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Appendix D: Commissioned Economic Analysis
Pages 285-322

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From page 285...
... 2021. Where There's a Will: Economic Considerations in Reforming America's Medical Product Supply Chains.
From page 286...
... Firm figures are harder to come by for the generic drugs involved in ongoing shortages, but total demand for these at preshortage prices is probably in the range of $700 million to $1 billion per year; sterile injectable drugs account for a substantial share of the shortage problem. It is worth noting that these are often produced in this country.
From page 287...
... • To bring about changes in medical product supply chains more generally, the federal government would need to take steps that actually change the incentives facing suppliers and purchasers, through some combination of subsidies for preferred activities or outcomes, penalties for the opposite, or regulations designed to achieve those goals, which in turn will often impose costs on sup pliers, purchasers, or both. • The federal government can also facilitate changes in medical prod uct supply chains by generating more information about the ulti mate sources of production for many items, the quality of those products, and the status of existing stockpiles across the country, but by themselves, those steps will not incentivize changes in medi cal product supply chains.
From page 288...
... A general goal is to make the medical product supply chains that yield those products more reliable and secure. In both cases, the basic options under discussion include moving more production of medical supplies to domestic sources, an approach known as on-shoring production, or at least creating more capacity to surge domestic production in a crisis.
From page 289...
... I then examine the benefits that are likely to accrue from having more reliable medical supplies, benefits that would be common to all of the options, to the extent they achieve that goal. Next, I turn to consider in greater detail the four options mentioned above for changing medical product supply chains, including any quantitative information that is available to help think about the costs of the options and the trade-offs among them.
From page 290...
... A PPE Shortages and the COVID-19 Pandemic The pandemic highlighted an important characteristic of current medical product supply chains -- a high reliance on foreign producers, especially China.
From page 291...
... 7  Data on PPE prices and spending in this paragraph and the next one drawn from this report: 2020 HIDA Personal Protective Equipment Market Report, Health Industry Distributors Association (December 2020)
From page 292...
... B Ongoing Problems with Supplies of Generic Drugs A second set of issues arises around the ongoing problems with medical product supply chains, ones that predated the COVID-19 pandemic and are likely to continue afterwards unless they are addressed in a new way.
From page 293...
... With that proviso in mind, the United States, Canada, and the European Union collectively account for 43 percent of the facilities for production of APIs and 59 percent of the facilities for production of FDFs.9 The same FDA report found the following: the number of ongoing drug shortages has recently been increasing after declining from a peak in 2011, and drug shortages have been lasting lon ger, in some cases more than 8 years. FDA analyzed 163 drugs that went into shortage in the 5-year period between 2013 and 2017.
From page 294...
... If buyers would like to have more, but are not willing to pay more for it, then the correct term is scarcity. 12  See pages 36-37 of FDA, Drug Shortages: Root Causes and Potential Solutions.
From page 295...
... The FDA report itself concludes that, taken together, "these findings lead to the hypothesis that drugs that go into shortage are products that companies may not have a strong financial incentive to market or to produce using mature manufacturing quality management." This finding simply begs the question of why producers lack these financial incentives, and why the drugs go into shortage in the first place. The report states that the market does not foster a reliable supply of generic drugs.
From page 296...
... These arrangements also mean that hospitals are often not required to finance any extra costs for drugs in shortage out of a fixed payment per admission. THE BENEFITS OF MORE RELIABLE MEDICAL PRODUCT SUPPLY CHAINS As we consider the benefits of different options for improving the reliability and security of America's medical product supply chains, it is useful and important to distinguish between benefits that may be unique to each
From page 297...
... Some of the benefits of having reliable and robust medical product supply chains will be difficult to quantify. In particular, there may be benefits to national security that stem from being less dependent on or beholden to a given country, but such benefits are inherently hard to measure.
From page 298...
... Based on the study of California cited above, I estimate that through November 2020 there were about 10,000 hospitalizations nationwide among health care workers and other essential workers that could have been avoided with plentiful supplies of PPE. In making that calculation, I estimated that the COVID-19 hospitalization rate among nonelderly adults was about 2.5 percent.
From page 299...
... As noted earlier, a recent study estimated that costs to hospitals dealing with drug shortages were about $360 million per year. These benefits would stem from any approach that achieves the objective of having reliable medical product supply chains, or at least, those that are substantially more reliable than the current arrangements.
From page 300...
... At the other end of the spectrum, steps could be taken to make medical product supply chains more robust without moving any additional production capacity or supplies on-shore, for example, by spreading capacity across more global locations to limit the risk of specific bottlenecks or disruptions. The second and third options represent something of a middle ground, with steady levels of supply being provided largely as they have been, but with added measures taken to ensure that supplies are available domestically in case of a disruption or shortage.
From page 301...
... In principle, global medical product supply chains could be made more diverse, primarily to guard against supply shocks, and at the same time more extensive, primarily to accommodate demand shocks. Ideally, the choice of approaches used, and the particular policy levers employed to pursue those approaches, would be informed by a careful consideration of the costs and benefits involved.
From page 302...
... A recent press report also indicated that production costs for N95 masks are about 25 cents, on average, in China, but can be more than double that amount in the United States.21 Despite indicating a wide range of possibilities, these two data points may actually be compatible, since masks produced in China will have additional costs for transportation to the United States that would make the aggregate costs of supply less disparate between the two countries than their respective costs of production might indicate. Another helpful data point was provided in the Biden administration's recent report on building resilient medical product supply chains.
From page 303...
... Companies responded and built capacity accordingly, but now that the total demand for masks has dropped and foreign supplies are available again, these very companies are having to lay off workers and close down production lines.24 Absent federal financial support or other interventions that make it optimal for purchasers to obtain most or all of their supplies from domestic sources, the United States is likely headed back to the same situation that existed prior to the pandemic in fairly short order regarding medical supplies. Some argue that new production methods, such as continuous production processes, will make domestic production more competitive or 23  See pages 214-215 of Building Resilient Supply Chains.
From page 304...
... Furthermore, the report acknowledged that the problem "is not necessarily an issue of foreign manufacturing because much of the infrastructure for sterile injectable manufacturing is located in the United States owing to the high costs of transporting liquids that often require climate control."26 In other words, natural disasters, pandemics, and other surprises can also disrupt a domestic medical product supply chain. Supply disruptions have happened often with sterile injectable drugs even though their production has been completed on shore.
From page 305...
... The option to create or rely on surge capacity located in other countries is discussed below in the section on diversifying global medical product supply chains. Just how feasible a strategy it is, particularly if demand jumps 10fold or more during a pandemic, and how costly it would be are unclear.
From page 306...
... The same issues arise when considering surge capacity in locations overseas, but at a lower level of spending because production costs are lower overseas. 27  The Defense Production Act became law in 1950.
From page 307...
... For reasons that are not clear, the most recent data on the contents of the stockpile that were available as of this writing is from May 21, 2021, nearly 6 months ago.30 TABLE 2 PPE in the Strategic National Stockpile (Millions of Items) 5/21/21 as Inventory on Inventory on Planned 90-day Percent of Product 2/26/21 5/21/21 Inventory Planned Surgical/Exam 227 516 4,500 11.5% Gloves N95 Respirators 307 424 300 141.3% Surgical/Face 411 273 400 68.3% Masks Surgical Gowns 66 17 265 6.4% & Coveralls Goggles & Face 18 20 18 111.1% Shields 29  Nick Miroff, "Protective Gear in National Stockpile is Nearly Depleted, DHS Of ficials Say," The Seattle Times (April 1, 2020)
From page 308...
... As stated previously, finding data on the costs involved in stockpiling PPE and other key medical supplies was difficult. Nevertheless, there are a few available data points that may be informative.
From page 309...
... The service fee includes the manual and the computational process the contractors need to refresh the stockpile, which is less than the original purchasing cost, because the con tractors could further sell the replaced stockpile to domestic institutions through the joint e-purchasing platform or to other countries through their own channels of distribution.35 Specifically, the authors estimated that the service fee for surgical masks was only 27 percent of the purchase price for those items; for N95 respirators, the fee was 46 percent of the purchase price, and for surgical gowns, it was 34 percent of the original price. A final economic consideration regarding the option to stockpile PPE and other supplies is that the costs of that option will largely be the same regardless of whether the federal government maintains the stockpile itself or imposes stockpiling requirements on states or on health care providers.
From page 310...
... At the same time, diversifying medical product supply chains so supplies come from a broader set of companies, countries, or regions will cost somewhat more than current supplies; if it did not cost more, the supply chain would probably be more diversified already. In other words, the current suppliers and their supply chains are probably the least expensive sources of medical supplies at the quality and reliability levels observed today.
From page 311...
... Because there are no institutions or authorities that can make and enforce international laws, the policies of cooperation that will bring mutual re wards if others cooperate may bring disaster if they do not. Because states are aware of this, anarchy encourages behavior that leaves all concerned worse off than they could be, even in the extreme case in which all states would like to freeze the status quo.36 While Jervis was focused on a situation in which nations wanted to maintain the status quo -- peace -- with a focus on nuclear arms control, the same issues arise when trying to cooperate to improve upon the status quo with respect to global medical product supply chains.
From page 312...
... If the medical product supply chains were able to handle that set of circumstances, they would almost certainly be able to address less cataclysmic events such as natural disasters or regional health crises. A specific question of interest is whether and under what circumstances it may be less expensive to stockpile supplies that are made abroad than to move production on shore.
From page 313...
... 600 million masks = $900 million (3) $Z = Annual cost of maintaining domestic surge capacity for 600 million masks The first expression captures that annual cost of meeting nonpandemic demand levels at domestic prices; the second is the cost of buying the masks needed when the pandemic hits; the third term reflects the annual cost of maintaining domestic surge capacity so that supplies can be ramped up from 50 million per year to 100 million per month when the next pandemic hits.
From page 314...
... Above the Line, Stockpiling Is Cheaper this analysis, I have maintained the assumption that domestic production involves a 50 percent price premium. Above the blue line, stockpiling is the cheaper option, which happens when the next pandemic is expected to occur sooner, or when the annual costs of maintaining domestic surge capacity rise.
From page 315...
... Private actors may also lack the information they need to make the choices that achieve their goals and ideally, to also produce outcomes that are better for society as a whole. Thus, another role for government may be to improve the information available to them that concerns the medical product supply chains.
From page 316...
... Such a step would probably be helpful in improving the reliability of medical product supply chains, particularly for generic drugs. It is worth noting, however, that consumers often have little information about where or how the products they buy are made except for perhaps a "made in" label.
From page 317...
... In addition to regulations primarily affecting the supply or demand of medical products, federal and state regulations for price or payment rates for items under Medicare or Medicaid also have a ripple effect on medical product supply chains, and may need to be reconsidered in light of efforts to improve reliability. Regulations Primarily Affecting Demand.
From page 318...
... Fiona Scott Morton, two widely recognized experts on prescription drugs, argue that drug companies should be required to report detailed information about their medical product supply chains in order to "receive annual approval to sell into the U.S. market, which would create a strong incentive for manufacturers to comply in a timely fashion."40 Furthermore, they propose a new office should be created within the Department of Health and Human Services, but outside of FDA, that would be charged with analyzing and improving the reliability of pharmaceutical supply chains.
From page 319...
... While the specifics differ, it stands to reason that a reduction in revenue for generic drug makers would put pressure on them to adopt lower-cost production methods and to use supply lines that are more vulnerable to disruptions, or at least to limit their investments in robust medical product supply chains. Under Medicaid, the most relevant regulation may be one that was enacted recently.
From page 320...
... C Providing Subsidies or Imposing Penalties If it chose to do so, the federal government could subsidize the higher costs of domestically produced PPE or the higher cost of maintaining robust supply lines for generic drugs in a wide variety of ways: • Medicare and Medicaid payments to hospitals could be increased to reward hospitals that purchase PPE domestically or that main tain robust supply lines.
From page 321...
... As a result, the market price of polluting will settle at the level needed to limit pollution to the prescribed amount. It might seem that imposing a tax on pollution and limiting the quantity of allowed pollution would be equally effective, but an important article in the field of regulatory economics found that in the face of uncertainty between optimal price and optimal quantity, the more efficient approach is to regulate the one which is less uncertain.44 How do these rather abstract considerations apply to medical product supply chains?


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