Drug companies are this morning braced for a huge change in the way that drugs are priced in an unwelcome report from the Office of Fair Trading.

Reports last night suggested that the OFT was poised to recommend sweeping changes to the Pharmaceutical Price Regulation Scheme (PPRS), under which the prices paid by the NHS are determined.

The OFT has spent 18 months investigating the issue and speculation last night was that it would conclude that the NHS was paying hundreds of millions of pounds too much every year.

The PPRS is a scheme unlikely to find favour with free-market enthusiasts such as the OFT. It does not set prices on drugs, but limits the profits companies can make from them. Companies are free to set their own prices, which on average have tended to be slightly higher than those paid in countries such as France and Germany. The justification for this has been that Britain supports a successful industry second only to financial services as a foreign exchange earner. Sustaining that industry has been seen as a vital interest.

In fact, price differentials have narrowed in recent years, and the large market in the UK for generic medicines (out of patent and much cheaper) means that average prices across the board are no higher here than elsewhere.

The industry defends the PPRS for providing a stable basis for planning. Negotiated every five years, it establishes a sound platform on which companies can introduce products. with confidence.

Nor are price cuts ruled out. The most recent PPRS negotiation produced a cut of 7 per cent across the board so while all other costs in the NHS went up, drug prices fell. Other models of regulation are possible. In France the price of every drug is negotiated individually. But this is time-consuming and can delay new products. In Germany generic and branded drugs are lumped together in the same price set — so branded medicines are cheaper but generics more expensive than in Britain.

International experience shows that pricing drugs in such a way as to provide the incentive for companies to go on searching for new ones is not simple. Just forcing down prices will kill the golden goose.

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