Adam Smith's greatest insight was that as long as people are free to engage in voluntary economic interactions, their self interests will advance the public interest.
The value that people attach to the goods and services they buy from companies is shown by the price they are willing to pay for them. The costs of producing those goods and services represents the opportunity cost that society pays to consume these goods. When the price people are willing to pay exceeds the cost, society gains and companies turn a profit. It would thus seem that the bigger the profits, the bigger the gains for society. However, corporate profits are not always a good guide to the value that companies create for society.
The problem occurs when greed replaces self-interest. Greed is not rational or calculating. In the long run, it serves neither self nor public interest. Self-interest is rational and enlightened. It makes a firm worry about the consequences of its actions. It promotes honesty and fair dealing. It is more concerned with long term profits over short term gains.
In addition, self-interest works for the public interest only under certain circumstances. One requirement is that firms be in competition with each other. When competition begins to be less than perfect, a company's profit measures market power, not social gain. In addition, for private enterprise to advance the public good, prices need to reflect the true social costs and benefits. Many transactions, however, have side effects - externalities - which are not taken into account. When prices fail to include these externalaties a wedge is driven between the private and public costs and benefits. This results in society consuming too much of a good when there are negative externalities and under producing a good when the externalities are positive. Letting markets set prices is the best policy if there is perfect competition and externalities are few.
The pharmaceutical industry has often come under scrutiny because of the high prices of drugs. On Wednesday, February 15, Genentech announced plans to offer Avastin, a drug already widely used for colon cancer, as a new treatment for breast and lung cancer. It also plans to charge about $100,000 a year for it. Avastin currently costs $50,000 a year as a colon cancer drug.
Avastin's new price would raise its annual cost to a level typically found for medicines used to treat rare diseases that affect small numbers of patients. These drugs are usually very expensive because of the high cost of research and the small markets they serve. However, this is not the case for Avastin, which is already a billion-dollar drug and which could potentially tap into a patient pool of hundreds of thousands of people.
Until now, drug makers have typically defended high prices by noting the cost of developing new medicines, but executives at Genentech are now using a different argument. They say that the high price of Avastin is justified because it represents the value of this medicine to society.
This is debatable. Avastin extends the life of a typical patient with late-stage colon cancer by only five months. When used to fight late-stage breast and lung cancer it will add several months to the lives of patients. These are modest gains. They do not bring huge benefits to society. In addition, such a high price will price many patients out of the drug, which certainly is not beneficial to society. Purchasing luxury goods may be beyond the means of most people. However, there is a big difference between a luxury good and health care. Cancer drugs are necessities, not luxuries, and they should be priced as such.
Because markets adjust automatically, if Avastin's price is too high it will have to come down to increase demand. This also might lead to the production of a generic version and encourage other pharmaceutical firms to produce a similar drug. The market will regulate itself; however, this takes time. The fact that prices will go down eventually does not address the current problem: such a high price could deny many patients the right to health care because they will be forced to look at Avastin as a luxury good.
It seems that the real reason Genentech is charging such a high price for Avastin is not because of its potentially huge benefit for society but rather because it thinks it can get away with it. This is not self interest but greed, and greed, unlike self interest, does not promote the public interest.
