Importing Price Controls

May 7, 2007 • Commentary
This article appeared in The Wall Street Journal on May 7, 2007.

Drug reimportation is back, and this time it may become law. Late last week the Senate voted by a near veto‐​proof 63–28 margin to clear the way for adding a reimportation amendment to the Food and Drug Administration Revitalization Act. Reform is sorely needed in this area, but this amendment, sponsored by Sens. Byron L. Dorgan (D., N.D.) and Olympia J. Snowe (R., Maine), is unsound. It would import foreign price controls on drugs, thus undercutting the R&D funding that companies need to produce the miracle drugs of the future.

Given FDA safety and efficacy standards, it takes on average 12 to 15 years and over $800 million for a company (and most are American) to develop a new drug. But only the U.S. market is free. Abroad, pharmaceutical companies must negotiate prices with socialized medical systems. As a result, foreigners usually pay far less than Americans for their patented drugs. Americans bear the lion’s share of R&D costs, subsidizing socialized medical systems in the process, while foreigners are classic “free riders.”

When Americans go online, however, or go abroad for cheaper drugs, they encounter the reimportation ban Congress enacted in 1987. Thus the repeated calls, especially from seniors, for lifting the ban, which the Senate measure would do.

But there’s also another side. Quite apart from foreign price controls, companies face varying levels of demand and ability to pay, which would lead them in any event to segment markets and price differentially, just like airlines, theaters, and many others do. Whether it’s due to foreign price controls or to the perfectly legitimate wish to maximize profits, therefore, companies are going to charge different prices in different markets.

To maintain that market segmentation, however, they have to guard against “parallel markets” — vendors in low‐​price markets reselling the drugs (at a profit) to high‐​price markets. If they don’t, their low‐​price vendors will out‐​compete them for their own drugs. That’s where the reimportation ban comes in. It keeps drugs sold at low prices abroad from coming back and flooding the American market.

The problem with that statutory solution, however, is that it’s inconsistent with free market principles. It’s a public law solution to a private law problem. If companies want or need to preserve their segmented markets, the right way to do it is through no‐​resale contracts or, if those prove difficult to enforce or illegal (as in Europe), limitations on supply.

But there, precisely, is where this Senate measure intrudes. It would lift the ban on reimporting drugs from a limited number of developed countries, where drug safety is not an issue. But rather than let markets sort the matter out thereafter — whether they’d remain segmented, or prices would tend toward equilibrium, we don’t know — this bill would prohibit American companies from defending themselves against parallel markets. They would be prohibited from charging foreign exporters higher prices than they charge foreign firms that do not export. And they would be prohibited from limiting supplies to foreign firms that reshipped those lower‐​priced drugs back to the U.S. That’s how Congress, unwilling itself to directly impose price controls on drugs, is trying to do so indirectly, by “importing” foreign price controls.

There’s no question that Congress is responding here to popular will. But the long‐​term implications are palpable. If companies are forced by the U.S. government to continue supplying cheap drugs to countries from which they are then reimported to the U.S. — crowding out the higher‐​priced domestic supply of drugs — it’s only a matter of time until profits are insufficient to support the enormous costs of R&D for future drugs. No one wants to kill that golden goose, but there it is.

The better answer is to simply lift the reimportation ban from a limited number of developed countries and then let the market play out. No one knows for sure how that would work, not least because there are complex and unresolved patent and treaty issues that loom in the background. But at the least, with the ban lifted and the threat of reimportation before them, companies would have far greater incentive than they now have to engage in hard bargaining with foreign governments over prices, no‐​resale contracts, and supply limits. And under current treaty law, developed countries could not engage in the “compulsory licensing” that would undermine company patents.

Opponents of this measure, as usual, are falling back on the safety issue, despite inspection, packaging and other provisions that address it very well. Thus, a vote is expected today on an amendment by Senator Thad Cochran (R., Miss.) that would require the administration to certify the safety of imported drugs and determine the economic benefit of reimportation, something the administration has said it cannot do, despite a recent Congressional Budget Office report to the contrary. If defeated, a vote will be taken on the reimportation amendment itself. The administration and its remaining supporters in Congress would be better advised to go to the principle of the matter.

Congress created the problem in the first place when it ignored principle and imposed the ban. It’s time now to correct that problem, not by ignoring principle again and creating an even greater problem — undercutting the market’s production of miracle drugs — but by opening up the market, thereby inviting foreign nations to contribute more equitably to the development of those drugs.

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