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Free markets in drugs

A debate is currently raging in libertarian as well as in less refined political circles about whether the USA should allow ‘reimportation’ of prescription drugs. Basically, the problem is that patented drugs in the US are sold at prices much higher than they are available overseas. Patented drugs are the newer drugs for which no generic equivalents are available, giving the patent-holder a monopoly on that drug while the patent endures.

The drugs are available more cheaply in other countries for a variety of reasons, but in large part because the governments of those other countries have intervened in the drug markets to set prices. Canada, in particular, has ‘negotiated’ some sweet deals for high-demand drugs, and Americans have flocked across the border to get some of that cheap drug action. With prescription drug prices soaring in the USA, legislation has surfaced to allow drugs to be ‘reimported’ from these socialist havens at the prices that prevail.

On the one side, many libertarians see lifting the ban on reimporting as a simple case of freeing up the market to let it do its magic. Probably the best case that I have seen for this side of the ledger is Conservative Drug Split at National Review Online.

However, it seems to me that this approach overlooks some pretty major issues. Leaving aside the safety issue, which my clients in the drug industry assure me is no straw argument, I do not believe that the cause of free markets is well-served by allowing reimportation.

To cut a long and sordid story short, prices are so cheap in other countries because the governments of those countries demand that the drugs be sold at slightly above their production cost. They can do this because (a) in many countries the government is a monopsonist via the national health system and/or (b) the government simply threatens to break the patent and start manufacturing the drug itself (or allowing someone else to manufacture the drug).

To claim that the sale or reimportation of drugs that are priced under this system has anything to do with the free market strikes me as delusional. First, of course, the prices now obtaining in these markets are not market prices, but are monopsonist prices extracted by threatening to break the patent. Keeping these drugs out of the relatively free US market is no more of a barrier to free trade than keeping the local fence from selling stolen TVs out of the back of a truck.

Proponents of reimportation seem to assume that, when reimportation is allowed, the drug companies will go to these nations and threaten to either cut them off or raise their prices, and the governments will meekly go along. This in turn assumes that these governments will not simply break the patents, as they have repeatedly threatened to do and in fact have occasionally done in the past. Nor am I convinced that breaking the patents will result in any real consequences for the nations that do so. The only hammer over these nations would be the WTO or other treaties, and I do not believe that the government of the US would go to the mattresses to protect Big Pharma’s patents. It never has in the past, and there is no reason to believe that it would in the future. With reimportation allowed, in fact, the US government would have to be crazy to do so, as protecting the patents overseas would dry up sources of cheap drugs that reimportation allows back into the US.

Sadly, the lure of cheap drugs is too much for your average politico to resist, so I think we can look forward to the corruption of the US drug market by overseas socialism.

25 comments to Free markets in drugs

  • Julian Morrison

    O ye of little faith.

    The high drug prices in the US are caused by FDA bureaucracy. Remove the FDA, and the research cost justification for patent monopolies goes away – research will be subsidized by early-adopters, just as in any other tech industry. Then remove patent monopolies, and the market breaks into two sectors: commodity pill pushers, trading on cheapness (who can compete with foreign susidized drug makers on equal terms), and innovators trading on newness (and probably requiring patients to sign NDAs) who would have no effective competition from the stodgy bureaucratically-mired commie imitators.

  • Kevin

    I dunno. This will either cause the US to import socialism, or the pressure on overseas price controls will weaken them, creating a kind of equilibrium between the two. I’m not sure anyone can actually predict the results of this change. This is an experiment we simply won’t know the results of until it is tried. Which will break? Foreign price controls? Foreign patent protection? The US free market? Darned if I know.

  • Attempting to establish legal restrictions on parallel importation and reimportation is one of the favourite tricks of the intellectual property industry, and it is a tactic I generally despise. If CDs or DVDs or books are cheaper in a large and more competitive market (usually America) than they are elsewhere, then consumers elsewhere should have a perfect right to buy their CDs from the US, and importers should have the perfect right to buy CDs from the US, import them to another country, and then resell them, assuming of course that we are talking legitimate products and the copyright holders receive appropriate royalties in the first place. (Artists sometimes do suffer from this kind of parallel importation due to their contracts giving them vastly different royalty rates for international sales compared to domestic sales. This however is not relevant to the issue at hand. They need to get better contracts and better lawyers).

    Passing laws to prevent this kind of parallel importation is a case of simple protectionism and such laws should not be passed (although they often are).

    However, drugs are a special case, because many of the purchasers of drugs are governments, who ultimately have the market power to set prices, and even if in theory they negotiate prices and do not use this power, it is always ultimately hanging there. So yes, Robert probably is right that prices in many countries are in effect fixed by governments, and allowing reimportation would in effect extend this price fixing to be extended into the US and lower the incentive for companies to develop new drugs. All else being equal, then for the reasons he gives reimportation of drugs into the US probably shouldn’t be allowed.

    However, this situation remains very unsatisfactory. All the arguments that apply for allowing parallel imports and reimportation for music or books do apply in the case of drugs. There are considerable economic costs that arise from the world being split up into a large number of small markets rather than one big one. The real problem is the government control of healthcare in so much of the world and the price fixing that goes on due to it. The long term aim should be to eliminate this. (If this was eliminated, then I would be entirely in favour of allowing reimportation). The reason such a ban makes me a little uneasy is that it legally entrenches the present highly unsatisfactory arangement further into international treaties and national laws. We have one thing that is in itself bad, and we are adding another thing that would also in itself be bad to try to lessen its impact. In short, we seem to be trying to use two wrongs to make a right, and I am not sure that this is ever a terribly good idea.

    Actually allowing reimportation, while likely a bad thing in the short run, might actual make the real evil more stakly obvious and easier to eliminate in the long term. It might be that turning the world into one big market to drugs will put pressure on foreign governments to eliminate the price controls, which would be a very good thing.

    I’m really not sure what is the best way to proceed here. If you think that government control of healthcare in much of the world is here to stay and nothing can be done about this, then you should favour a ban on reimportation. If not, they you probably shouldn’t. I personally have mixed feelings on this, because I really do not know quite what the consequences of any action would be. As a general rule, though, I tend to favour free market approaches, even if they are adopted unilaterally.

  • FastNed

    It appears that the reason the majority of new drugs come from the American Pharmas is their ability to recover development costs plus a profit from sales in the American market. If the figure of 800 million per new drug has any accuracy, without such a market with a reasonable opportunity of recovery, who would invest such sums without an expectation of profit? The government is going to develop new drugs? Surely you jest!

    The “Free Lunch” politicians of America together with their counterparts in “Free Rider” Countries are speeding down a dead-end street while ignoring all the warning signs.

    Exports of new drugs will cease; who in their right mind will export “FDA Approved” medications to fuel a destructive black market? The “Free Riders” are not only going to have to break the patent, they are going to have to find someone who has the ability to produce these drugs. No doubt some Third World plant making DDT would be happy to add a product line but there are going to be serious quality control issues. The “Stinger” missle comes to mind – at one time (& perhaps still today) there were some manufacturing methods used which could not be duplicated outside of America. Were I a Drug producer, if possible there would be a trade secret or two involved in addition to the patent and those who copied it would do so at their own risk.

  • h0mi

    Price caps which cause American consumers to subsidize consumers in other countries (and the stupid drug companies who allowed this idea to flourish instead of refusing to produce the drugs at a loss in the first place) is a significant part of the problem. Maybe reimportation will make the drug companies rethink this policy of making US customers subsidize the world.

  • Seems to me that the net effect will be to introduce the effects of government price caps into a US market currently uninhibited by them. High prices in the US ARE a function of the market’s reaction to givernment interference at home and overseas. Reimportations seems like a good way, as has been said, to simply import socialism.

    The experts will have to duke this one out, of course, but I’m very skeptical of any attempt to inject price-controlled goods into our economy in this way. If there’s one thing I’m fairly certain of, it’s that you can’t “outsmart” the market, and this looks like an attempt to do just that.

  • This is actually simple:

    Drugs sold elswhere at rates determined by government fiat, aka at the point of a gun, are grey-market goods.

    They aren’t stolen in the sense that the drug companies are complicit in the sale, but actual force and threat of wholesale theft is being used against them. The drugs are sold under duress.

    We should absolutely ban the reimportation of these stolen goods! Depending upon the source there might even be grounds for confiscation.

    I realize that this issue, although simple to me, is not so clear to most. I understand that if our legislators do ban re-importation they won’t use the reasoning I’ve stated above. I believe this would be the unarticulated, implicit reason that someone might use for a ban.

  • Kevin

    Hmm. Prices overseas are set by a number of factors. Degree of bureaucracy to get approval. Liability incurred from adverse reactions. Ability to pay.

    Once conceivable result may be that drug companies will set up in the least bureaucratic, least litigious jurisdiction and export from there. In short, this may stimilate regulatory competition and even prompt tort reform in the US.

    I do not think the consequences of this are at all simple. They may be far-reaching and take a decade or more before being fully realized.

  • Merlin

    I think many people have missed a very important point here. Many of the drugs sold overseas, including in Canada and Mexico, are in fact already counterfeit. Although, this has been used as an excuse by politicians and drug companies opposed to reimportation for other reasons, it nonetheless remains a very real concern as to the safety of these drugs.

  • Correct me if I’m wrong, everyone, but as I recall the classic free-market argument from Ricardo down is that unilaterally importing cheaper products, even if those were made abroad using unfair dumping practices, still benefits the freer economy?

    Isn’t the idea that US drug consumers benefit from cheap labour in making drug clones abroad? That “unfairly” cheap foreign imports are simply a way foreign countries transfer funds to US consumers?

    I think according to this approach [I have reservations about classic free-market approaches, by the way, but standard Ricardian comparitive advantage with some unspoken mercantilist doubts seems to be the standard on this thread so far] we have to look carefully at profits from intellectual property.

    Is it a rent due to an asset owner [the inventor/developer]? Or is it a freely-moving price where the innovator is able to charge monopolistic prices for a short while, then must drop prices as competitors enter with imitations?

    I fear this is a real Achilles Heel for free-market fans, because Continental and East Asian economics types will tell you that most [all?] industrial take-offs got started by nicking someone else’s ideas. Chinese printing to European printing. Indian use of zero to later Arabic to later European use of zero. European and American 19th-century industrial engineering to Japanese, Korean etc industrial engineering. US tin smelters got their big break in the last quarter of the 19th century when US tariffs priced the then better and cheaper British tin products out of the US and domestic producers could compete on price, and later on quality too.

    So if we all do it, how honest are these arguments that the markup of US drug researchers is sacred and must be protected at all costs?

    Are we real free-marketeers here [which is a tough but honest position, entailing we shouldn’t care about drug reimportation], or just mercantilists who can currently pretend to be free marketeers because we happen to be right now inside cultures with the most developed science, so win anyway in a tariff-free world? Which is it?

    I think if it’s the first, we shouldn’t care about intellectual property, because drug makers can do something else with their capital if pharmaceuticals becomes unprofitable, and consumers benefit from lower prices, right? Isn’t it classic dirigisme to care more about domestic producers’ lost profits from foreign undercutting than about domestic consumers’ savings from foreign undercutting?

    I think we’re all the second, myself – disguised mercantilists. I certainly would like to benefit from intellectual-property protection of things I do [copyright and so on].

    In which case, can I honestly criticise foreigners from wanting to catch up, and copy and cheapen whatever drug manufacturing they can? Can I be anti-tariff one moment, but want the power to force tariff protection on my ideas the next? I’m not sure about the idea of owning ideas, unfortunately. I think it’s still a very grey area.

  • R.C. Dean

    Julian, if I were making policy, I would definitely follow your lead and do away with the FDA bureaucracy driving up the cost of drug development. Unfortunately, I am not, and nobody seriously trying to knock back the FDA that I know of is . If the FDA is a given (and I think it is, at this point), then development costs will remain high and your really very pure market solution isn’t feasible. (I don’t think that you could cover any but very minimal research costs without some form of patent protection, either.)

    Kevin summed up the issue nicely: “This is an experiment we simply won’t know the results of until it is tried. Which will break? Foreign price controls? Foreign patent protection?”

    I don’t think you can reasonably expect foreign governments to either give up their access to the good stuff or absorb much higher costs for it, so push will come to shove. If it does, then the issue becomes whether the US government will go to the wall to enforce patents, and thereby increase the costs of reimported drugs to American voters. I don’t think that is very likely, either.

    This issue is too easily demagogued as “poor old granny v. the evil drug plutocrats,” and I have very little faith in the willingness of our politicians to start a trade war that will have a net result of increasing drug prices at home.

  • R.C. Dean

    mark, I don’t know how “comparative advantage” arises in a situation where the cheaper price is not the result of cheap labor or other economic factors, but rather results from government-sponsored distortions (monopsony pricing and threats of patent breaking).

    It may be true that US consumers would benefit from cheap gray market drugs, but then so do the customers of the fence selling TVs out of the back of his truck. We also need to look at what kind of legal arrangements (property rights, patents, etc.) are necessary to support both ends of the market, both producer and consumer.

    Really, I think the argument over this topic ultimately bottoms out on whether you think that drugs should be patented at all, a subcategory of the question of whether you think “intellectual property” is legitimate at all. If you think patents and intellectual property are necessary to the functioning of an information economy (as I do), then you are well down the road of saying these forms of property are important, should be protected, and that drugs created or priced in violation of these principles should not be reimported.

  • veryretired

    I am afraid all this talk about free markets, in medical services, drugs, or anything else, is woefully out of touch with reality. There hasn’t been any free market in medical care or drug sales since the government entered the market so massively in the 1960’s and 1970’s during the build up of the Great Society programs for the poor and elderly.

    The above average rise in medical prices compared to other prices in the economy can be traced directly to the years when huge governmental purchases began, and utterly warped the market pricing system.

    Now, and heading toward a future in which the situation grows exponentionally, the basic facts of the medical system are that a great percentage of all medical services are used within the last 24 months of life by the elderly, huge costs are borne by citizens in the most productive parts of their family life to maintain the tenuous hold on life of aging strangers who have no chance for recovery in any meaningful sense of the word, and enormous efforts are made to keep large numbers of people alive who would have no chance for survival without the ability to consume medical services provided by taxing the healthy and productive in ever greater amounts.

    This situation is not going to change due to some sudden conversion of a majority of the population to the principles of free markets. The most powerful group in the electorate is on the threshold of becoming the most medically needy segment of society, as the baby boom reaches AARP status.

    The warnings about this ticking bomb in the economy have been made repeatedly over the last few decades. The only political result has been to increase governmental involvement in the medical system, regardless which party is in power.

    The main question now is: How long can the economy afford to provide an ever increasing, and ever more expensive, array of medical services to tens of millions of aging boomers if the only rule of thumb is that everything must be done for everyone regardless of the cost or potential outcome?

    This is an exquisite moral and emotional dilemna which should be at the top of our “we really need a thoughtful solution” agenda. Pardon my disgust when I notice that most people are much more caught up in the crucially important question of who J-Lo is going to sleep with this month.

  • I agree, R.C., the crux is how we view intellectual property rights, and owning them.

    I certainly like the idea of benefitting from owning my intellectual property! I’m just not sure if the arguments I could make for them are self-serving or not. Of course I’d want to own and profit from my ideas, agreed, but can I make a case where it benefits someone who could copy them, to stop doing that and agree he is better off respecting my intangible property rights?

    I hope so, but I’m not sure. If he never has any ideas of his own [most people are pretty unoriginal], or he thinks I have an unfair start in some technology he’s entitled to copy because my culture did that too a few generations back, how am I going to persuade him he benefits from signing up with my present ownership of a lot more ideas than he has now or can plausibly get any time soon?

  • T. Hartin

    “I certainly like the idea of benefitting from owning my intellectual property! I’m just not sure if the arguments I could make for them are self-serving or not.”

    Just because your arguments are self-serving doesn’t mean they are wrong!

    “but can I make a case where it benefits someone who could copy them, to stop doing that and agree he is better off respecting my intangible property rights?”

    All he has to do is pay you to use your intellectual property. This stranger would also “benefit” from the use of your car and your house whenever he feels the need, but that doesn’t invalidate your property rights in those items.

    “how am I going to persuade him he benefits from signing up with my present ownership of a lot more ideas than he has now or can plausibly get any time soon?”

    Who said anything about persuading him? To protect your property rights, you mostly need to out-gun him.

  • Robust stuff, T.! I was thinking that intellectual property is a bit more slippery than other kinds of property. I’ll try to be a bit braver in future!

  • T. Hartin

    mark, talk is cheap, especially blog-talk.

    BTW, veryretired, your post was right on the money.

  • AC

    …most people are much more caught up in the crucially important question of who J-Lo is going to sleep with this month.

    I’ve pretty much ignored this entire topic, so I didn’t realize is was such a big deal in the wider world. OTOH, I would care a lot about this topic if I thought there was a reasonable chance that the answer was going to be “me.”

  • Dishman

    Twenty years ago, my great-grandmother was diagnosed with chronic myoleucitic leukemia (CML). Three months later, she was dead. Seven years ago, my mother was diagnosed with CML. She survived for 3 years on a variety of drugs, including Interferon. Then, she became part of a Phase I clinical trial for Gleevec from Novartis. She is now back to being fully functional. I got to watch a lot of the FDA process.
    Thanks to the rather extensive FDA process, we know what safe dosages are. We know who it is going to be effective for. We know what its side-effects are. We know what the signs are that it is not being fully effective. We also found in the clinical trials that there are other related illnesses for which Gleevec is useful. This particular bit of information is a result of having carefully mapped its toxicity, interactions and side-effects. With that information in hand, it was determined that it would likely cause no harm to try Gleevec on certain other illnesses.
    On the other side, there’s the case of L-Tryptophan. My understanding is that it is a naturally occurring hormone that helps induce sleep. It should logically produce natural sleep, rather than drug-induced. Unfortunately, it has the side-effect of dissolving blood vessels walls. Without careful monitoring, such ‘wonderful’ products could make it to market and be widely distributed. My recollection is that because L-Tryptophan was considered a ‘supplement’, that very thing happened. My recollection is that something like 80 or 120 deaths were linked to it.
    The FDA process is expensive (in money and in lives). It also increases the value of the product (as indicated in the Gleevec example). A large part of the value is in the form of guidelines for usage. To my mind, these guidelines represent a product in and of themselves.

    Some socialist governments believe that because they have the power of government, that gives them the right to not pay for the guidelines. Sure, they’re buying the drugs at cost plus. I’m actually ok with that. I believe they should pay for the usage guidelines. Instead, they are demanding that in order to sell the drug product, they must give, free of charge, the very valuable and expensive guidelines IP to the government.

    As for effects of this legislation, I suspect that one of two things will happen (in some combination):
    1) Drug research will be curtailed as the profit motive is removed
    2) Pharmaceutical companies will stop selling their drugs in socialist nations, rather than allow those grey-market drugs to compete with their profit margins in the US.

    In effect, it would force pharmaceutical companies to choose between the US market and much of the rest of the world. I think that is a pretty clear-cut decision. Americans pay, socialists don’t.

    I say screw ’em. A dead socialist is no great loss.

  • Phil Bradley

    Dishman has nicely summarized the issue – Governments that deliberately free-ride to the expense and detriment of particularly Americans.

    This legislation is an effective response to the problem and should be a major dis-incentive to pharma companies signing up to such deals in the future.

    I say screw ’em. A dead socialist is no great loss.


    BTW 1) Drug research will be curtailed as the profit motive is removed I think this is extremely unlikely. Much more likely is that it results in real demand seeking products/solutions in the market-place, i.e. more money.

  • As for effects of this legislation, I suspect that one of two things will happen (in some combination):
    1) Drug research will be curtailed as the profit motive is removed
    2) Pharmaceutical companies will stop selling their drugs in socialist nations, rather than allow those grey-market drugs to compete with their profit margins in the US.

    That is certainly the crux of the matter yes. Outcome (1) is unequivocally bad. Outcome (2) is presumably followed by governments in “socialist nations” having to do something in order that they can obtain the drugs for their citizens. If the answer is that they abolish their price fixing and adopt more free market medical systems, then the outcome is good. If on the other hand they break their patent systems and start producing unofficial versions of the drugs, the situation is bad. (Although how bad depends on how successful the companies are at keeping unofficial versions of their drugs outside the US and other similar markets. At that point you have to partition the world into markets that do accept US style patent regimes and those that don’t, and prevent the flow of drugs from one to the other, which is no doubt very difficult).

    I think the difference between the positions of RCD and that of the National Review article he quotes are that they both think this, too, only they differ as to which of these outcomes they think more likely. And the trouble is that I don’t know the answer to this. And neither does everyone else.

  • R C Dean

    “At that point you have to partition the world into markets that do accept US style patent regimes and those that don’t, and prevent the flow of drugs from one to the other, which is no doubt very difficult).”

    In other words, pretty much the system that we have now.

  • Dishman

    I would say that reimportation effectively breaks down the partition. It’s too much for me to really evaluate it properly right now.
    I might actually be in favor of it as one way to apply a sledgehammer to the socialists. This is particularly true in light of some of the drugs that are arriving or will arrive shortly. “What, you’re dying of something we know how to treat? You made your choice when you expressed an opposition to capitalism by electing a socialist. Enjoy the fruits of your labors. Buh-bye.”

  • linden

    The Volokh Conspiracy guy had an idea:

    “Perhaps some creative legislation is in order, like a law requiring drug companies within a few years to offer their products to Americans at the same price they offer them to other developed countries, with the prices standard for purchasing power parity. The key would be that the basic price of the drugs would be set by the U.S. market, not by European and Canadian bureaucrats. And what power this would give to the drug companies in negotiations with those bureaucrats! “We’d love to give you an 80% discount on the market price of Zoloft, but then we wouldn’t be allowed to sell it in the U.S. where we make our big profits, so I guess we can only give you a 20% discount relative to the U.S. price.” Arguments that this system is unfair to less wealthy countries and their consumers would founder on the PPP adjustment. End result: U.S. prices probably go down a little, prices in Canada and Europe go up somewhat more, and a bit of equity and market economics (if only a bit) is restored.”

    Of course, if they do break the patents and call the pharm industry’s bluff… I wonder how the WTO would rule.

  • elod

    Excuse me, but I thinked that marketing budgets were superior to research budgets in America.