The State of Maine recently passed a law to try to force down drug prices. If drug manufacturers and distributors dont lower prices after "negotiations" with the state then the Maine law threatens that price controls will be imposed and fines of up to $100,000 will be assessed for "excessive" prices. Several other states reportedly are preparing similar legislation.
Maines politicians were especially persuaded by claims that drug prices are substantially lower in Canada. In fact, although some drugs are cheaper in Canada, other drugs are more expensive. Government studies suggesting that pharmaceutical prices are much lower in developed nations like Canada, Britain and Germany have been severely criticized by Wharton School economist Patricia Danzon.
Danzon found that the government studies surveyed only a handful of drugs. Also, these studies did not account for the quantity of drug prescriptions. Suppose, for example, that seven drugs are more expensive in the U.S. than in Canada and three are cheaper. If the three which are cheaper are prescribed more often than the seven which are more expensive, in which country are drugs truly less expensive? Finally, the government studies sometimes compared wholesale prices to retail prices. When these errors are corrected, prices in the United States are not on average more expensive (often they are less expensive) than in other developed nations.
Its true that drugs are cheaper in less-developed countries such as Mexico but this is a benefit not a cost to U.S. consumers. The market for drugs in less-developed countries is too small and too poor to support the research and development costs required to create a new drug. (On average it costs about $500 million to create a new drug.) Once a drug has been created, however, production costs are typically low. So long as the price covers production costs, firms can recoup some of their R&D costs by selling drugs at low prices in less-developed nations. Because consumers in less-developed nations cover some of the R&D costs, U.S. consumers are better off than they would be if firms charged the same price everywhere.
Put simply, if firms had to charge a single low price throughout the world there would be much less money to spend on R&D and fewer new drugs. If firms had to charge a single high price throughout the world then consumers in less-developed countries could not afford to buy any new drugs and U.S. consumers would pay all of the R&D costs. Allowing a firm to charge different prices in different parts of the world benefits consumers everywhere.
Some developing nations like India as well as some developed nations like Canada have in the past refused to patent U.S. drugs. Governments in other countries have similarly forced U.S. pharmaceutical companies to sell at below-market prices. These countries have unfairly taken a free ride on the research costs paid for by U.S. consumers. But the answer to this problem is not to join the free-riders as Mainers and others are now contemplating!
Joining the free-riders mean less research and fewer new drugs. Instead, the United States should push for the protection of intellectual property rights in other countries. In fact, acting through the World Intellectual Property Organization and the World Trade Organization the United States has been quite successful in having patent protection for U.S. drugs extended overseas. Acting at home, the United States could lower drug prices by reforming its tort system, which imposes large costs on pharmaceutical manufacturers, and by reducing burdensome FDA regulations.
The U.S. pharmaceutical industry is an unfortunate victim of its own success. Spending on drugs has doubled in the past decade but not because of price increases. Spending has doubled because revolutionary new drugs have been created for the treatment of heart disease, diabetes, osteoporosis, arthritis, depression, obesity, blood pressure and other illnesses. In other words, were spending more on drugs because were using drugs more.
The new drugs are so much better than the previous generation that if one controls for quality, its clear that the cost of treating these diseases has actually been falling not rising. Nevertheless, the increased spending on drugs has made the pharmaceutical firms a target for politicians seeking electoral advantage over sound public policy.
Politicians are always short-sighted. One hopes, however, that U.S. consumers of pharmaceuticals will take a longer view. Will consumers ten years from now be able to choose from a new generation of revolutionary drugs? Not if price controls are imposed today.
Alexander Tabarrok is Senior Fellow for The Independent Institute, Assistant Editor of The Independent Review, and Associate Professor of Economics at George Mason University. He received his Ph.D. in economics from George Mason University, and he has taught at the University of Virginia and Ball State University. Dr. Tabarrok is the editor of The Independent Institute books, Entrepreneurial Economics (Oxford University Press), The Voluntary City (with David Beito and Peter Gordon, University of Michigan Press), and Changing the Guard: Private Prisons and the Control of Crime.
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