Special Report

Reimportation Looms

Americans and Canadians alike could soon learn that you don't know what you've got till it's gone.

By 11.1.06

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As of last month, Americans can now purchase Canadian drugs through the mail without fear of U.S. Customs officers seizing the packages. Meanwhile Congress reached agreement on a bill that would allow Americans to buy prescription drugs at Canadian pharmacies and transport them home.

Several U.S. lawmakers have suggested that because of these two moves, the full-scale reimportation of pharmaceuticals is just around the corner. After all, brand-name drugs are significantly cheaper in Canada than they are in the United States.

At first glance, legalizing importation seems like a laudable cause. It would make drugs cheaper for all Americans. Right?

Unfortunately, this argument is deeply flawed -- because it assumes that if importation were legalized, prices in Canada would remain at their current levels. That would not happen. Instead, because the U.S. market is 10 times larger, the two national markets would merge and Canada's prices would simply rise to U.S. levels.

If Americans truly want to achieve "Canadian" drug prices, then we must first understand the market and government forces that create the lower prices up north and the higher prices in the States.

Most people attribute Canada's cheaper drugs to the fact that the government imposes price controls on patented medicines.

But contrary to popular belief, these pricing rules are not the primary reason for Canada's lower prices. Canada doesn't control the retail price of drugs -- only what drug manufacturers can charge wholesalers. Wholesale and retail mark-ups are left to the market. More importantly, many drug manufacturers don't even charge the full price permitted under federal rules.

THE FACT IS, RESEARCH SHOWS that most of the price differential on patented pharmaceuticals can be explained by three factors other than price controls:

(1) Differences in standard of living.

While our respective standards of living used to be quite comparable, Canada's has been steadily falling in comparison to that of the United States. Today, the average Canadian's standard of living is 20-30% lower than the average American's. That affects drug prices because of what economists call "price discrimination."

When a firm sells its product in two different markets, it will calculate a profit-maximizing price for each market. The general rule is that prices will be higher in markets where consumers are less sensitive to price and lower where consumers are more price-sensitive.

That's why Budweiser is cheaper in rural New Mexico than it is in Beverly Hills. And it's also why drugs like Lipitor and Nexium are cheaper in Canada -- because Canadians cannot afford to pay as much as their American counterparts.

(2) The "insurance" factor.

America has an incredibly comprehensive insurance system. Ironically, this has led to higher drug prices -- because most Americans are insensitive to changes in the price of drugs.

The fact is, whether they're insured by a private plan or a government one, most Americans pay very little out of their own pocket for drugs. And when you only pay a few dollars for a prescription, you have no particular incentive to shop around. Because U.S. "shoppers" don't care about price, drug suppliers have little competitive incentive to keep prices low.

Eventually, of course, those higher drug prices will be passed back to consumers in the form of higher insurance premiums. But in the absence of a direct link between their drug usage and what they pay for insurance, there won't be an incentive for individual consumers to keep an eye on the full prices of the prescriptions they've filled.

(3) The tort tax on pharmaceuticals.

Finally, drugs are also more expensive in the United States because of the American legal system, which heavily distorts the U.S. pharmaceutical market. Like the rest of America's health sector, drug companies are favorite targets for American trial lawyers.

Although civil lawsuits exist in Canada, they are less common. Perhaps more importantly, awards are almost never decided by juries. And Canadian judges are less willing to give huge awards to sympathetic plaintiffs just because drug or insurance companies have deep pockets.
As a result, the American legal system effectively imposes a tax on pharmaceuticals that Canadians do not have to pay.

SO DESPITE CONVENTIONAL WISDOM, price controls are not the primary cause of Canada's cheaper drugs. But this is not to say that price controls aren't harmful -- they are. The Canadian government's intervention in drug pricing has done enormous harm to the country. Indeed, it has completely stifled Canada's pharmaceutical industry.

Canada produces pharmaceutical inventions at half the rate of the U.S. industry. And per capita investment in pharmaceutical research and development is one of the lowest in the developed world.

If the U.S . Congress truly wants Canadian drug prices in the United States, the steps to follow are clear. First, Americans must cut their standard of living by 20-30%, and drop their comprehensive insurance coverage. Product liability laws should be reformed. Finally, Congress must impose price controls and other restrictions on cutting-edge medicine so that it's unprofitable for scientists to invent new cures.

For those of us who live north of the border, that sounds like a prescription to undermine the superior quality of American healthcare. But as Canadian Joni Mitchell used to say, "You don't know what you've got till it's gone."

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About the Author

Brian Lee Crowley is president of the Atlantic Institute for Market Studies, a public policy think tank in Halifax, Nova Scotia.