The Magazine

The High Price of Cheap Drugs

The House is tempted by a terrible idea.

Jul 21, 2003, Vol. 8, No. 43 • By JOHN E. CALFEE
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What would this law actually do? For one thing, Burton, Gutknecht, and their allies might not get the low prices they want even if Congress passes their law. Prices won't drop in the United States unless foreign drugs really will be imported in large volumes. Importation from Canada alone won't do the trick because the Canadian market is tiny, about 5 percent of the U.S. market in terms of revenues. When Canadian pharmaceutical wholesalers ask Pfizer, Merck, and their competitors to ship them 10 times the usual volumes of Lipitor and Zocor and other blockbuster drugs, with the obvious intention of shipping them right back to the United States, any manufacturer with a decent regard for its shareholders will refuse. Why sacrifice billions of dollars in U.S. sales to maintain sales in a market one-twentieth the size?

If that were the end of the story, events would follow a simple course. Canadian authorities, who understand the importation logic as well as anyone, would have to reassess their price ceilings or leave their citizens short of the best pharmaceuticals. At some point, it would become clear that Canadian drug importation would not bring the low U.S. prices its advocates want, although it might put a good number of patients at risk if importation--including importation of counterfeits--were to ramp up before prices adjusted. Prices in Canada, meanwhile, would rise.

But the House bill is not limited to Canada. There is also France, Italy, the Netherlands, Portugal, and Greece, not to mention Israel and South Africa and soon, Hungary and the Czech Republic, and on and on. That makes for a lot of places from which to ship drugs that can be purchased for a lot less than they cost here.

Two scenarios could play out, one bad and the other worse. In the first scenario, drug manufacturers would again simply refuse to ship huge volumes of drugs to small foreign countries in order for the drugs to be shipped back and cripple profits at home, where the drugs were invented. If that happened (and I think it would), our European friends would probably have a political fit. They would face the prospect of either going without American drugs or raising their own price ceilings--and with them the costs of their fiscally strapped socialist health care systems. From their point of view, the importation plan would be a clever way to force U.S. drug prices on Europeans. They would want very much to prevent that. An international demand for drug price controls in the United States (not just in Europe) would become a centerpiece of international diplomacy. And we might cave in, pushed by the same politicians who want importation.

In scenario two, Burton and Gutknecht would win in the short run. Importation would rapidly escalate to massive volumes from Canada and Europe, maybe from South Africa and elsewhere. The process would resemble the "parallel trade" now engulfing European drug markets as products with Greek or Spanish labels flow to patients in Germany and Britain. Drug prices would drop here, limited only by fears of counterfeiting, dilution, or inadequate storage. Wholesalers, pharmacies, managed care organizations, and other large-volume dealers would feel intense price pressure from the imports, and the U.S. pricing structure would gradually collapse, just as congressmen Gutknecht and Burton now pray and predict.

Either way, price controls would end up suppressing innovation here, just as they have done abroad. It is one thing for the Canadians and Europeans to free-ride on American R&D, but we can't free-ride on ourselves. The system that gave us the drugs the whole world wants would be hobbled just when researchers are finally glimpsing pathways to cures for cancer, Alzheimer's, and other killers.

The hundreds of biotechnology firms searching for these cures would know that if and when one of them discovers the elusive solution that no one else could find, it will face the prospect of price ceilings set by a government agency intent upon cutting costs. Given that the expensive part--all the laboratory work and the years of clinical trials--had already been paid for, the manufacturer of a breakthrough drug would have no choice but to take whatever deal it could get as long as the price covered manufacturing and distribution, without consideration for the expensive failures littering the path to success. The market would understand with perfect clarity that the days of free-market rewards for high-risk-high-payoff research were over. The implications for future drug research are both obvious and depressing.