Trump Says World Is Free-Riding on U.S. Health Spending. He Has a Point.

As Donald Trump awaits a return to office, he is likely to revisit his stance that the U.S. is being “ripped off” by other countries. While his first term focused heavily on trade deficits and NATO contributions, his administration also tried to address global drug-pricing disparities through an executive order. The most-favored nation rule, as the executive order was known, sought to link some U.S. drug prices purchased through Medicare to those of other wealthy countries. Though the order was never implemented because of legal challenges, there are indications that Trump might revive similar efforts. Recently, Eli Lilly LLY 1.80%increase; green up pointing triangle Chief Executive David Ricks, who dined with Trump at Mar-a-Lago, hinted at the possibility of such initiatives resurfacing.

Unlike other countries, the U.S. hasn’t been willing to impose strict drug-pricing controls, leaving Americans to pay about three times more than drug systems elsewhere. While the U.S. accounts for a little over a quarter of the global economy, it contributes about 70% of pharmaceutical profits, according to University of Southern California research.

This is why critics of the U.S. system, including European officials, have long argued that the U.S.’s free-riding problem is self-inflicted and keeps drug prices artificially high. In Europe, pharmaceutical companies face strict price regulations and cost-effectiveness assessments, whereas the U.S. approval process focuses solely on whether a drug is safe and effective, allowing drug companies to more freely set the price of their medicines. Many drugs launched at high prices in the U.S. are unavailable in Europe, where their cost is carefully tied to their perceived benefit.

But it is hard to argue with the idea that, by paying more, Americans seed the rest of the world with innovation. Pharma is an industry in which companies spend the lion’s share of their operating cash flow on research and development, and higher revenues and profits lead to more of it. For instance, when Medicare sharply expanded drug coverage for seniors in 2006, research shows, it led to a jump in new treatment launches. 

Without the massive opportunities in the U.S. market, it is worth considering whether cutting-edge treatments would see the light of day. Take cancer treatments such as Kymriah (developed by Novartis NOVN -0.25%decrease; red down pointing triangle) and Yescarta (developed by Gilead Sciences), which rely on a highly complex process called cell therapy. This involves modifying a patient’s T-cells in a lab to target cancer, with costs often running into hundreds of thousands of dollars per treatment. Adoption of these therapies in Europe took longer than in the U.S., in part because they had to get the green light in many countries.

A similar dynamic can be seen with obesity treatments such as Eli Lilly’s tirzepatide, the active ingredient for its blockbuster obesity drug Zepbound. Although approved in the U.K., the drug’s use has been restricted to a small subset of severely overweight patients, and at a much lower price than in the U.S. 

“To some extent, European consumers are free-riding on the willingness of American society to give new drugs a chance,” says Ed Schoonveld, executive adviser at Schoonveld Advisory and a former pricing executive at pharma companies including Eli Lilly.

Yet, while higher profits generally lead to more drug development, diminishing returns are likely. A group of academics found in 2015 research that the top global pharma companies’ excess drug revenues in the U.S. of $116 billion far exceeded the $76 billion spent on global R&D. In other words, some of the money devoted to overpaying for drugs just leads to better profit margins for pharma.

And there is another catch: While breakthrough drugs such as Sovaldi offer obvious value, the U.S. system currently encourages too much spending on drugs that provide only modest benefits compared with existing generics. Indeed, a 2014 paper by academics at Northwestern University and Johns Hopkins found that the Medicare drug expansion in 2006 only spurred innovation for diseases that already had multiple treatments. 

Patricia Danzon, a health economist at the University of Pennsylvania’s Wharton School, argues that if the U.S. began paying more rigorously for value, companies would focus on developing drugs that deliver meaningful advancements. “We want to be paying for innovation that is worth it,” she says.

As Andrew Lo, a finance professor at the Massachusetts Institute of Technology, points out, society routinely makes decisions to limit spending in other critical areas, such as highway safety, even when it could save lives. Lo suggests a two-tiered system: tighter price controls for drugs addressing well-established health issues, such as insulin for diabetes, alongside higher profits for areas with unmet medical needs, such as Alzheimer’s.

Ultimately, paying less for drugs would mean some reduction in innovation. But, because drugs are a global good, it is reasonable to discuss how the costs of development and access could be shared more equitably. Much like Janet Yellen’s push for a global tax treaty, a better balance in funding drug innovation could make sense. 

Trump’s policy of linking U.S. prices to other countries could theoretically pressure other nations to pay more, but it risks unintended consequences. For instance, pharma companies could pull their drugs out of some European countries, says Dana Goldman, a health economist at USC. Still, he says some countries might be forced to go along if the Trump administration were to deploy a combination of the most-favored-nation rule alongside tariffs.

Getting European countries to pay more, though, is going to be anything but easy. Countries such as the U.K., Germany and France already face stretched healthcare budgets that have sparked political crises.

The broader question remains: How much medical innovation does the world need, and how should it be funded? U.S. spending has long made this calculation easier for other countries. Now, it might be America’s turn to run the numbers.

Write to David Wainer at david.wainer@wsj.com and Jon Sindreu at jon.sindreu@wsj.com