Drug Re importation And The Current Split Among Free-Marketeers

I’ve argued the issue of drug reimportation to death, going as far as to call it “idiocy”. Of course, I use that word a lot, so keep that in mind as we discuss this and try to figure out who the real idiots are.

First, I’d like to do away with the bogus issue of safety: there is no issue of safety because these are the same drugs we already use being reimported — note that word, because in many cases the drugs are actually manufactured in this country.

The issue is an economic one: will the re importation of drugs from countries that use price controls harm research and development in this country by artificially lowering the prices in this country. We already have artificially high prices due to, among other things, price controls in foreign countries, abuse of the patent system and the system of prescriptions itself which gives drug companies a sort of monopoly protection from competition.

The abuse of the patent system should be ended and the time limit should be firm: twenty years and the drug loses patent protection.

Prescription status should also revisited with, at a minimum, the removal of obvious drugs such as shampoos, and further consideration for putting drugs into the over-the-counter market as safety allows.

The economics of R&D is much more complicated. Right now the United States essentially subsidizes the drug R&D for the whole world because we don’t use price controls. We pay inflated prices for drugs and drug companies continue to sell abroad at the price-controlled prices because they know they can re-coup their R&D costs here. The cost of manufacturing the pills is so low it is easily recovered, even in a price-controlled environment, making it worthwhile for the drug companies to sell there.

A quick glance at a supply and demand curve would seem to indicate that reimportation is a no-brainer: when confronted with price controls and no uncontrolled market — the U.S. — drug companies would simply refuse to sell in countries with price controls in place unless the prices were set high enough to meet a market — or voluntary — price threshold. Or so it would seem.

Profit maximizers, and I think we can all agree the drug companies are profit maximizers even to the point of abuse, will sell existing drugs as long as marginal revenue exceeds marginal cost. That is, they will sell as long as the revenue generated by one pill exceeds the cost incurred in producing that pill.

Again, that’s why they sell in the price-controlled countries to begin with: marginal revenue exceeds marginal cost. The price-controlled countries are smart enough to set the price high enough for the drug companies to recover their manufacturing costs, and perhaps a portion of their R&D, and entice the drug companies to sell there.

What happens if reimportation is allowed? It sets up an arbitrage situation where the price-controlled countries will benefit initially by reselling drugs, unless contracts to the contrary ban it, purchased at the artificially low prices in their own countries in the United States for a profit. In the short run, this will work out well for the price-controlled countries because they will not only get to buy the drugs at the low prices but they will also be able to profit by reselling those drugs in the U.S. at higher prices but undercutting the existing prices.

In the long run the story is different.

The concept of profit maximization with marginal revenue exceeding marginal cost applies to undiscovered drugs as well, only in this scenario the drug has not yet been developed . The question is whether drug companies will continue to invest the hundreds of millions of dollars to develop the drugs absent a market uninfluenced by price controls. By allowing reimportation we will be, in effect, importing the price controls as well and drug purchasers will pursue the drugs from countries with the lowest prices, or tightest price controls. This could very well compel drug makers to abandon research if they see no hope of recovering the R&D costs.

In spite of the patent on the drug, the drug companies have no pricing power in a country with price controls — hence, the term price controls — and no assurance they will be able to recover their cost. About all they can do is refuse to sell there unless the caps are raised. Considering the hellish aging problem Europe has in front of it I have a hard time believing they will allow price increases and will instead opt to break the patents on the drugs and make knock-offs. It’s theft but I would expect no less from the statist countries that populate Europe.

There is the temptation to believe this will force Europe and Canada to liberalize their drug markets and, indeed, this NRO article does exactly that. The article is persuasive but doesn’t allow for the possibility that Europe might choose to break the patents rather than pay the higher prices.

If we’re going to pursue this route we should make it a part of our foreign policy to work, diplomatically, against price controls and the breaking of patents. The threat that patents will be broken is real and there should be consequences for countries that go that route.

And we can keep our fingers crossed that, in the end, drug company R&D is not devastated by this move.

For more on this issue look here, here, here, here, here, here, here and here.

I would also add, though, that we do need to create a functioning drug market within this country where people pay out of pocket or out of employer-funded MSAs for their drugs. As bad as reimportation may be — note the hedging there — we have a long way to go before we have a functioning market for drugs in this country as well. Having individuals, rather than bulk purchasers and other third parties, buy drugs based on consultation with their doctors and with price as a consideration will deprive the drug companies of a sounding board — the large purchasers’ budgets in this case — and force them to begin calculating the sale price of the drug based on the price necessary to recover their investment, not the amount of money available in an insurance company’s budget.

No comments yet.

Leave a Comment