Friday, August 26, 2016

Drug Companies Aren't That Profitable

Mylan is under attack for the EpiPen price hikes. The way U.S. healthcare works is there's a Byzantine system of prices. The ACA causes people to lose health insurance, or to see their coverage shrink. Everyone understands that paying more for less healthcare is how the ACA is designed to work, but many do not know this also applies to paying retail prices for drugs. The lie told by some, and misunderstanding by others, is that drug companies are someone looting the public.

Without going into all the details of profitability and financial statements, I can quickly debunk the idea that drug companies are super profitable by doing a simple thought experiment with a testable hypothesis. If drug companies are becoming more profitable, then their stocks prices should be rising much faster than the broader market because investors will bid up the stocks of companies with earnings rising faster than the rest of the market. Healthcare inflation is the highest of any industry since 2000, so clearly there's lots and lots more money being spent on healthcare. If drug companies are helping to drive up prices, their stocks should be destroying the competition as ever increasing profits flow to their shareholders. If instead they are not beating the market, if they perform as well as other stocks, it signals the system is seriously messed up. All this extra money being spent on healthcare isn't showing up as higher profits.

The chart below shows General Electric (GE), Wal-Mart (WMT), Pfizer (PFE), a Pharma ETF (IHE), a biotech ETF (IBB) and paint maker Sherwin-Williams (SHW).

The 20-year chart of these stocks shows paint maker Sherwin-Williams was the most sought after stock. Wal-Mart (WMT), a now struggling retailer losing out to online sales, has performed far better than drug companies. If I stretch it back to 1990, Pfizer does well thanks to a run-up in the 1990s, but Shermin-Williams still annihilates the competition and most drug companies are still middling performers.

Healthcare is the largest bubble in the American economy, destroying hundreds of billions of dollars of economic output each year. Only education and various government programs (from defense to welfare) come close to being as large of an economic sinkhole. A free market reform of the sector would lead to a collapse in healthcare spending. Government spending might increase because market prices would be above Medicare's price controls, but total spending would drop because those prices would be far below "retail" prices. The out of pocket cost for most services would be low enough that middle class families could pay without insurance, getting by on a catastrophic insurance plan to cover medical emergencies. Efficiently run companies creating value would see their profitability soar; many would cease operations.

Drug companies aren't individually lobbying to make drug companies profitable. The government steps in and screws up the system, to the point where perfectly healthy companies will go out of business due to the government action. The lobbyists step in to make everyone profitable and the result is higher overall healthcare spending. It is how the progressive government solves every conflict: with more spending on everything. The assumption is resources will never run out and there will never be a price to pay for inflating the money supply.

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