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Why Do Drugs Cost Less in Canada?

John Buntin
Posted Thursday, May 25, 2000, at 7:46 PM ET

Prescription drugs, even those manufactured by American companies, cost much less in Canada than in the United States. Why?

The simple answer is price controls. A Canadian law authorizes a review board to order a price reduction whenever the price of a drug exceeds the median of the prices in six European countries plus the United States. Since all the European countries intervene in various ways to hold down drug costs, Canada in effect piggy-backs on other countries' price controls.

So why not do the same thing south of the border? Trouble is, drug companies are willing to sell for less in Canada and elsewhere only because they can sell for more in the United States. They are engaging in what economists call "price discrimination"--that is, charging different prices to different buyers of the same product. Price discrimination works in the drug industry because drugs are very expensive to develop, but fairly cheap to manufacture. As long as companies can recoup their research and development costs by charging high prices in the United States, they can make a profit in Canada and elsewhere by merely covering the cost of making the pill (or tube of ointment or whatever). Similar price discrimination occurs within the United States, with HMOs and other large buyers able to negotiate lower prices while the uninsured pay top dollar.

In recent months, members of Congress from both parties have introduced bills to stop this drug price discrimination, either by allowing the re-importation of drugs from Canada and Mexico or by requiring U.S. drug companies to offer drugs at one price for all of North America. If drug companies had to charge the same price in the U.S. and Canada, what would that price be? It would have to cover R&D costs, so it would be higher than the current Canadian price. But those costs would be spread over more pills, so it should be lower than the current American price. (This assumes that companies will maintain the same profit levels they currently enjoy.) Canada would have to abandon or modify its price controls, or its citizens would not be able to buy these drugs.

Price discrimination seems, and often is, unfair. But there is a case for it in some circumstances. Mexico is a clearer example than Canada. Most Mexicans simply cannot afford to pay much higher prices for drugs. When price discrimination leads to sales that otherwise wouldn't take place, it costs the higher-paying customer nothing. In fact, if the lower price includes at least some contribution to R&D expenses, price discrimination can even reduce the higher price. Thus allowing Mexicans and Africans and other poor people to buy drugs for much less than they cost in America may not only help them but may make drugs a bit cheaper in the United States as well.

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Reader Response from The Fray:


It's not clear that prescription drugs cost less in Canada than the U.S. The price comparisons that have recently drawn a lot of attention have generally been for brand-name drugs. Generics tend to be cheaper in the U.S. and that's important since almost half of U.S. prescriptions are for generics. A study by Patricia Danzon and Jeong Kim showed that depending on the variables used, they could show that Canadian prescription drug prices were 218% higher than those in the U.S.--or that U.S. prices were 171% higher than in Canada. Their best estimate was that an average U.S. consumer would have paid 3% more in Canada for the same drugs over the period of a year.

But even if prescription prices are lower in Canada, it is doubtful that the reason is price controls. There are three likely causes: First, Canada has relatively weak patent protection for pharmaceuticals. This allows lower-cost generics to be manufactured which serves to keep price pressure on the name brands. Second, the Canadian legal system is such that the product liability costs for pharmaceutical companies in Canada is much lower than in the U.S. And last, with a 66 cent dollar, Canadians have significantly less real income than do Americans and accordingly, many products in Canada are priced so as to maximize their sellers' revenue. This is true for cars and Big Macs and it is especially evident for products with low marginal costs like CDs and drugs. This last point is I think what Explainer was trying to get at.

--Steve Cohen

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To Steve Cohen: Canadians may have less real income, but not just because of currency translation.

--Edward Brynes

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This piece severely disappoints by simply passing along as fact the pharmaceutical industry spin about the R&D costs of life-saving drugs:

Price discrimination works in the drug industry because drugs are very expensive to develop.

Barring an opening of the companies' accounting to scrutiny (they consistently refuse to provide details about all of this apparently crushingly expensive R&D), we have little reason to simply accept it as true. In fact, we have plenty of reason to doubt it, as demonstrated by the recent NYT report about drug companies' use of public universities and tax dollars as R&D divisions--with little return to the public who funded the development of marketable drugs.

If you want to know where the real costs are for drug companies, try reading Ad Age. Take a look at the way pharmaceutical companies are throwing hundreds of millions of dollars into direct-to-consumer advertising for lifestyle drugs. That's where their money is going, instead of, say, R&D for illnesses that affect millions of people in developing countries.

--Todd Morman

(To reply, click here.)

(5/28)

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