Passing the Proposed Drug Amendment Could Be Harmful to Your Health

For days now, the health care legislation in the Senate has been stalled. Democrats are divided over a proposed amendment that would let consumers buy pharmaceuticals from abroad. During the presidential campaign, Obama promised to allow such purchases. But earlier this year he announced his opposition in return for pharmaceutical companies promising to spend at least $150 million, and possibly as much as $200 million, to push his health care legislation.

President Obama obviously faces a dilemma: either he keeps the campaign promise he made to voters or he keep his later promise to drug companies. Passing the proposed drug amendment may bring down the entire health care bill, losing the votes the votes of Democratic Senators from New Jersey and Delaware, where the largest pharmaceutical companies are located. Politico reports: "Senate Democratic leaders are blaming Republicans for the hold up, but insiders argue that those leaders are trying to figure out how to give Democratic Sen. Byron Dorgan (N.D.) a vote on his amendment without busting the carefully crafted and fiercely protected deal between drug companies and the White House. Some Democrats worry that a broken [Pharmaceutical Research and Manufacturers of America] agreement could send health reform completely off the rails." "[The pharmaceutical] industry support is considered a key to passage," the The Los Angeles Times claims The Los Angeles Times claims.

Americans are upset that Canadians can buy American-produced drugs at a lower price than Americans, especially since nearly all of their prescription drugs are made in the U.S. in the first place. The reason Canadians, and for that matter Europeans, who have similar national-health care systems, are able to enforce price controls and benefit from the lower prices is that they threaten the pharmaceutical companies with the loss of their patents. If pharmaceutical companies don't accept the price that the Canadian government is willing to pay for a drug, they can't sell their drug there. But, under World Trade Organization rules, if their drugs aren't sold in Canada within two years after they are sold in the U.S., the company loses its patent and Canadian companies can copy the drug -- leaving the company that created it with absolutely nothing.

These foreign countries 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 companies are willing to sell the medicines at a price just slightly above the cost of manufacturing and distribution.

The American consumers thus 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. 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.

Even Canadians and Europeans, who currently benefit from both low prices and free-ride from the continued research, would be hurt from exporting their price-controls because they would also suffer from the reduced research. And 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 many 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 private pharmaceutical research will collapse if re-importation becomes legal. Because of the price-setting in foreign countries, re-importation does not constitute the free-market ideal some claim. Further, the proposed law called for in the amendment will outlaw contracts that drug companies have signed with those who purchase their drugs at price-controlled prices in other countries not to re-import them back to the United States.

U.S. legislators who advocate such a change -- some of them Republican, such as Senators Chuck Grassley (R-Iowa) and John McCain (R-Arizona) -- are understandably responding to the clamor of constituents. But drug-price controls are particularly 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 have not 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.

At the heart of the issue lies the enormous cost of developing a new drug and overcoming the regulatory hurdles to bring it to market: $1.4 billion on average. Even then, only 3 in 10 market drugs that are actually marketed produce enough revenues to match or exceed the average costs of research and development. R&D in the U.S. pharmaceutical industry 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 drugs are re-imported from Canada and other countries. 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 real incomes than Americans (Canada's per-capita GDP in 2007 was $38,950, Germany's was $34,171, compared with $46,139 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 Lipid regulators, drugs that lower cholesterol and reduce the risk of cardiovascular disease, total $2.3 billion in Canada vs. $14.5 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.

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 $336 for the same dosage of Lipitor that's sold in Canada for $215. But if Americans paid less, the system that has helped the entire world live longer and healthier will come crashing down.

*John Lott is the author of Freedomnomics.