This Is Your Senate on Drugs

May 4, 2004 • Commentary

Leave it to Congress to take a bad situation and make it worse, while ignoring the easy solution staring it in the face. Pressured by governors, mayors, and senior citizens who increasingly are ignoring the federal ban on buying prescription drugs abroad, where they’re far cheaper than here at home, the House last year passed a bill lifting the ban. That’s the easy, and correct, free‐​trade solution. In the Senate, however, a bipartisan group of seven has introduced a complex 73‐​page bill of their own that plays right into the hands of free‐​trade critics. If enacted, the bill would import foreign price controls, killing the drug R&D that has given us our modern pharmaceutical miracles.

The background for this “drug reimportation” issue begins with politics. Armed today with the Internet, Americans look to Canada and Europe and see drugs selling for a small fraction of their prices at home. When they ask why, they’re told, correctly, that drugs are expensive not because of manufacturing and distribution costs, which are quite low, but because of the extraordinary R&D costs that FDA safety and efficacy standards require. Once a new drug is finally approved for sale, which can take years, a company’s patent enables it to recoup those costs.

But that doesn’t account for the price discrepancies. For that, we have to look at the market a company faces. Burdened as America’s medical market is with regulations and cost controls, it’s still relatively free compared to the socialized systems abroad. As a result, American companies, which today do most of the world’s drug R&D, recoup most of their costs in the domestic market, then sell abroad to foreign governments at prices far below true costs. Foreigners are thus classic “free riders.” As with defense, Americans are underwriting a good part of the health‐​care costs of the rest of the world, and they don’t like it.

But defenders of the ban contend that if we remove it and allow Americans to reimport those below‐​cost drugs, we’d be reimporting foreign price controls. And that would destroy the domestic pricing structure that underwrites future R&D.

Not so fast. If the ban were lifted, and the market were allowed to take its course, companies would clearly have to change their pricing strategies. Otherwise, reimported below‐​cost drugs would indeed lead to massive aggregate losses. Thus, in a free market, companies would adjust prices on both sides sufficiently to discourage reimportation. (And that would solve the drug safety issue in a flash, an obsession of the Senate bill.)

But foreign governments wouldn’t pay those higher prices, it is said. They’d either allow their citizens to go without the drugs — or they’d steal American patents. We’ll never know if they’d refuse to pay the going rate until we test it, of course, but in either case, the choice would be theirs. Were they to steal patents, however, that’s a treaty matter. We shouldn’t be blackmailed: “Sell us drugs at far below cost, or we’ll steal them.”

In the end, however, drug companies turn to “parallel trade” arguments to justify price discrimination and the importation ban. Since Americans are willing and able to pay more, they say, they’re charged more. But companies can sustain price discrimination only if those charged low prices don’t turn around and resell the drugs, at a markup, to consumers in the high‐​priced market. And that’s exactly what “reimportation” is all about. Canadian and European vendors are selling their cheap drugs back to willing Americans, marked up slightly.

We come then to the nub of the matter. To maintain this parallel trade, companies have to enforce “no‐​resell” contracts with the foreigners to whom they sell so cheaply. Rather than insist that foreign governments police their own vendors, however, American companies went to Congress years ago — not to prohibit foreign vendors from selling but to prohibit Americans, no parties to any no‐​resell contract, from buying. If that seems wrong, you’re right. Drug companies should be going after those foreigners who breach their contracts, not asking Congress to restrict the freedom of American consumers.

What this Senate bill has done, however, is swing too far in the other direction. If the import ban were simply lifted, prices would move toward equilibrium and there’d be no “reimportation.” After all, no company will long be in business if its below‐​cost sales undermine its above‐​cost market. But the Senate bill ensures below‐​cost reimportation by prohibiting American companies from “taking actions that would have the effect of thwarting drug importation.” It prohibits companies from raising prices abroad. It prohibits them from reducing supplies abroad. It truly does import foreign price controls. In a word, it goes right past free trade to forced trade — at prices that make future R&D impossible. We’ll have cheap drugs for a while, but no new drugs ever.

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