America is a funny nation. After giving Canada the cold shoulder
for not supporting the War to Liberate Iraq, Americans now seem
eager to embrace Canada for its prescription drug prices. At least
that’s what some Midwest governors are hoping.
In mid-September, Illinois Governor Rod Blagojevich ordered a
study to examine the cost of purchasing drugs from Canada for the
purposes of holding down costs for state workers’ insurance plans
and Medicaid. However, as Greg Blankenship of the Illinois Policy
Institute put it, “It was a case of get the policy first and the
evidence later.” Barely a week after he ordered the study,
Blagojevich hopped a plane to Washington, D.C. to lobby the Federal
government to allow states to reimport drugs from Canada. He was
quickly rebuffed by both the Food and Drug Administration and
Speaker Dennis Hastert.
Yet Blagojevich soon found allies. Jennifer Granholm, governor
of Michigan, expressed interest in the idea, as did Minnesota Gov.
Tim Pawlenty. Pawlenty recently released a plan to have the state
government create a website which will allow state employees to
purchase drugs from approved pharmacies in Canada. Under the
agreement, state officials will be able to negotiate prices with
the approved pharmacies. Pawlenty is “cautiously optimistic” that
it will not violate Federal law.
Not to be outdone, my governor, Iowa’s Tom Vilsack, called for
his own study in late September. Vilsack then followed
Blagojevich’s lead on the need to study the issue: The other week,
he was imploring Iowans to sign a petition set up by Blagojevich
urging Congress and the FDA to legalize drug reimportation.
The reason drugs in Canada often sell for less can be explained
in two words: price controls. However, prices in Canada are only
high enough to permit pharmaceutical companies to recover their
production costs. Their much higher research and design (R&D)
costs are recovered by selling market-based (higher) prices in the
United States. By reimporting drugs from Canada, we are actually
reimporting a system of price controls. The justification for this
is, of course, the onerous drug companies. According to the state
government officials I spoke with, the big pharmaceuticals have
sins aplenty.
One such sin is supposedly overstating the cost of bringing a
new drug to market. Drug companies often refer to a study by Joe
DiMasi, Ronald W. Hansen, and Henry G. Grabowski that estimated the
cost of bringing a new drug to market was over $800 million.
Critics point to a study by Public Citizen showing that the true
cost is much closer to $115 million. Yet Public Citizen’s figure is
erroneous in two ways.
First, Public Citizen arrived at its number by dividing the
amount that members of Pharmaceutical Research and Manufacturers of
America (PhRMA) spent on R&D by the number of new drugs
approved by the FDA. The problem is that many of the new drugs
approved come from companies that are not members of PhRMA. In
short, Public Citizen deflates the numerator, and inflates the
denominator.
Second, Public Citizen further reduced the cost by 34% by
claiming that R&D expenditures are deductible from the
corporate income tax. This is misleading because the corporate
income tax is a tax on profits. As Joe DiMasi notes “Profits are
equal to revenues minus costs; deducting R&D expenditures and
other costs from revenues is a means by which the base for a tax on
profits can be determined. In short, subtracting the costs that
generate that income from taxable income is not a tax break for
corporations.”
Another sin is exemplified in remarks from Amanda Crumley,
communications director for Governor Vilsack. “Drug companies
should spend less on marketing and advertising,” Crumley said.
Supposedly, drug companies spend too much money on both commercial
and public relations advertising. But the criticism regarding
commercial advertising is selective — no one criticizes Ford,
Wal-Mart, or Microsoft for advertising their products. Somehow,
drug companies are “special.”
As for the public relations advertising, consider remarks by
presidential hopeful Senator John Edwards at the most recent
Democratic debate:
We have to bring down the cost of prescription drugs
for you and for all of those Americans who are struggling to pay
the cost, which means having a president to do what I’ve done my
whole life, which is have the backbone to stand up to these big
drug companies, with their advertising, with their price gouging,
not allowing drugs to come back in here out of Canada, stopping
their abuse of the system to keep a monopoly and keep generics out
of the market.
Edwards’ remarks encapsulate the PR campaign that has been waged
against the drug companies for some time now. Do critics really
expect the drug companies to sit back and not respond to such
demonization? It’s a no win situation: First drug companies are
criticized for selling their product; then they are criticized when
they defend themselves.
According to Kevin Concannon, head of Iowa’s Department of Human
Services, another sin is that “the drug companies are the most
profitable industry in the U.S.” And, indeed, they are. Yet Merrill
Matthews, Jr. of the Council for Affordable Health Insurance notes,
“The implications of this criticism are that drug companies could
lower their prices and still be profitable, and that there is some
publicly acceptable level of corporate profits that should not be
exceeded.” If we want the flow of new drugs to continue, we need
the drug companies to be very profitable. The reason is that
developing a new drug is extremely risky, with only one of every
5,000 new chemical compounds making it to the market, and only
three in ten drugs becoming profitable. Unless the drug industry
has a large profit margin, investors will not put their money into
the development of new drugs. The profitability criticism is also
selective. As Merrill states, “Coca-Cola made more money in most
years of the 1990s than the median pharmaceutical company, and no
one accuses the company of price gouging.”
Concannon leveled another common criticism at the drug
companies, that much of their money is “spent on me-too drugs,
which don’t add to the ‘medical kit bag.’” This is the criticism
that drug companies are not investing R&D on new drugs, but
imitations of drugs that already exist. Yet DiMasi notes that the
“me-too” term is “loosely defined, and has a built-in pejorative
sense.” It implies that such drugs are cheap knock-offs. But often
times such drugs are ones that have gone through the entire
research and FDA approval process. For example, suppose that
Company A began research on a drug to treat leukemia in 1993, and
Company B began research on such a drug in 1994. If both companies
have the same research and approval time, say seven years, then
Company A’s drug will hit the market in 2000, while Company B’s
will appear in 2001. Yet Company B’s drug will be dubbed “me-too”
even though it probably cost just as much to bring to market as
Company A’s drug. Finally, the critics of “me-too drugs” are
overlooking a simple economic concept: More than one drug means
competition, and competition drives down prices.
Indeed, it seems that an ignorance of economics is in part what
drives the movement to reimport drugs. When asked if reimporting
drugs would cut into the industries profits resulting in a
reduction in R&D spending, Concannon dismissed it as a “bogus
argument.” “It is in their interest to keep producing,” he said,
“because that’s how they make money.” Given that reducing drug
company profits to zero would result in a drop in R&D spending,
it is only a question of “how much” will R&D be reduced if
profits are reduced via reimportation.
What ultimately drives this is a desire for power and control
over the drug companies. Many on the political left want drug
companies to charge prices which they deem to be “fair.” If they
can’t get price controls imposed by the governments in the U.S.,
perhaps they can get them through the back door of Canada. After
all, if American consumers can get cheaper drugs from Canada, and
Canada has price controls, it isn’t much of a stretch to think that
Americans might demand a regime of price controls here.
Price controls on prescription drugs will have the same
disastrous consequences that they have had everywhere, such as
shortages and less investment in the product that is controlled.
And it will mean higher costs in the long term. In one study,
economist Frank Lichtenberg found that an expenditure of $11,000 on
general medical care extends life by an average of one year, while
an expenditure of only $1,345 on prescription drug research yielded
the same result. Limiting research on prescription drugs will only
shift health-care to other more costly treatments. Pay less now,
pay more later.
Unfortunately, it is likely to get worse before it gets better.
The movement to force drug companies to sell for less is no longer
limited to the left. Minnesota’s Governor Pawlenty recently said,
“This system is unsustainable. It seems odd to me that, in this
crisis situation, the federal government and the industry have a
white-knuckle grip on the status quo.” Pawlenty is a
Republican.
