Generic Drug Price Fixing Highlights Issues Of Oligopoly And Common Ownership

Today's installment of corporate crime involves generic drug makers. The case starts in my home state of Connecticut and our Attorney General George Jepsen. His investigation of collusion and price fixing among generic drug makers has led to a civil suit signed on to by 20 states accusing six generic drug makers of a conspiring to fix the prices of an antibiotic and an diabetes drug. In announcing the suit, Jepsen ominously said, "We believe that this is just the tip of the iceberg. I stress that our investigation is continuing, and it goes way beyond the two drugs in this lawsuit, and it involves many more companies than are in this lawsuit." In what is apparently a pattern in the industry, generic drug makers routinely reached out to rivals in order to obtain some kind of deal or assurance that they would be able to maintain market share and avoid a price war when they decided to sell a new drug. All this happened during frequent meetings at industry conferences, social gatherings, and even via email. One of the companies named in the suit is Teva Pharmaceuticals, an industry leader in generic drugs. Another big name in the generic industry that was also named is familiar to all of us - Mylan. You remember Mylan as the company that jacked up the price of EpiPen, the lifesaving device for those with severe allergies, by over 600% in the span of a couple of years. It has now added price fixing to its already legendary price-gouging and tax desertion. Earlier in the week, the Feds arrested two executives at one of the smaller firms also named in the suit for the price fixing that Jepsen also references. It also appears that the executives embezzled millions from that company as well. Sadly, Jepsen's suit is only a civil case meaning that none of the executives face the jail time they deserve. The federal case, however, may actually end up with executives in jail, but I'll believe it when I see it.

Jepsen's implication that the scope of this price fixing is wide ranging has enormous implications considering that 80% of all prescriptions written in the US are for generic drugs. Thinking about that, it makes you wonder how many billions of dollars these companies stole from all of us via these price fixing schemes.

As with most American industries these days, it looks like the generic drug business is another oligopoly. There are two companies that dominate the industry and then a handful of smaller companies that probably have their own special niche. In all these situations where there is undue concentration in an industry, the temptation to divide up the market so that none of these companies actually compete with each other is immense. And in the rare cases where they do compete, the temptation to price fix so that they all make money is also great. This is clearly what has happened with Teva, Mylan, and the rest of the generic drug makers.

I have written about how the lack of real competition in American business is driving higher profits, lower investment, and a rise in inequality. The share of GDP going to profits has risen dramatically while the shares for labor and capital, in other words, investment have fallen. This does not bode well for the long-term future of our economy. Many studies have shown that increasing concentration in various industries is primarily responsible for this trend. A new study from the National Bureau of Economic Research adds to this finding. The study looks at what is called the "Q" ratio developed by Nobel Prize-winning economist (and my former professor) James Tobin. If the ratio is higher than 1, the result implies that the company should increase investment; below 1 implies there is no incentive for capital projects. Tobin's Q has been very predictive since he developed it back in 1969. For most of this century, the Q has been over 1, indicating that capital investment should be increasing. Instead, the reality is that investment has been weak. The authors of the study point to a number of factors for this, including the increase in those mythical "intangible assets". But by far and away the largest factor is "the increasing concentration of companies within industries and increased 'common ownership' of companies by large investment firms. These 'commonly owned' companies not only don’t invest as much as we might expect given their Qs but instead use these their funds to finance share buybacks and other shareholder payouts. The high profitability of these companies isn’t reinvested in these firms but instead flows to predominantly wealthy shareholders."

It is important to understand that the increased concentration in American industry is in many was linked and even driven by the common ownership of the companies in that industry. Common ownership refers to the fact that the same group of Wall Street firms own significant stakes in all the major players within an industry. As an example, Blackrock, Vanguard, and State Street own the largest bloc of shares of Dupont and its competitor, Monsanto. In addition, they own significant blocs of other competitors, such as Bayer. The incentive for these investment firms is to NOT have these companies compete with each other, because, if one firm gains market share or competes on price, it will do so at the expense of the other. The CEOs in these companies understand who their masters are, so the investment firms do not even have to actively restrict competition in order for to happen. However, when necessary, these investment firms can and do act to suppress competition as they have enough power to restrict proxy access and appoint or control members of the board. For example, an investment manager from Berkshire Hathaway has recently been appointed to the JP Morgan Chase board. Berkshire Hathaway is the largest shareholder in Wells Fargo. What do you think the chances are the JP Morgan is going to aggressively compete with Wells Fargo. In addition, this common ownership has also helped drive the enormous rise in CEO pay as individual CEO performance matters much less to these shareholders than the performance of the industry as a whole. It has driven the enormous increase in profits through the lack of actual competition which is then passed on to rich shareholders and has also increased the practice of share buybacks which only serve to reward those existing rich shareholders again. I suggest you read the whole interview with Martin Schmalz that I linked to above as it is enlightening and focuses on an issue that is broadly overlooked.

If we want to address the lack of investment, stagnating wages, and rising inequality in this country, we need to attack the monopoly and oligopoly powers of America's highly concentrated industries, primarily through stronger antitrust enforcement. But that alone will not be enough. We will also need to break up this pattern of common ownership through stronger regulation and enforcement of ownership concentration, not just in individual companies but also across entire industries. Without that additional step, just breaking up the oligopolies may not be enough to address the structural economic problems we have.