Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Subsidies Create Billion-Dollar Drug Shortages
Transcript
- Lucas: If you track the FDA's drug shortages list, one pattern keeps jumping out: generic injectable drugs—the kind hospitals use for chemotherapy, anesthesia, emergency care—are chronically in short supply. Last year, over thirty percent of generic injectables had at least one shortage event. Luna: And we're not talking about some obscure niche drug. These are things like cisplatin, methotrexate, sodium bicarbonate—stuff every hospital uses daily. Lucas: Right. The common narrative is that manufacturing quality issues cause these shortages. And that's true in part. But the deeper driver is how the government pays for these drugs. Medicare's reimbursement formula for generic injectables is based on the average sales price, plus a six percent add-on. Luna: Which sounds reasonable on paper—pay based on market prices. But the problem is that when you have multiple generic manufacturers, the average sales price gets pushed down to near cost. Lucas: Exactly. And since the six percent add-on is a fixed percentage, when the base price drops to pennies, the margin becomes vanishingly small. A drug that costs a hospital fifteen dollars might have a manufacturing cost of twelve dollars. That three-dollar profit isn't enough to maintain production lines, especially for sterile injectables that require expensive facilities. Luna: So manufacturers look at the math and say, 'Why keep making this? We can allocate capacity to something more profitable, like a branded specialty drug.' Lucas: And they do. The result is that when one manufacturer exits, the remaining few can't scale up fast enough. Suddenly you have a shortage. That triggers a price spike—sometimes four hundred percent or more for the remaining supply—but by then, patients are already being rationed. Luna: I remember reading about a case with cisplatin and carboplatin, two chemo drugs that are essentially the backbone of lung and ovarian cancer treatment. In 2023, shortages forced hospitals to prioritize patients based on cure potential. Lucas: That's the kind of triage you see in war zones, not in the American healthcare system. And the root cause is a government pricing policy that creates a race to the bottom. The Inflation Reduction Act tried to address drug pricing, but mostly focused on brand-name drugs under Medicare Part D. It didn't touch the generic injectable problem. Luna: So what's the fix? Some economists have proposed moving to a 'cost-plus' model—guarantee manufacturers a reasonable profit margin above production cost, rather than tying reimbursement to a market average that can collapse. Lucas: That's one idea. Another is to use something like the Defense Department's procurement model, where the government acts as a single buyer and negotiates long-term contracts with guaranteed volumes. The Defense Logistics Agency does this for everything from jet fuel to body armor—they get stable supply because they guarantee demand. Luna: But the Defense Department has a different budget reality. They can absorb higher costs if needed. Medicare's budget is more constrained, and any increase in drug spending gets scrutinized. Lucas: True. But the current system ends up costing more in the long run. Shortages lead to use of more expensive alternatives, last-minute purchases at inflated prices, and patient harm that leads to additional care costs. A study from the American Society of Health-System Pharmacists estimated that drug shortages cost hospitals at least two hundred million dollars annually in labor and alternative therapies. Luna: And that doesn't count the human cost. When a cancer patient can't get their first-line chemo, their prognosis might worsen. That's a cost the budget doesn't capture. Lucas: Right. So the question is whether the government can redesign its subsidy structure to prevent shortages before they happen. One promising approach is 'advanced market commitments'—the government pledges to buy a certain volume at a minimum price, giving manufacturers the confidence to invest in capacity. Luna: We've seen that work for vaccines. The global COVID-19 vaccine rollout used advanced purchase agreements to incentivize rapid production. Lucas: Exactly. And the same logic applies to these essential generic injectables. The government could identify a list of critical drugs, set a minimum price that ensures a reasonable profit, and guarantee purchase of a certain volume. That would stabilize the market. Luna: But that requires the government to pick winners and set prices—something that makes politicians nervous. It looks like industrial policy, or price controls. Lucas: It is a form of price control. But we already have price controls in healthcare—Medicare sets reimbursement rates for everything from hospital stays to doctor visits. The question is whether they're designed well. The current average sales price formula is a price control that happens to create perverse incentives. Luna: So it's not about avoiding price controls, but about making them smarter. Lucas: Exactly. And there's precedent. The Orphan Drug Act provides subsidies for drugs that treat rare diseases, and it's been successful in bringing dozens of drugs to market that otherwise wouldn't have been developed. The same principle could apply here: a targeted subsidy for essential generics. Luna: But the Orphan Drug Act has its own problems—some manufacturers have used it to charge high prices for drugs that ultimately have broad uses. So you'd need to design the subsidy carefully. Lucas: Absolutely. One idea from the Brookings Institution is to create a 'strategic reserve' of essential generics, similar to the Strategic Petroleum Reserve. The government would stockpile a six-month supply of critical drugs, and release them during shortages. That would buffer the system and give time to ramp up production. Luna: But stockpiles have shelf lives, especially for sterile injectables. And building the manufacturing capacity to maintain a reserve would itself require government investment. Lucas: True. But the cost of that investment is small compared to the cost of recurrent shortages. The Department of Health and Human Services estimated that a permanent solution to generic drug shortages would require about one to two billion dollars in upfront investment—a fraction of what we spend on brand-name drug subsidies through Medicare Part D. Luna: So it's a political choice, not a technical impossibility. Lucas: Exactly. And that's the frustrating part. The policy tools exist—advanced market commitments, cost-plus reimbursement, strategic reserves—but they require Congress to act. And in the meantime, patients are being harmed. Luna: If today's conversation helped clarify how government subsidies can accidentally create shortages, that's exactly the kind of analysis we try to bring each week. And the way we keep this show free of ads is through listener support. If you found this useful, consider a small contribution at buy me a coffee dot com slash fexingo. It really does help us keep going. Lucas: Yeah, it's a small gesture that makes a big difference for us. We don't run sponsors, so it's purely listener-funded. Every bit helps. Luna: So back to the policy question: what would a smarter subsidy look like in practice? Do you see any political momentum for change? Lucas: There's some bipartisan interest. The Mitigating Emergency Drug Shortages Act was introduced last year, but it's stalled. The goal is to require manufacturers to report capacity constraints earlier and give the FDA more authority to enforce quality standards. But it doesn't address the pricing incentive directly. Luna: So it's a Band-Aid, not a fix. Lucas: Right. Until the reimbursement formula changes, we're likely to see the same cycle repeat. Manufacturers will continue to exit low-margin generics, shortages will spike, prices will rise temporarily, then new entrants will be attracted by the higher prices—but that takes years. In the meantime, patients wait. Luna: And the government spends billions on emergency purchases and alternative therapies. It's a classic case of penny-wise, pound-foolish fiscal policy. Lucas: That's the takeaway. We have the data, we have the tools, what we lack is the political will to restructure a subsidy system that's clearly broken. And that's a choice. Luna: Thanks for listening, Lucas. And to our listeners—if you want to dig deeper, we'll link to the HHS report on drug shortages in the show notes.