External Reference Pricing: How One Country's Drug Price Follows Another's

External reference pricing, sometimes called international reference pricing, is a method for setting a medicine's national price by comparing it to what a defined group of other countries pays, then applying a formula such as the average, the median, or the lowest price in that basket. A country using this approach is, in effect, letting its own price follow the prices posted elsewhere. The method is common across Europe and beyond, and it appeals to policymakers because it is easy to describe. Whether it delivers durable savings is a more contested question than the mechanism's simplicity suggests.

This article explains the mechanism and the trade-offs economists debate, without endorsing or ranking any country's system. It is educational and not medical or policy advice.

How the mechanism works

Three design choices define any reference-pricing scheme. The first is the basket: which countries a regulator looks at. A systematic review by Kanavos and colleagues in the European Journal of Health Economics gathered evidence from 21 countries that use reference pricing as a primary or supplementary tool, and found basket sizes ranging from a handful of neighbors to more than two dozen countries. Regulators tend to pick reference countries by geographic proximity, comparable income levels, or simply because those markets are expected to produce a desirable price.

The second choice is the formula. Some countries anchor to the average or median of the basket; others take the single lowest price they can find. Lowest-price rules exert the most downward pressure, but they also make a country's price hostage to the cheapest market in its reference set.

The third choice is timing. The same review found that about a third of countries recalculate a reference price only at launch, while others revise on annual, biannual, or multi-year cycles, or ad hoc when new evidence appears. Frequent revision with a large basket and a lowest-price formula produces the strongest downward push. Infrequent revision lets a price drift away from current market reality.

The opacity problem

Reference pricing depends on being able to see what other countries actually pay. In practice, that visibility is limited. The review reported that countries relying on reference pricing tend to adopt "increasingly fictitious list prices" that sit systematically and substantially above the prices actually transacted. The reason is that much of the real discounting happens through confidential rebates, clawbacks, and managed-entry agreements that never touch the published list price.

This creates a feedback loop. If a country benchmarks to another country's list price, and that list price is inflated to protect confidential discounts, the benchmark imports the inflation rather than the discount. Each country has an incentive to keep its headline price high so that other countries referencing it do not drag real revenue down. Over time, the gap between what a price says and what a payer pays can widen, which is precisely the opacity that makes reference pricing harder to evaluate.

Launch sequencing effects

Because a low price in one country can cascade into every country that references it, manufacturers have a reason to manage the order in which they launch. The evidence describes companies delaying regulatory or pricing submissions in lower-priced markets to avoid setting a benchmark that pulls down revenue elsewhere. The review documented Belgium as a case where firms systematically delayed dossier submission, and it identified 11 products across seven European Union countries that manufacturers chose not to launch at all, in order to avoid an expected low price.

The consequence is a distributional one. Larger, higher-priced markets tend to see new medicines first, while smaller or lower-income markets may wait longer or, in some cases, not receive a product. Reference pricing can therefore contain a country's per-unit price and, at the same time, affect when and whether its patients gain access. That tension between price and availability is central to why the mechanism is debated rather than simply adopted.

Why the savings are contested

Short-term price reductions are well documented. The review cites examples of single-digit to double-digit percentage decreases after countries introduced or tightened reference pricing. But it also describes a "fadeout effect," in which the savings erode as list prices adjust upward, baskets stop reflecting real transaction prices, and manufacturers adapt their launch and discounting behavior. Whether reference pricing can keep reducing prices over time, the authors conclude, remains unclear.

Two features of the underlying evidence deserve emphasis. First, quality is limited: from nearly 7,000 database hits the review included 45 studies, and only three used rigorous empirical designs, leading the authors to rate the overall evidence as very low. Second, most estimates measure list-price movements, not the confidential net prices that actually determine spending. A method whose visible savings are measured on prices that are themselves partly fictitious is difficult to judge with confidence.

The United States illustrates a related policy fork. Rather than adopt reference pricing, the Inflation Reduction Act created a domestic negotiation program in which the Secretary of Health and Human Services negotiates a maximum fair price for selected high-spending drugs, weighing statutory factors such as research and development costs, production costs, and prior federal support, as a Congressional Research Service report on the program describes. Separately, a May 2025 executive order directed agencies to pursue a "most favored nation" approach that would tie certain US prices to the lowest price paid in comparable developed countries, which is reference pricing applied to a large market rather than a smaller one. The same mechanics that shape savings and launch behavior abroad would apply, with a large market setting the benchmark.

The bottom line

External reference pricing is a rule for importing other countries' prices through a chosen basket, formula, and revision schedule. It can lower a launch price and is administratively simple, which explains its spread. Its limits come from the same feature that makes it appealing: because prices reference one another, they push list prices apart from real prices, and they reward launching first where prices are highest. The economics are not settled, and the honest reading of the evidence is that reference pricing can move prices in the short run while its long-run effect on access and spending remains genuinely uncertain.