This is a partial transcript of The Big Story With John Gibson, October 27, 2003, that has been edited for clarity.

JOHN GIBSON, HOST: Believe it or not, there is now a northern front in the war on illegal drugs, but we're not talking about narcotics (search). Otherwise honest Americans are crossing over into Canada to save money on prescription drugs.

Heather Nauert is here to get into the economics of it all.

HEATHER NAUERT, FNC CORRESPONDENT: Well, John, it may be illegal for Americans to buy prescription drugs from Canada, but one million Americans ignore the law and buy the cheaper drugs through Canada anyway, mostly over the Internet.

Now a handful of states, including Illinois, are lobbying the federal government for approval to buy drugs from Canada for state employees and retirees in order to save money.

Joining me to explain this now is Austan Goolsbee (search), professor of economics at the University of Chicago Graduate School of Business.

Austan, today's big question is... why are drugs cheaper in Canada than in the U.S.?

AUSTAN GOOLSBEE, U. CHICAGO GRAD SCHOOL OF BUSINESS: Well, the simplistic version is — it's easy to see why they are cheaper. Canada has a nationalized health care system. They have price controls so they say the price can't go higher than some amount, which is a lot lower than the U.S. price.

NAUERT: Of course, we have a free market health care system (search) here. To the average person — or perhaps the average elderly person who may be paying thousands of dollars for a drug here in the U.S., and they see that drug may cost just a fraction of that overseas, they may ask the question, “Well, if price controls work in Canada, why not here in the U.S.?” What would those types of price controls do to the U.S. market?

GOOLSBEE: Yes, there is no doubt they are probably very upset because it's the same medicine. It's just going for half the price, say, in Canada.

The main reason why you can't have a price control system in the broader market, or if we tried to put that in place in the United States, is whenever you put in these price controls, they are going to run out of drugs. They are going to cease engaging in research and development. They are not going to want to come out with new drugs that are improvements on the old ones.

And you have already seen this in Canada. Once the drug companies start seeing that there is going to be this arbitrage, if you will, they start saying they are going to limit the amount of drugs that can go to Canada, just the number of pills that the Canadians need. So you look at pervasive shortages if they did that in the U.S.

NAUERT: So what's the simple reason as to why we pay so much here? Other than we have a free market? What do you attribute that to?

GOOLSBEE: Well, a lot of it is that other rich countries, like Canada, the countries in Europe, they are free riding off the [research and development] that takes place in the U.S.

Because we have a free market, a lot of the drug companies view the U.S. as their primary place of business. So they develop drugs, they sell them in the U.S. for quite high prices. They use that to cover their costs. And then selling the drugs in Canada or Europe or wherever else is really just gravy on top of the costs that they need to cover the [research and development].

NAUERT: So here in the U.S., then, what you're actually saying is that we're footing the bill for Canadians, for the French, for everybody else, because those U.S. manufacturers are making the drugs, and nobody else in the world pays the prices that we do?

GOOLSBEE: That's absolutely right. I mean, in many ways, if your grandfather Jack is on Lipitor, in many ways, you know, Grandpere Jean-Pierre in France is able to buy Lipitor precisely because they invented it for the U.S. market, knowing that they could sell it for a lot here.

NAUERT: Well, to make the system more fair, is there any way that U.S. companies can basically say to the Canadians, “Hey, you guys. We're going to quit downsizing you guys. You have to start paying some of our research and development prices, fees?”

GOOLSBEE: Well, see, what's hard is there is no — there is no enforcement. You can't pass a world law that says we have to charge the same price in every country. And so once you — if you rule that out, then you have a hard time figuring out how would you get them to go ahead and pay that?

So a lot of people criticize the drug companies because they say, “Look, you negotiated these contracts with Europe, with Canada. Why are you willing to sell these drugs for such a cheap price? Why don't you sell them in the U.S. for that price?” But the answer is the U.S. is just such a big market that if they sold it at that price in the U.S., they would cease selling it. They would not want to develop the drugs.

NAUERT: Okay, Austin Goolsbee from the University of Chicago Graduate School of Business, thank you very much for joining us.

Now... the Federal Drug Administration (search) opposes plans for Americans to buy drugs from Canada, saying that the FDA can't insure the quality of those drugs. The reason is some could be counterfeit. Others worry that Canadian doctors are writing prescriptions for people they have never even met.

GIBSON: How about we not sell the drugs to Canada. Go ahead. You want pot legal. Try to cure your diseases with that stuff. We're not going to sell you these things. Heather, thanks very much.

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