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Martin Shkreli raised his drug's price 5,500 percent because, in America, he can


Daraprim is a small, white tablet that looks a lot like aspirin. It was created in the 1960s and treats a parasitic infection called toxoplasmosis. And, in August, a pharmaceutical executive named Martin Shkreli decided to hike Daraprim's price increased 5,500 percent.

Shkreli was arrested Wednesday on charges of security fraud. He is accused of taking stock from a biotech company he founded and was later pushed out of, Retrophin, in order to pay off debts from another one of his businesses, a hedge fund that lost more than $7 million in 2011.

But that's not the reason that some have dubbed Shkreli "the most hated man in America." Much of that has to do with how Shkreli took advantage of American drug pricing policy.

The story of Martin Shkreli and Daraprim's giant price increase is, more fundamentally, a story about America's unique drug pricing policies. We are the only developed nation that lets drugmakers set their own prices — maximizing profits the same way that sellers of chairs, mugs, shoes, or any other seller of manufactured goods would.

In Europe, Canada, and Australia, governments view the market for cures as essentially uncompetitive and set the price as part of a bureaucratic process — similar to how electricity or water are priced in regulated US utility markets.

Other countries do this for drugs and medical care — but not other products, like phones or cars — because of something fundamentally unique about medication: If consumers can't afford the product, they could have worse odds of living. In some cases, they face quite certain odds of dying. So most governments have decided that keeping these products affordable is a good reason to introduce more government regulation.

When drug companies set their American prices, they don't focus on the price of making the pills. Instead, they look at what their competitors already charge for similar products — and try to land their price somewhere in that same range, regardless of production costs or how good the drug actually is. Since most drugs are already expensive, new drugs keep matching those prices.

And if you're a drug company that produces the best cure for a disease (as Turing does for toxoplasmosis), this makes a ton of sense: You have consumers whose life, quite literally, depends on buying your product. This is what Shkreli talked about, quite bluntly, in a Bloomberg interview in September.

"We know these days that modern pharmaceuticals and cancer drugs can cost $100,000 or more," he said. "Daraprim is still underpriced compared to its peers."

The real question at the heart of the Shkreli outrage isn't why one pharmaceutical executive decided to hike a drug price. The real question is why other companies aren't taking advantage of the pick-your-price nature of American pharmaceutical policy.

On American drug prices, "the sky is really the limit"

Drug pricing follows a predictable pattern in most developed countries. In places like Spain, the United Kingdom and the Netherlands, the government sits down with drugmakers and haggles over how much they will pay. Each country uses a different process, but the goal is the same — to balance drug companies' pursuit of profit with the public's interest in making useful treatments widely available and affordable.

The United Kingdom, for example, runs its bargaining through the National Institute for Clinical Evaluation (NICE). NICE exists solely to decide at what point a new treatment is cost-effective: when it will save the health-care system money, in the long run, by preventing further disease. NICE runs dozens of these analyses each year, on drugs and surgeries and scanning devices. And it uses its findings to tell medical manufacturers: This is the price our country will pay for your service.

In the United States, there's no such negotiation process to speak of. Federal law bars Medicare, the country's largest insurance plan, from even trying to negotiate bulk discounts with drugmakers. Once a pharmaceutical company sets its price, the government-run plan that insures 49 million seniors is required to accept it.

"For Medicare, the sky is really the limit," said Jamie Love, who has studied drug pricing and directs the DC nonprofit Knowledge Ecology International.

Other federal programs get certain discounts from drugmakers. Federal law requires that Medicaid, the program that covers low-income Americans, get a 23 percent discount on of all brand-name drugs' sticker prices. Each state's Medicaid program also has the authority to negotiate even lower prices. The Department of Veterans Affairs also negotiates drug prices, as do private health insurance plans.

There are thousands of private insurers, though, and they often have little clout to demand lower prices. Other countries are essentially buying in bulk — like shopping at Costco. The United States does the equivalent of going to the local grocery store — and paying more.

"We don't have a NICE in the United States," said Steven Pearson, founder and president of the Institute for Clinical and Economic Reviews, a nonprofit that evaluates evidence on medical tests. "We have a system that says, ‘If it's better, we have to provide this pill, and you, the drugmaker, get to name the price.' It's not a market. It's a drugmaker saying what they want."

When Daraprim changed the price of its drug to $750 per tablet, large insurance plans might try to haggle with the company, or look for alternative, less expensive treatment options. But Medicare is the country's biggest insurance plan, and it legally cannot try to negotiate down the $750 price. It has to pay it. When the sky is the limit in American drug pricing, the hardest thing for a company to figure out is how high to go.

Forget the $750 pill. The era of the $1,000 pill is already upon us.

A handful of high-profile, expensive drugs have caused similar outrages to the current Daraprim backlash. But drug companies have largely weathered those controversies unscathed, trading a few months of bad press for blockbuster returns.

Consider the case of Sovaldi, a new hepatitis C drug that came onto the market in 2012 at the price of $1,000 per pill. Its maker, Gilead, faced fierce backlash over the price; for an entire course of treatment that lasted three months, the drug would cost $84,000.

Drugmakers — and particularly the makers of Sovaldi — could do this for two reasons that also apply to the Daraprim case. First, there's no regulatory body to tell them not to. But second, and perhaps more importantly, consumers don't have any leverage to not buy their product. Sovaldi was, when it came on the market, the only drug that cures hepatitis C. And pyrimethamine, the active ingredient in Daraprim, is the best treatment for a specific disease (toxoplasmosis). It's important enough that the World Health Organization includes it on its list of essential medications that all basic health-care systems must have.

When Sovaldi hit the market, coalitions sprang up to denounce the high price. Congress launched an investigation into the issue in July. Sovaldi, Sens. Ron Wyden (D-OR) and Chuck Grassley (R-IA) said in a rare bipartisan press release, raises "serious questions about the extent to which the market for this drug is operating efficiently and rationally."

All of these actions were meant to send a signal: It's unacceptable for drugmakers to price their products so high. Pharmaceutical companies will be made to answer for these actions.

It didn't work: While Sovaldi became a poster child for pharmaceutical greed, it has brought Gilead and its shareholders a hefty profit. The drug "catapulted Gilead Sciences into the ranks of the top-selling pharmaceutical companies," the Wall Street Journal reported this summer. Gilead has sold more than 280,000 Sovaldi prescriptions this year, according to a CitiGroup analysis. The company earned $3.5 billion in Sovaldi sales in 2014's second quarter (sales fell to $2.8 billion the quarter after).

Daraprim, in a way, took a page from the Sovaldi playbook: The company sees that it's possible to charge much higher prices for a drug and weather the ensuing storm — with plenty of profit made at the other end.

Shkreli repeats a common pharma refrain: higher prices increase innovation

Shortly after the price hike, Shkreli appeared on Bloomberg to offer one of the pharmaceutical industry's most common defenses of high drug prices: Companies have to charge more in order to develop even better drugs.

"This is a tough disease," he said, "and it requires a lot of attention and focus."

It is definitely true that if the United States began to regulate drug prices, then Turing and Gilead and other pharmaceutical companies would earn less money. One paper in the journal Health Affairs estimates that if the United States adopted European-like price controls, drug company revenue would fall by 20.3 percent.

Researchers have estimated that drug companies devote about 20 percent of their revenues to research and development. So it's probably true that Turing, by charging more for Daraprim, will have more money to spend on researching other toxoplasmosis drugs.

But it's also true that Turing doesn't necessarily have to raise its prices to do that. Pharmaceutical companies have some of the highest profit margins in the health-care sector. The World Health Organization estimates that, internationally, they hover around 30 percent. If Turing is similar to other pharmaceutical companies, it's entirely possible that it could earn a smaller profit and spend more on research.

In the American health-care system, though, there's no reason to do this: Turing gets to choose the price it sets for Daraprim. Other competitors are unlikely to begin producing the medication; although its patents have expired, it still wouldn't be a boon to produce a drug that treats a relatively rare disease.

Shkreli hasn't done much to make himself well-liked in this controversy; he purchased the rights to a Wu-Tang Clan album so he could be the only listener and regular spews insults over Twitter.

But if you want to be angry about the drug price, Shkreli isn't the most sensible target — he's taking advantage of a system that allows drug makers to name their price. Congress has not taken steps that would allow the government to negotiate drug prices, and created a system where pharmaceutical executives like Shkreli can easily win.