July 19, 2002
From the desk of Jane Galt:Well, I'm back, and spoiling
Well, I'm back, and spoiling for a good argument, and here's one ready made: Andrew Sullivan is talking about prescription drug reimportation, as is Glenn Reynolds. Reynolds thinks that reimportation promotes competition. This is true, but in the same way that stealing cars and chopping them up for the parts puts downward pressure on the prices for auto parts in your area. Not having to actually manufacture the parts cuts down on a lot of overhead.
But a common belief, particularly in communities whose focus on Intellectual Property law centers around media content providers, where the incentive and pricing structures are really quite different, although the pricing model is superficially the same.
For now, I am going to ask you to stipulate that, plus or minus 10%, drug prices represent about what the drug companies need to make in order to recover the costs of developing the drugs they made, and get the capital to research more drugs. If this were not the case, my friends, the pharmaceutical industry would be swarming with new entrants. So let's argue about profits another time and cede me the point that, given that pharmaceutical companies sell drugs to Canada for close to what it costs to make and distribute the pills, without including the R&D costs, they cannot sell everyone in the entire world their drugs at this price without ceasing to invent new drugs. Since we all want new drugs, I think most of us can agree that it would be a bad thing if this happened.
So: Pharmaceutical reimportation -- yea or nay?
Let's look at pricing in the two markets. Right now, pharmaceutical companies sell into the Canadian market at a price far below the average cost of each unit of the drugs: the cost you get by taking the total costs of, say, Pfizer, and dividing it by the number of pills Pfizer sells. (I am going to assume that Pfizer sells the same mix of drugs in every country so that we don't have to start doing complicated overhead allocations, 'kay?) In fact, they sell to pretty much every major country in the world at below the average cost of making the drugs; they price very near marginal cost, which is the cost of making one additional pill. Because major pharmaceutical companies do a lot of research and such, the marginal cost of a drug is far, far below the average cost; that's how you can get such a steep discount by buying drugs over the internet from Canadian pharmacies.
Why do they do this? Because they like moose-hunting and Molson? Tee-hee, no; it's because they are dealing with a single buyer for their product in that market; the Canadian government. They can either price low, or forgoe all sales to Our Neighbors to the North. Since they're still making more than the actual cost of making the drug, it's pretty much gravy for them. They sell at the low price.
Can you spot the problem with this arrangement? Yes, that's right -- someone has to pay for all the capital that was tied up in the R&D. And guess who that someone is? Got a mirror handy?
In America, the drugs are priced far higher than average cost -- higher, probably, than they would be if all the other countries allowed prices to float. Not in the short term, of course. But over the long term, the profits would attract other entrants into the market, and prices would fall. You're subsidizing some neurotic Canadian woman with 50 cats every time she pops a Valium and drives to the pharmacy for more Prozac.
This is what's known as the Free Rider Problem. We have a free market that pays for drugs to be developed. Other countries use their legal and economic power to force the price of the drugs their citizens consume down below the average cost of producing the drug, thus appropriating the benefits of the research without paying for it.
The Free Rider Problem is all around us. Take, for example, this web site. Every so often, someone puts money in the tip jar in order to keep the site going. Yet, the other 1599 of you who read this site each day do not. You have chosen to enjoy the many benefits of Live from The WTC without paying for them, secure in the knowlege that someone else, someone with a conscience who cares enough to ensure that they get the finest in political, economic, and bullmastiff-related commentary seven days a week, will do it for you. So you can see how tempting it must be for Canada to do the same thing to us.
Now, let us assume that Senator Wellstone's little foray into Fabian Socialism is actually passed by the house, and drug reimportation becomes legal. (It's not right now, and you'd better hide those Viagra pills before your friend the Sheriff comes over for dinner.) What happens?
Well, first of all, people could start purchasing their drugs from Canada in droves, or they could pay extra for the Made in the USA label. Which will they do?
The difference between prices is large; the price for shipping them is very low. And people hate the pharmaceutical firms, whose products are not only outrageously expensive but often come with nasty side effects, and who have no desperate unions to make commercials touting the "Made in the USA" label. The reason that there is not currently widespread transshipping is that it's illegal; an operation of any size would be noticed and shut down. Economics tells us that arbitrage opportunities, otherwise known as "Free money", do not last long in the absence of government intervention. I think it is likely that prices would, to a large extent, equalize between the two countries over the medium term.
Assuming that they do, in fact, equalize, there are two ways the prices could go: Canada's prices could drift upwards towards ours, as one of Sullivan's readers thinks they will, because drug companies are unwilling to sell at a low price in order to secure the paltry Canadian market. Canadian consumers will be forced to pay the same price we do, and all those people who have been screaming about the wonders of single payer health care are going to find that their fact sheets suddenly look a lot less attractive.
Or our prices could be forced down to Canadian levels, which is what Wellstone hopes.
Which do I think? Well, from a competitive strategy standpoint, Sullivan's reader is absolutely correct; the pharma companies will not underprice themselves in the Canadian market if it threatens their US profits. In a model, the company would do just what he predicts: charge the Canadian government what it charges US citizens, with the same sort of volume discount they offer all large health insurers. (A health care analyst once told me that the Canadian government insures fewer people than Aetna. So in a sense, we have a single payer system. We have dozens of them. ;-)
Only there's one little problem with the model: the government is not a normal market. Aetna may be bigger, but Canada can beat it even fighting out of its weight class. Why? Not, thank you my little lefties, because the government is efficient or just or thrifty or just a better negotiator. But because Canada has an unbeatable hand.
It can break the patent.
If drug companies try to charge the Canadian government what they charge Aetna, the Canadian government can do what Aetna can't: authorize companies to legally produce generic substitutes. All the instructions are on file in our patent office and with our FDA; it wouldn't be hard. This is, in fact, what many third world countries do.
And actually, the companies don't really mind. Contrary to propaganda, Pfizer et al. would be happy to sell into the Indian market at below average cost -- it's gravy to them. What prevents them is not The Evil Corporate Overlords Trying to Make All the Third World People Die, it's the US government. Drug companies used to, in fact, do exactly this, but this gave grandstanding Democratic politicians a platform to decry the drug companies who were Profiteering Off the Backs of Hard Working American Citizens. Now the drug companies don't sell many drugs to the third world, and less developed nations get crappy generics made in often questionable conditions. Everyone wins.
Now, Canada doesn't want to break the patents; among other things, it would put a damper on business growth, as the risk premium on R&D goes up and cutting edge firms seek other locations where their property rights are assured. But I think that it would be politically impossible for the Canadian government to pay full freight on drugs; their health service is already hemorrhaging money. They would simply have to break the patents, or be forced out of office.
In other words, drug reimportation, by my analysis, puts the pharma companies between a rock and a hard place. They can sell to Canada at close to marginal cost and cannibalize profitable sales in the US; or they can let Canadian generic manufacturers do it for them. Companies are not suicidal. They will sell into the US market at the Canadian price plus whatever it costs to ship drugs from Canada, thus making a small premium, but nowhere near enough to cover R&D.
Now, it is possible that the Canadian government, recognizing that we all have an interest in new drugs being developed, will allow the price to rise, or forbid shipping to the US. I think the former is infinitely unlikely, given that allowing prices to float would be political suicide now in exchange for an unrealized public good ten or twenty years down the line. The latter seems slightly more likely, but only slightly; the citizens of Canada who elect them will perceive it as sacrificing a Canadian interest (the generics manufacturers) for an American one (the drug companies).
In the end, I think that reimportation would kill the last profitable large drug market. R&D would, for all intents and purposes, stop. Now, advocates will say that the government can pick up the slack. Come again? First of all, you're talking about a massive budget increase; each drug, remember, takes an average of $800 million dollars to bring to market. (That's just R&D, not sales or what have you.) Second of all, the government does not efficiently allocate research priorities. Pharmaceutical companies look at the size of the market; the government looks at how loud it is. Thus the government spends 10 times as much per victim on breast cancer research as colon cancer, even though the latter is far more likely to kill you; breasts, thank God, are expendable and easy to examine.
Yes, there are all those lifestyle drugs. Like. . . Rogaine and Viagra and . . . oh, shut up, you Nazi, I'm sure there are more.
We can all probably agree that curing baldness is not as pressing a need as, say, curing cancer. But when you start talking about "lifestyle drugs", watch out -- you might find out that your idea of a crippling illness is someone else's idea of a "lifestyle" -- probably the taxpayer who's picking up the check, which is why in Canada heart bypass surgery is "elective". And in fact, political factors already sway pricing -- if you look at drug prices, you'll see that the more optional a drug is, the higher its price over its average cost. Pharma companies have no fear that a coalition headed by Jason Alexander is going to descend on Washington to demand that the Senate do something about the high price of Monoxidil.
The point being, we are not going to save an enormous amount of money by getting rid of those useless "lifestyle" drugs; if they really are inessential, they're subsidizing the drugs that save lives. And if they aren't, a loud group somewhere is going to demand that we do something about the problem, double quick -- and we're right back where we started.
So I think that reimporation would, yes, pretty much eliminate the development of new drugs. And I think that that would be a bad thing. And I hope to God that we elect a Senate with some sense come November, before they can legislate away my chances for a healthy old age.
Posted by Jane Galt at July 19, 2002 04:07 PM | TrackBack | Technorati inbound links