Arnold Kling  

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If I were to attempt to practice medicine without a license, I could be prosecuted. On the other hand, there is nothing stopping a doctor from pronouncing himself an economic expert and recommending price controls. In today's Washington Post, physician Marc Siegel writes,


Price controls, which the Bush administration opposes, would help the Medicare system gain lower drug prices, but why stop there? Congress should also change the laws that prohibit the importation of prescription drugs from other countries, where they are less expensive.

As 'Jane Galt' once put it,

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...
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.

Siegel mentions the issue of research and development for drugs, only to change the subject to drug company advertising. This is a common tactic among those who want to rein in the drug industry. In fact, as 'Jane Galt' points out, "in 1999 the Pharmaceutical industry spent $1.6 billion on consumer advertising." Meanwhile, according to the chart on page three of this report, drug industry R&D expenditures were close to $25 billion in 1999.

Ironically, another article in the Post mentions this NBER working paper by Frank Lichtenberg. Lichtenberg says that his results show that 40 percent of the increase in longevity between 1986 and 2000 is accounted for by new drug discoveries.

For Discussion. Is hostility toward the private sector higher for pharmaceutical companies than for other industries? If so, is there economic justification?


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COMMENTS (27 to date)
Chris writes:

Hi, Arnold. Interesting that the guy is an NYU prof. I am somehow not surprised.

Drug prices have risen along with the increasing number of individuals who have prescription drug coverage as part of their healthcare plan. It would be interesting to see what would happen if the favorable tax treatment of health benefits were eliminated. Would drug companies voluntarily lower prices once the distortion produced by third-party payment is removed?

David Thomson writes:

"Would drug companies voluntarily lower prices once the distortion produced by third-party payment is removed?"

Why should they? Why not just let the free market sort out these matters? As for the foreign countries---I have long argued that the Canadians and others are parasites. Mooching off America is their standard behavior. Let's not forget that the United States also essentially pays for the military defense of Canada.

Did you say that you want drug prices to drop? There are two major ways of accomplishing this goal.

1.) Raise the co-payment requirements so that the patient pays more for their medicine.

2.) Encourage a culture of guilt tripping those who smoke, eat too much, engage in promiscuous sex, and other self destructive behaviors. Why should the rest of us pay for their silliness?

Brad Hutchings writes:

When the pharmaceutical industry has "open source pharmaceuticals", then we can talk about hostility ;-).

I have a problem with Jane's analogy to chop shops though. Drug companies make money by selling to Canada at a price above their marginal production costs. Drug companies are then protected by a combination of laws and licensing agreements from having those discounted prices affect their home markets.

Clearly, proponents of reimporting expect and argue that Americans can get their drugs at the same price as Canadians. I disagree. I do think that reimportation would have the downstream affect of forcing the drug companies to spread their R&D cost structure more uniformly among all customers, and that would result in a very slight overall decrease in prices for us and significant increases for the freeloaders. Follow me for a moment, but this is a lot like Oil Econ 101, except the drug companies and freeloader countries have managed to make sure that they only use Saudi oil, so to speak. Does that make any sense to anyone?

-Brad

Chris writes:

Does anyone think that drug companies could limit their losses due to re-importation by selling only limited quantities to Canada -- only barely enough to cover the needs of Canadians?

Jane Galt writes:

The analogy is not perfect, but closer than you think. Governments in developed countries negotiate with an implied threat that if they do not get a price they like, they will steal the product -- break the patent and allow generic manufacturers to make it. If we look at it in terms of patents, leaving out manufacturing costs (which are generally, although not always, trivial), the analogy is quite apt. It is as if a thief gave you the choice of handing him the keys, or taking the car himself.

Brad Hutchings writes:

But Jane... What would you expect to happen if the drug companies could not block re-importing? I'd assume that if patents were violated, drug companies would go to the WTO with legitimate complaints. I'd also assume that drugs which violated patents could not be imported. So let's consider the case where everyone plays fair with the IP and our government no longer enforces the drug companies' ban on grey market goods. Because if Canada blatantly stole from us, we could make hockey illegal, right?

What I am suggesting is that the drug companies could very well be complicit in the current arrangement because Canada et al are profitable (and probably fairly stable due to top-down decision making) revenue streams. If they weren't incrementally profitable, there would be no incentive for the drug companies to supply those channels at all. By banning reimporting and having the feds enforce the ban, the drug companies eliminate obvious channel conflict over price. And they can get away with charging what each compartmentalized market will bear.

-Brad

Mcwop writes:

Why are prescription drugs and the companies that produce them always the villan? Why are rising drug costs always positioned as the root of medical care price increases?

If price controls are put on drugs then doctor salaries should be controlled too*. How does $75,000 a year sound?

*I do not really advocate this psoition, but am trying to illustarte how arbitrary price controls could be.

Chris writes:

>> Is hostility toward the private sector higher for pharmaceutical companies than for other industries?

A number of individuals have raised this point. I suspect that one aspect of hostility towards the drug industry is that people don't understand how their products work and the benefits are not always obvious. At least if you buy a car or a stereo you have a tangible product. For many of the most popular classes of drugs -- including cholesterol-lowering drugs like Lipitor, blood pressure drugs, and SSRIs like Paxil -- the benefits are not apparent the user for months or even years. People justifiably wonder why they're spending all this money when they don't "feel" any different. Writers like Andrew Sullivan, on the other hand, are partial to the drug industry because they can see the effect of AIDS drugs in their daily lives.

Keith writes:

Dr. Siegal is no more and no less qualfied to pronounce on medical economics then I am to pronounce on computer software economics (I'm a data processing manager).

Bruce Bartlett writes:

It would cut medical costs even more if we forced all doctors to work for the minimum wage.

Arnold Kling writes:

Keith,
Whether or not your are more qualified depends on your understanding of first-year economics. If your knowledge base is as weak as Dr. Siegel's, then as a manager you might want to take an economics class.

Bruce,
your point about physicians anticipates a forthcoming article in TechCentralStation that I just finished. In the article, I draw an analogy between the effect of drug price controls on new drugs and the effect of a reduction in physician payments on the decision of people to attend medical school.

David Thomson writes:

Arnold Kling recently told us about the bizarre reaction of his friends when he gave up his six figure job. They greatly exaggerated the impact of his lost health insurance which comprised a mere fraction of his overall income. How does one explain such weirdness? I’m afraid that we have become a nation of people with misplaced priorities. Some of us don’t think twice about purchasing expensive cars, eating at the very best restaurants, and taking luxury ocean cruises---but we scream bloody murder if our health insurance is increased by a few dollars each month.

Furthermore, what is this nonsense concerning giving more financial assistance to retired people? Aren’t they the wealthiest folks in America?

Bernard Yomtov writes:

The people criticizing Canada for its low drug prices seem mostly to just be complaining that Canada drives a harder bargain than we do, or takes intelligent advantage of its bargaining position.

I see nothing wrong with that, and there's a case to be made, on abstract grounds, that as long as they are paying even a little above marginal cost it helps us.

David Thomson writes:

“I see nothing wrong with that, and there's a case to be made, on abstract grounds, that as long as they are paying even a little above marginal cost it helps us.”

The drug companies were foolish to initially capitulate to Canada’s shenanigans. I personally can understand giving a financial break to Third World poverty stricken countries, but Canadians? These back stabber have long parasited off the United States. Their citizens even had the gall to vote in a national government that despises and insults Americans. It’s time to pull the plug on our so-called Canadian allies. We must not forget that many of them are FRENCH-Canadians.

Eric Krieg writes:

>>Lichtenberg says that his results show that 40 percent of the increase in longevity between 1986 and 2000 is accounted for by new drug discoveries.

Brad Hutchings writes:

Bernard wrote:

[quote]
The people criticizing Canada for its low drug prices seem mostly to just be complaining that Canada drives a harder bargain than we do, or takes intelligent advantage of its bargaining position.
[end quote]

I think you missed the point of my post, which is (to put it another way) to the extent that Canada takes advantage of US laws that restrict drug reimportation in order to secure a little sandbox market where the drug companies can make money on incremental sales at a clearly below market price, some group of players are doing something ethically shady.

Still, nobody here has addressed or predicted what the effect on drug prices would be if the drug companies and freeloader nations could not put great walls of china around their market segments using the laws of this country.

Being for "free markets" cuts both ways. A "free market" political position on tarrifs and legal barriers that restrict trade in ways that allow the Canada situation would be to remove those tarrifs and barriers. Free markets don't just work to companies' and countries' advantages -- they work to consumers advantage by not artificially distorting price.

-Brad

Eric Krieg writes:

>>Still, nobody here has addressed or predicted what the effect on drug prices would be if the drug companies and freeloader nations could not put great walls of china around their market segments using the laws of this country

Bernard Yomtov writes:

Brad,

Maybe I did miss your point. I wasn't referring to your specific post.

Your first post suggests, correctly, that it is the drug companies who are taking advantage of the ban on reimportation. This lets them engage in textbook monopoly price discrimination, keeping markets separate so they can charge different prices in each.

Of course it is Canada's negotiating stance that makes this happen, and I was just pointing out that it seems unfair to criticize somebody for getting themselves a better deal than we get.

Jane claims that part of the strategy is to threaten to break patents, but my impression, subject to correction, is that it is developing countries, such as Brazil, that are doing this, not Canada.

I confess to some sympathy for poor countries who do this. What is the actual cost to the US of drug companies selling to Brazil at marginal cost? The practice clearly raises overall social welfare. Does refusing to do so really raise our prices significantly, or even noticeably?

Maybe we should bar reimportation from poor countries, but not from rich ones, to make this process easier. Or maybe the developed world should do this en masse.

Utopian, no doubt.

Brad Hutchings writes:

Eric asked:

[begin quote]
Isn't the basis for reimportation prohibition the same as requiring a doctor's prescription to buy drugs? Remember that most countries do not require a doctor's prescription.
[end quote]

The road to hell is paved with good intentions. Or maybe not even paved in this case. I'm a bit of a cynic, but I detect an old, worn out slurry coat on this road. Meaning... Those who benefit from this arrangement have what passes for "public common sense" on their side. That's why politicians who say that grandma should be allowed to scuttle down to Tijuana to buy her heart medication appear to be way out there, and why when we hear that, we call up grandma to make sure she isn't going to do that and thank our favorite god that her wackiness doesn't extend beyond herbals and vitamin stores. Believe it or not, I have done exactly that. I'm not advocating individuals going out of country to get their drugs cheap. I am advocating that bans on reimportation be lifted so that companies cannot engage in egregious price discrimination. If they don't do it, nobody will bother reimporting.

Bernard's point is also quite valid, and although his vision is a bit Utopian, I see and respect where he's coming from. I'd find it cleaner if dealt with as a government foreign aid issue (as we seem to be doing with Africa and AIDS) rather than as an item on corporate balance sheets.

I'll shut up now :-).

-Brad

Jane Galt writes:

Bruce -- you are assuming that if we lift the reimportation ban, Canada will stop forcing drug companies to sell near production cost. Why do you think this is so? From the point of view of a Canadian politician, the choice between pandering to consumers or preserving the profitability of drug companies so that they can continue to develop new drugs is unlikely to be made in favor of future consumers who will not be voting in the next election. Particularly as the consumers probably will not perceive a direct link between the lack of new drugs and their government's behavior. In fact, for Canada, it's something of a net plus; they get more business for their pharmacies, at least until our drug prices fall to match theirs. I'm sure they'll regret putting the world's drug industry out of business, but the political calculus is pretty clear. Besides, knowing Canadian politicians, many of them will feel it's the fault of the drug companies for not continuing to do research at a loss.

Jane Galt writes:

Bernard -- it's the developing countries that actually break the patent now; industrialized countries simply rely on the implied threat.

As for the WTO, the drug companies can't bring a suit; the same US government that is planning to allow reimportation has to. Not going to happen. Also, patent terms vary by country; that's not, in itself, a cause for action (or else Canadian generic makers could sue us for using patents as a barrier to entry). Canada could just set the patent term for a drug to one year, renewable at the discretion of the patent office -- and then use its discretion to not renew patents where the price is thought to be too high.

David Thomson writes:

"Besides, knowing Canadian politicians, many of them will feel it's the fault of the drug companies for not continuing to do research at a loss."

Yup, that's right. Let’s get to the nitty-gritty: we cannot afford policies that discourage drug development. It’s just that simple. Either the drug companies earn a high profit---or the new drugs will not be forthcoming. This little bit of cold reality must underpin one’s views on this subject.

The silliness of the Canadians and other “progressives” inadvertently doom many people. By the way, does anyone know when the last time the Canadians released a major life enhancing drug? Since I’m on this subject, what have the French and the other Old Europeans done recently in behalf of the medical salvation of their fellow human beings?

David Thomson writes:

Sadly, the Canadians are no longer our allies. We can no longer avoid this harsh truth. Our politicians must deal with the Canadians similar to the way they dealt with the former Soviet Union: in an adversarial manner!

Will the Canadians commit violent acts against us? No, that is most unlikely. Nevertheless, they will stick it to us in just about every other way. They can no longer be trusted.

Eric Krieg writes:

Brad, I'm not worried about Grandma getting her medication from Tijuana. More likely, you'll get internet marketing of intoxicants and Viagara to teenagers and adults, which getting a doctor's prescription is supposed to prevent.

The first two things that you see when going over the border from Brownsville, Texas to Madamoros, Mexico is a bar and a pharamcy. The internet can bring that right into your home office.

Bernard Yomtov writes:

"Bruce, you are assuming that if we lift the reimportation ban, Canada will stop forcing drug companies to sell near production cost. Why do you think this is so?"

I don't know what Bruce thinks, but I think it's because the drug companies won't agree to those prices if we lift the reimportation ban.

Is Canada using an "implied threat" to break patents? Well, I suppose they have the power to do that, though what the broader consequences would be I have no idea. I suspect that would create enough problems that the threat is not wholly credible. Can you imagine the political reaction of Canadian patent-holders (in all areas) if the US used an "implied threat" to void their patents in the US?

Bernard Yomtov writes:

One more point onthe "Implied threat" issue. I don't think it's reasonable to criticize Canada for this unless they have actually given some indication that they are willing to break patents.

Yes, Brazil breaks patents, so drug companies might fear Canada will also. But there is little Canada can do about Brazil. The "implied threat" exists because of what Brazil did, not Canada. So unless the Canadians hav given some indication that they will do the same, they cannot really be accused of making this threat.

John Voltin writes:

Everyone has their opinion about why drug prices keep going up. For some reason, the most basic reason is seldom if ever mentioned as follows:
The market solution does not work for items that are perceived as life-and-death necessities, unless their is significant competition. Food is a necessity, but the individual items are commodities, and there is massive competition. Drugs are very non-standardized and protected by patents. As a result, these perceived critical necessities effectively do not have serious competition.
So the drug companies keep raising prices simply because they can get away with it. The only solution is some degree of price parity. Most developed countries have recognized this, and as a result, regulate drug prices to some degree.
P.S- The current administration has proposed that the govt pay about 50% in the new Prescription Drug law being considered. This will only lead to further drug price increases, and encourage companies to drop their current drug coverage. And guess who gets to pay for it....the taxpayer.

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