Results 1 to 2 of 2

Thread: Your Brain on Drugs

  1. #1
    Senior Member Max's Avatar
    Join Date
    Jul 2001
    Location
    Montreal,Province of Quebec, CANADA
    Posts
    15,036

    Your Brain on Drugs

    Your Brain on Drugs
    By Kevin Hassett 07/18/2003
    E-Mail Bookmark Print Save


    TCS

    Congress is poised to pass a new law that will make it legal to import drugs from foreign nations. This "reimportation" bill has strong bipartisan support, and may well become law. If it does, the results will be disastrous.

    The logic of the bill appears attractive at first glance. U.S. drug companies sell their drugs abroad at prices below those paid by domestic customers. For example, 30 tablets of Zocor cost $89.95 in a typical U.S. pharmacy, and only $41.20 in a Munich pharmacy.

    This large difference in prices creates an impression that drug profiteers are gouging American customers. If they can sell to the French for less at a profit, why can't they sell it at home at the same price? Rather than specifically setting the price, the reimportation bill will allow U.S. customers to purchase drugs at these low foreign prices. Those low prices will make U.S. customers better off, won't they?

    Not really. The crafters of this bill have clearly misunderstood the basic economics of drugs. Therefore, a review is in order. The U.S. is the only significant market in the world where companies are allowed to set the price for their products in the marketplace. The pricing of drugs is very complicated. At the time that a new and important drug is approved, a drug company likely has a monopoly on that specific product and can charge a very high price for the drug if it so chooses.

    The monopoly can be relatively short-lived, however, since there are no significant barriers to entry, and other companies can develop competing products if a new and successful moneymaker is discovered. (One need only think about all of the different competing pain medications to understand this process).

    Moreoever, after the patent period expires (usually about 10 years after a drug hits the market) generic competitors can enter and drive prices down as well. So a window exists wherein a firm can charge a price that is higher than the immediate production cost. During that period, a firm hopes to earn enough profit from the drug to cover that drug's development cost (often in the billions) and also to offset the losses for all of the other drugs that the firm investigated and dropped.

    Because of these challenges, the drug industry is perhaps the only industry where a firm can currently market goods at a price significantly above the marginal cost of production and yet not be insanely profitable on balance. For example, Merck is one of the larger U.S. drug companies with many successful drugs such as the cholesterol drug Zocor, and yet its share price (about $60 per share) is exactly where it was five years ago. While that is going on at the top of the sector, the new entrants seeking to compete for Merck's profit in the biotechnology sector are famously hurting for cash, with many of them near bankruptcy. That is hardly a story of an industry with runaway profits.

    U.S. firms use the profits on the winners to balance out the losses on the losers. In the U.S. they have significant room for maneuvering, but in Europe (and Canada) the story is much different. There, the U.S. firm must negotiate with government bodies that present the firm with a take-it-or-leave-it offer. If a drug costs $10 a pill to produce at the margin and is being sold in the U.S. for $20 a pill, then a European government can say "sell it to my people for $11 a pill or you can not sell it at all in my country." Since the deal gives the firm $1 profit at the margin, the U.S. firm makes the deal. The choice is not surprising since it is a very basic result in economics that "price discrimination" can help a monopolist maximize the revenue from its product.

    So the marginal profit on a sale in a country with socialized medicine is lower, but the extra profit on top of that earned in the U.S. free market helps firms balance out all the other losses. The system has worked for U.S. firms, while low profits in Europe have shut off product development and innovation there. The U.S. is responsible for most new discoveries and for 15 of the top 20 drugs worldwide. The development disparity is getting larger, as U.S. firms are responsible for the lion's share of worldwide R&D.

    By allowing reimportation, the new bill remove the pricing power that firms have in the "window of profitability" for new drugs and cede it to foreign governments. While the change in law may force U.S. firms to try to take a harder line with foreign governments, it is hard to be optimistic about the outcome of the debate since foreign governments can always just decide to ignore the U.S. patents and counterfeit the drug themselves. While such an action would violate treaties, it is hard to imagine that the socialists (already nearly bankrupt) would agree to commit significant new funds to drugs. So firms will have to either stop selling the drug abroad, or lower their U.S. prices. Either way they lose.

    Accordingly, the bill will destroy the system that allows profits from winners to offset losses from losers, and likely destroy the economic architecture that has led the U.S. pharmaceutical industry to be the envy of the world. It will also significantly reduce the profitability of U.S. firms which will have a dramatic impact on their share prices, and the stock market as a whole. Lower profits will inevitably lead to reduced research and development, which will slow the discovery of new drugs.

    This last effect puts this Congressional action in proper perspective. Congress is sacrificing future cures so that they can offer voters cheaper drugs between now and the next election. Such crass calculations have sadly become par for the course in American politics.

    That said, I am not even sure that the political calculation is correct. For example, the Associated Press reported on July 16th that the FDA discovered that millions of fake Lipitor pills were slipped into the country this spring. The extent to which these fake drugs harmed consumers is not yet known, but the FDA is concerned that it will be unable to adequately monitor the quality of imported drugs if this bill becomes law. FDA commissioner Mark McClellan told the AP that "our enemies are smart, they're cunning, they're aggressive." Imagine the news coverage when U.S. patients start dying because their cheap imported drugs proved to be ineffective counterfeits. It is hard to imagine that such stories will help incumbents.

    If Congress allows reimportation, it will be frittering away a crown jewel of the U.S. economy for short-term political gain that will endanger Americans. Let's hope our elected officials see the light before it is too late.

    Kevin A. Hassett is Director of Economic Policy Studies at the American Enterprise Institute.




    E-Mail Bookmark Print Save


    http://www.techcentralstation.com/10...D=1051-071803E

  2. #2
    Senior Member Max's Avatar
    Join Date
    Jul 2001
    Location
    Montreal,Province of Quebec, CANADA
    Posts
    15,036

    A Risky Shot In the Dark

    A Risky Shot In the Dark
    By Kevin Hassett 07/22/2003
    E-Mail Bookmark Print Save
    http://www.techcentralstation.com/10...D=1051-072203F

    TCS

    The latest word is that the bill to permit reimportation of drugs mentioned in my previous piece is very close to having enough votes to pass. The reason the bill is so close to becoming law is that a number of traditionally free-market Republicans have rallied behind it. Why would they do that? Apparently, members have grown tired of watching foreign governments pay far less for U.S. drugs than U.S. citizens pay. Exasperated that the Canadians and French (and others) are free-riding off of our drug discoveries, members have decided to force the drug companies to charge the Canadians the same price they charge Americans. The hope is that this will raise the price faced abroad and lower the price here.

    My first response to this is to note that this complicated world system has helped the U.S. drug industry become the envy of the world, so why are you messing with it? But a more detailed response is warranted as well.

    The problem with this analysis is that the hope is misplaced. Recall how prices are set when a U.S. firm attempts to sell a drug abroad. It must negotiate a price with a government monopolist that can give the firm a take-it-or-leave-it offer. U.S. firms today want to extract as much profit as they can in these negotiations, and the result is the relatively low prices that we see abroad.

    How is it that foreign governments can extract such healthy price concessions? There are two answers. First, if the U.S. firm decides to refuse to offer a government any drugs at the offered price then the government could well decide to ignore the patent and encourage a domestic producer to supply a generic version of the drug. It might even claim to do so for humanitarian reasons. Second, it is relatively unusual for a firm to have a product that has an entire market to itself. A pain medication, for example, has many competitors. Foreign governments can play one supplier off against the other, since Johnson and Johnson can rush in where Merck decides to exit.

    If reimportation is allowed, then U.S. firms will be more willing to fight these lower prices, but it is hard to imagine that this will have much of an impact on the dynamics of price negotiation. This is especially true because the governments that firms will be negotiating with are already out of cash. It is impossible to use economics to say exactly how this process will work out, but it is a lock that a new single price for all countries that makes U.S. consumers better off and leaves drug revenues unscathed will not prevail. The first move will undoubtedly be a rejection of the demand for a higher price. The second move might be a search for informal side agreements that offset the new law. For example, a firm might sell at a lower price only on the condition that a country discourages exports of that drug. A black market will likely emerge to get around these deals. This is probably the most likely outcome. The bill creates a costly mess abroad, does little to prices at home, and crushes only the drug companies.

    Alternatively, U.S. firms could play a game of chicken with foreign governments and refuse to offer drugs at low prices any longer. I am a little doubtful that this would happen since firms could play chicken now and don't, but exploring the possibility is instructive anyway.

    In this scenario, there would likely be different outcomes for different types of drugs. For drugs with slightly inferior off-patent substitutes, foreign governments will likely just do without the superior product. For drugs -- like those that lower cholesterol -- that have long-run benefits but do not necessarily have an immediate and visible effect on mortality sales could disappear as well. Only for unique drugs (cancer, high-end antibiotics etc.) that immediately affect mortality, would I expect the U.S. firm to possibly be able to extract a higher price, but only if foreign nations continue to respect U.S. patents -- a rather iffy proposition.

    But follow this scenario further. Suppose that a cancer drug manufacturer is able to significantly increase revenue from France for its drug. The French do not have the budget to significantly increase spending on drugs across the board, so they clearly will offset the concession to the U.S. cancer drug manufacturer by taking a harder line against other U.S. manufacturers either by demanding a lower price or by reducing the use of their product. On balance, U.S. firms will not likely extract new resources from abroad.

    At home, the firms that concede the lower price abroad will face competition from imports of their own product at home. The powerful firms with highly unique drugs will not. This might provide some near-term relief for drug prices, but that relief will likely pale in comparison to the losses that will emerge in the pharmaceutical industry. It is hard to imagine that drug discovery will be aided by this dynamic. Don't forget that the firms that pull out of foreign markets will take an enormous profit hit.

    Staying in this scenario a bit longer, it is also important to make a theoretical point. Drug firms need to maximize their profit from their winners in order to offset the losses for all of their losers. That is how we encourage them to swing for the fences and try new things. Price discrimination is a pretty efficient way to allow them to do this. Recall where the demand curve from Econ 1 comes from. Think of their being a continuum of individuals willing to purchase your widget. If you charge $10 then only David is willing to buy it. If you charge $9, David and Tiger are willing to buy it. If you charge $8, then David, Tiger, and James are all willing to buy it. If you have to charge them all the same price ($8), then David is very happy, since the widget is worth at least $10 to him. A firm can maximize its revenue for a given product by charging each customer a different price, by charging David $10. Reimportation takes this strategy away from firms, and it must make them worse off.

    But will U.S. consumers be better off? They might be in the short run in the unlikely case that a new single world price emerges that is somewhere between the U.S. and foreign price. But even in that case, the net drag on profits will significantly reduce drug discovery.

    Thus, while there are a number of paths that could be taken, in every scenario drug profits and research are lower. This hurts folks who hope for future cures, and it harms investors as well. It is exasperating that foreign governments extract such huge concessions from our firms, but this bill is a risky shot in the dark at the problem.

Posting Permissions

  • You may not post new threads
  • You may not post replies
  • You may not post attachments
  • You may not edit your posts
  •