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.
