Protection Money

Protection Money

Protection Money

Policy made plain.
Dec. 29 2000 8:30 PM

Protection Money

How pols play poker with pill prices. 

When you think of all the yackety from both parties about free trade, and when you think of all the things that you can bring into the United States unmolested, it certainly is odd that the short-list of things you can't bring in includes prescription drugs that were manufactured here in the first place. Other industries spend millions buying politicians in the failed hope of government protection from foreign competition. Meanwhile, the pharmaceutical industry spends similar millions on politicians and succeeds in getting protection not just from others but from itself.

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On the other hand, President-elect Bush may have put it too strongly when he said, during one of the election campaign debates, that packing up a pile of good ol' American pills, trucking them across the border to Canada, unpacking them, performing some bureaucratic voodoo, repacking them, and trucking them back across the border to the country where they were produced actually "makes sense." As a way to control the cost of pills, touching Canada like third base and then dashing home is pretty odd itself.

In September, Congress passed a law ending the ban on reimportation of American-manufactured pharmaceuticals. President Clinton gave it mixed reviews but signed it. The law contains a mealy-mouthed provision that it should only take effect if it won't imperil the health of the citizenry and if it will actually reduce drug prices. These are precisely the issues raised by opponents of lifting the ban. So this law is like one that calls for curing cancer by distributing free Kit Kat bars, with a provision that it won't take effect unless the secretary of health and human services determines that Kit Kat bars really do cure cancer. If you're Congress, you pass that law, announce that you've cured cancer, and leave the secretary holding the bag. HHS Secretary Donna Shalala refused to oblige, as she announced Tuesday, so the law lifting the import ban won't take effect.

All sides are being disingenuous about their reasons. The drug companies say their concern is safety. Just imagine what those nefarious Canadians might do to innocent American pills entrusted, however briefly, to their possession. The companies' actual concern, of course, is to preserve the ability to sell pills around the world for a lot less than they charge in the United States. The Republican-controlled Congress deserves credit for standing up to the drug companies—and scorn for pretending that this is a serious way to reduce drug costs. The Clinton administration deserves a smirk, if not a smack, for its position that fixing some details and "loopholes" could make the law work. It can't.

This bring-the-pills-home issue, though small, nicely illustrates big current problems of both the American political system and the American economic system. The political problem is the free lunch. There are several plausible approaches to soaring pharmaceutical costs. One would be to accept them as a price worth paying for good health and extended life. Another would be to say that society cannot afford them and we must all do without (including those who could pay on their own, because the pills won't even be developed). A third might be price controls on the drug companies. A fourth would be various methods of structured competition like those discussed during the Hillary health-care debate of the early 1990s.

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Not plausible is the notion that you can cut the price of drugs 30 percent or 50 percent by tossing them across Niagara Falls and back again.

And why not—since the drug companies do in fact charge much less to Canadians, and to foreigners generally? The answer is that pharmaceuticals (like computer software, etc.) have the New Economy characteristic described by Treasury Secretary Lawrence Summers, among others: The costs are front-loaded. Getting to the point of producing the first pill can cost hundreds of millions of dollars, but producing the second and subsequent pills costs practically nothing.

The pill-maker enjoys a monopoly for a while, thanks to a patent, which is pleasant. Nevertheless, the company faces a puzzle: It makes money on any pill sold for more than the trivial cost of producing that pill. But it loses money overall unless at least some customers pay for a share of the original costs as well. The solution is price discrimination: charging what the market will bear in different markets. Some nations, like Mexico, are too poor to pay what Americans pay; others, like Canada, bargain harder or have price controls (which amount to a take-it-or-leave-it bargaining stance).

An effective law enabling Americans to buy American drugs at Canadian or Mexican prices would make price discrimination impossible. That is the whole idea. But the resulting price would not be the current Mexican or Canadian bargain. It might be something in between that and the current American price. That would mean more money from foreign customers who stick, but less from American customers, and nothing from foreigners who drop out. The bottom line might well be not a bargain, but a drug that never gets developed at all.

But why must we be the top-dollar saps? Answer: It's not because we're so generous and forward-thinking. It's because we have no leverage. Leverage comes from negotiating as a group, which means giving up some rights to individual choice. The Hillary experience made any suggestion along those lines political anathema. Leverage ultimately means being willing to walk. In this context, it would mean convincing the drug companies we would actually rather see some new wonder drug go undeveloped than pay what they're asking.

I'm not sure it's necessary for the richest nation in the history of the world to play poker like this with its own lives and health. I'm absolutely sure we're not capable of it.