They are all products made by companies that have been prosecuted for price fixing by the US Department of Justice. In reality, industry players operated as a cartel, colluding to set high prices.
While the idea of a cartel may bring to mind shadowy groups that distribute illegal products, the concept is also relevant to everyday business. “It’s not always sophisticated criminals and dark alleys,” he says Amanda Stark, associate professor of strategy at the Kellogg School. “And, in this case, they’re very bad at it.” However, it is still a crime with a large negative impact on consumers, who are stuck with higher prices than the natural competition would have.
As a health economist, Starc was interested in how cartels could affect drug pricing. This was in the heart of 2020 DOJ case against Teva Pharmaceuticals for its efforts that began in 2013 to raise generic drug prices in coordination with other drug companies. However, the DOJ case is ongoing the company paid $420 million to settle a lawsuit brought by investors without admitting wrongdoing.
The intended benefit of generic drugs is, of course, that they cost consumers less. Teva’s alleged collusion — which the government alleged was carried out through emails, LinkedIn messages, in-person conversations and other means — led to price increases for generic drugs that cost consumers, insurers and the government hundreds of millions or even billions of dollars.
The case and related documents allowed Starc and co Thomas Wollmann of the University of Chicago to study the dynamics of cartel behavior: not just how it affects prices, but what might limit collusion among drugmakers.
There are two possible ways this could happen, says Starc. A cartel member could go rogue and set lower prices. “But in this industry, other members would know right away, so that’s not going to happen,” he notes. Or, more likely, a new company could enter the market willing to set lower prices.
“If there’s no entry,” says Starc, “consumers are going to be in big trouble, potentially for a long time.”
In studying Teva’s alleged collusion, the researchers showed that when certain drugs are targeted by cartels, prices for those drugs rise—as does the number of new companies entering the market to make that drug. While increased entry eventually lowers prices, it can take years, in part because of FDA delays for new drug applications.
Starc suggests that reducing FDA delays, or even shifting the cost of implementing new drugs to taxpayers, could significantly reduce price-fixing: “The goal is to make markets more competitive and better for consumers.”
Comparison of scheduled and non-scheduled drugs
The investigators compared parts of the generic drug market where Teva allegedly used cartel behavior with those where it did not.
“We knew there were many markets Teva was active in, but it chose not to form a cartel,” says Starc. “It had to do with where Teva executives knew people.” For example, evidence of price-fixing was observed in drugs for cancer, arthritis and hypertension, but not in products for some other conditions.
This allowed for a natural experiment of how cartel behavior affected both prices and firm entry. They looked at the amount of generic drugs sold under prescriptions, mostly by Medicaid. point-of-sale prices for drugs; and steady-state entry patterns based on new drug applications submitted to the FDA. The data the researchers constructed covered the period from 2008 to 2019 and included over 400 drugs.
Increased prices, Delayed entry
As expected, the researchers found that the prices of generic drugs increase significantly in the areas where the cartels are supposed to have formed. The authors write, “collusion leads to steep price increases, averaging 40-50 percent.”
Moreover, “prices remain quite high, even after the complaint is filed,” says Starc. “I’ll paraphrase a good quote from the legal complaint: ‘Collusion is hard to start but easy to sustain.’
She explains: “Once cartel executives reach a new price level, they don’t need to talk to each other, or play golf or go on girls’ nights out to achieve it. They just keep the prices where they are. So someone has to come along to disrupt that, or prices will stay high, even when the DOJ comes knocking on your door.”
But there was also good news. The study did reveal an increase in new entrants to cartelized markets. After collusion, 30-40 percent more new drug applications were filed with the FDA than in non-collusive markets.
This eventually reduced prices, but the reduction was slow. “We shouldn’t expect prices to immediately go back to where they were before the cartel,” says Starc. This is because new entrants arrive in part to take advantage of the high profit margins that cartelized markets represent, so they set prices slightly below those of incumbents initially, with natural competition driving prices down over time.
However, the researchers found that industry finances were not the only factor leading to the delay in lower prices. The FDA’s large backlog of drug manufacturing applications is also to blame.
“Companies that tried to enter these markets were delayed by an order of magnitude of years, not months,” says Starc. “And every month that goes by is a month where consumers face increased prices.” Indeed, by the researcher’s calculation, the average delay was two years. They also found that reducing regulatory delays by one to two years could mean up to $1.5 billion in generic drug savings for consumers.
An effective (but unpopular) solution
So what’s the best way to combat cartel pricing in generic drugs?
Legal action – in the form of antitrust enforcement – is important, but not enough, suggests Starc. “The reason it’s insufficient is that we know prices will potentially remain high even after enforcement because of the ‘hard to start, easy to maintain’ concept,” he says.
A more comprehensive approach would make it much easier for businesses to enter these markets. “This is not the job of the antitrust authority but of the FDA,” says Starc.
Because it can be difficult to get the FDA to work faster, Starc offers an innovative, if potentially hard-to-sell, route to ease entry. “The FDA charges companies application fees to get approval for entry, and that helps fund the agency, but it can limit entry. It might make sense to just fund the FDA with tax dollars and not charge application fees,” he says. This would allow the FDA to hire more people to expedite the review. “We would have more entry, and the additional competition would lower the price of drugs for consumers enough to offset any additional taxes”—as indicated by the billions in consumer savings the study revealed.
“American taxpayers should be very happy with this deal,” says Starc. But he acknowledges the challenge of asking people to pay even a penny more in taxes: “It’s probably my least popular policy proposal ever!”
Still, it’s a better plan than hoping that widespread cartel behavior will somehow stop on its own. “We have seen antitrust authorities investigate a number of cases in various industries. And those are just the ones that catch on,” he says. “So we need to do everything we can to make markets competitive and lower barriers to entry. If they know someone is going to come right in and undercut them, they have less incentive to conspire to raise prices.”
