards.

No new legislation is required to fix this limitation in current FDA practice. While the Hatch-Waxman Act requires the submission of evidence sufficient to show that a generic drug is bioequivalent to an existing drug, it does not specify the precise nature of the evidence required. The FDA already permits the temporary importation of unapproved drugs that have been approved in foreign jurisdictions when necessary to alleviate a drug shortage, after ensuring that the drug is of adequate quality.

It also routinely allows US citizens to import prescription medicines approved in foreign jurisdictions for their personal use, and many thousands of patients use the Internet to make such purchases to save money on their medications. In any event, the active ingredients in most medicines sold in the US are manufactured overseas, often in India and other foreign facilities, so that American patients are already filling most of their prescriptions with products made in other countries.

Acceptance of quality assurance determinations by regulatory authorities from advanced countries such as the European Medicines Agency and Health Canada would enable us to overcome our reliance on a strictly US-based approval process that is incapable of keeping up with demand. This bottleneck creates shortages, undermines competition, and poses greater risks to the public’s health than reliance on regulatory processes employed by other advanced nations to ensure the quality of established pharmaceutical products.

Thus far, the FDA has not taken the steps required to alleviate the current crisis on its own, and the Obama Administration’s Executive Order lacks the required specificity to compel the FDA to do so. But that order could be amended to authorize two specific actions aimed at more rapidly reducing generic drug shortages and price gouging.

First, the FDA should be instructed to grant expedited regulatory review to any manufacturer seeking to produce a generic drug for which just three or fewer manufacturers are actively serving the US market. The highest priority should be given to applications to market a drug for which there is currently only one manufacturer.

Second, in reviewing applications for approval of generic drugs, the FDA should be permitted and encouraged to approve a generic product based on data already collected, if that product has been approved by a regulatory authority in another advanced country that enforces standards for good manufacturing practices that are as high as its own. Just as states within the US recognize driver’s licenses issued by other states, it is possible to identify drug regulatory bodies in other nations that have sufficiently rigorous procedures in place and recognize their certification of a given generic product.

Some might raise concerns about the safety of products approved based on reliance on foreign regulatory approval. But no one has suggested that manufacturing standards imposed by regulators in Europe, Canada, or Japan, for example, are meaningfully different (and certainly not lower) than those used by the FDA.

Restoring A Competitive Market For Generic Drugs

The trend towards globalization has increased competition and lowered prices in many aspects of trade. Consumers and companies are free to purchase computers, cars, and produce from all over the world. But pharmaceuticals have been insulated from such global competitiveness.

Generic drugs comprise more than 85 percent of all prescriptions in the US, but account for less than 20 percent of the cost of all medicines. Their critically important role is in jeopardy: changing dynamics in the domestic generic drug marketplace and the time required to gain FDA approval to produce a generic drug have reduced competition among generic manufacturers, which is essential to assure sufficient supplies and reasonable prices.

Only the creation of a global market for generic drugs can restore the healthy balance required to maximize competition, normalize prices, and put those who improperly thrive on market failures out of business. That global market will exist only when we can reduce (or preferably eliminate) the incremental cost and time required to gain approval to market a generic drug in the US if it is already being produced and sold in another advanced health care system.

Eliminating unnecessarily burdensome regulation and maximizing competition are widely supported principles, and the changes proposed could be accomplished within the executive branch without requiring the intervention of Congress. This will benefit the public as well as health care payors, and would disadvantage only a small number of companies that seek to benefit unfairly from market distortions at the expense of health care systems and patients.