Published July 23, 2003 , in The Wall Street Journal Europe

COMMENTARY
The Drug World's Easy Riders

By JAMES K. GLASSMAN and JOHN R. LOTT, JR.

For years, Americans have enviously eyed low drug prices just over the border in Canada, where strict price controls prevail as part of a socialized national healthcare system. Canadian drugs are cheaper by about two-fifths.

Now, Americans are getting fed up, and the U.S. Congress is moving to lift restrictions on importing drugs from Canada -- or re-importing, since nearly all drugs are made in the U.S. in the first place. A key vote on this issue is scheduled for today in the House of Representatives.

The reason Canadians, and Europeans who have similar national-healthcare systems, are able to enforce price controls and benefit from the lower prices that result is that they are classic free riders. U.S.-based drug companies spend vast sums to develop new drugs, and Americans pay market prices for them. Once developed, drugs are reasonably inexpensive to produce and reproduce, and companies are willing to sell the medicines at a price that merely covers the marginal cost of manufacturing and distribution.

The Americans pay the fixed cost of R&D, and that is all important. Over the long haul, companies will not keep developing new drugs unless they can recoup the massive costs of research and regulatory approval. Incredibly, Americans, who comprise just 5% of the world's population, account for 50% of the world's spending on drugs. In effect, the U.S. is underwriting the cost of a critical chunk of the world's health care. If U.S. spending on drugs dropped sharply -- as a result of re-importation -- drug companies would simply stop making new drugs.

Re-importation, which, at first glance, seems like a decent idea, would be a disaster for all concerned. Canadians and Europeans, who currently benefit from both low prices and continued research, would be killing the goose that's laying the golden eggs. But American consumers too would be hurt. While they would get the short-term windfall of lower prices, they would end up suffering and not living as long as they could have -- since promising new therapies would never be developed.

In other words, the current system, as unfair as it appears, actually works relatively well. It would work better, of course, if the world paid market prices for drugs. But the system will collapse if re-importation becomes legal.

U.S. legislators who advocate such a change -- many of them Republican -- are acting irresponsibly. Still, their response to the clamor of constituents is understandable. In the end, the most effective opposition to re-importation may have to come from Canada and Europe, which have little gain and everything, including lives, to lose.

At the heart of the issue lies the cost of developing a new drug and overcoming the regulatory hurdles to bring it to market: $802 million on average, according to a study by Tufts University. Even then, only three in 10 market drugs produce enough revenues to match or exceed the average costs of research and development. R&D now totals $30 billion a year. Despite such high risks, drug companies in the past 25 years have developed powerful new therapies for conditions -- including high cholesterol, sepsis, depression, Alzheimer's, HIV/AIDS and asthma -- that had been difficult or impossible to treat in the past.

But imagine if the legislation passes and the Food and Drug Administration gives its assent to the safety of re-imported drugs. It will then be profitable for middlemen to buy drugs outside the U.S. and keep shipping them back until U.S. prices are driven down to the level of Canadian and European prices -- which are low not just because of price controls but also because of government restrictions on their use and because Canadians and Europeans have lower incomes than Americans (Canada's per-capita GDP in 2001 was $22,000, and the EU's $20,900, compared with $35,000 for the U.S.).

In response, drug companies might stop selling drugs to countries that allow re-exportation. The companies may be able to control sales from Canada since it is such a small market -- sales of Vioxx, the popular arthritis pain treatment, total $145 million in Canada vs. $2 billion in the U.S. But if re-importation comes from the large European market, firms would face revenue losses that could be tolerated only by drastically reducing R&D.

In effect, re-importation of drugs would import something else to the U.S.: price controls, where the lack of such practices is the oxygen that allows pharmaceutical research to thrive.

Drug-price controls are pernicious. While controls on oil and other products tend to be short-lived, as voters eventually object to the resulting shortages, the effects of drug regulations are more difficult to observe since they mainly affect medicines that haven't been invented yet.

Even if people realized that controls were preventing new drugs from being developed, the lags would make the controls difficult to remove. Customers would have to pay higher prices for years before they saw any benefits. Firms would have to be convinced that new controls would not be imposed as soon as the new drugs are released.

This lost innovation would have real health costs. A recent study by Frank Lichtenberg of Columbia University found that life expectancy in 52 countries increased by an average of almost two years between 1986 and 2000 and that launches of "new chemical entities" accounted for 40% of that gain.

If Canada and Europe paid market prices for drugs, even more pharmaceuticals would be available to fight disease and save lives around the world. But that's a fantasy; they won't. The best the world can hope for is a continuation of the current process -- which is another example of how Americans, often maligned by others for their selfishness, are, in fact, carrying heavy burdens for the rest of the world.

U.S. consumers, however, are unhappy with the status quo. They ask plaintively why they have to pay $270 for the same dosage of Lipitor that's sold in Canada for $180. But if Americans paid less, the system that has helped the entire world live longer and healthier would come crashing down. The irony is that Canada and Europe -- by opposing the folly of re-importation -- may be the last effective line of defense in maintaining the system, however rickety and anomalous, that so dramatically improves the health of nations.

Mr. Glassman is a resident fellow and Mr. Lott a resident scholar at the American Enterprise Institute.

The Drug World's Easy Riders
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