Drug Re-importation: A Doomed Disaster

For years, Americans have enviously eyed low drug prices just over the border in Canada, where strict price controls prevail as part of a socialized national healthcare system (search). Canadian drugs are cheaper by about two-fifths.

Yet, as Canada's Internet drug sales (search) to the United States have topped $700 million, the Canadian Minister of Health Ujjal Dosanjh says the shipping drugs south should stop.

Some blame the Bush administration for putting pressure on the Canadian government, though both governments deny this. Others claim that it is a matter of public safety.

But the explanation is much more straightforward: Canadian drug sales to the United States threaten the free ride that Canadians and other countries have received.

The reason Canadians and Europeans, who have similar national healthcare systems, pay so little for drugs is they enforce price controls. U.S.-based drug companies spend vast sums to develop new drugs, and Americans pay market prices for them. Once developed, drugs are reasonably inexpensive to produce and reproduce, and companies are willing to sell the medicines at a price that merely covers the marginal cost of manufacturing and distribution.

Americans pay the fixed cost of research and development, and that is all-important. In the long haul, companies will not keep developing new drugs unless they can recoup the massive costs of research and regulatory approval.

Incredibly, Americans, who comprise just 5 percent of the world's population, account for 50 percent of the world's spending on drugs. In effect, the United States is underwriting the cost of a critical chunk of the world's health care. If U.S. spending on drugs dropped sharply — as a result of re-importation (search) — drug companies would simply stop making new drugs.

Re-importation, which, at first glance, seems like a decent idea, would be a disaster for all concerned. Canadians and Europeans, who currently benefit from both low prices and continued research, would be killing the goose that's laying the golden eggs.

But American consumers too would be hurt. While they would get the short-term windfall of lower prices, they would end up suffering and not living as long as they could have — since promising new therapies would never be developed.

In other words, the current system, as unfair as it appears, actually works relatively well. It would work better, of course, if the world paid market prices for drugs. But the system will collapse if re-importation becomes legal.

U.S. politicians who advocate such a change — many of them Republican — are acting irresponsibly. Still, their response to the clamor of constituents is understandable. In the end, the most effective opposition to re-importation may have to come from Canada and Europe, which have little to gain and everything, including lives, to lose.

At the heart of the issue lies the cost of developing a new drug and overcoming the regulatory hurdles to bring it to market: $802 million on average, according to a study by Tufts University. Even then, only three in 10 market drugs produce enough revenues to match or exceed the average costs of research and development.

R&D now totals $30 billion a year. Despite such high risks, drug companies in the past 25 years have developed powerful new therapies for conditions — including high cholesterol, sepsis, depression, Alzheimer's, HIV/AIDS and asthma — that had been difficult or impossible to treat in the past.

But imagine if the legislation passes and the Food and Drug Administration gives its assent to the safety of re-imported drugs. It will then be profitable for middlemen to buy drugs outside the United States and keep shipping them back until U.S. prices are driven down to the level of Canadian and European prices — which are low not just because of price controls but also because of government restrictions on their use and because Canadians and Europeans have lower incomes than Americans (Canada's per-capita GDP in 2001 was $22,000, and the EU's $20,900, compared with $35,000 for the United States).

In response, drug companies might stop selling drugs to countries that allow re-exportation. The companies may be able to control sales from Canada since it is such a small market — with the sales of many popular drugs in Canada amounting to only 5 to 7 percent of U.S. sales. The companies may respond by limiting sales to Canada and making Canadians choose between sales to their citizens or resale to Americans. But if re-importation comes from the large European market, firms would face revenue losses that could be tolerated only by drastically reducing R&D.

In effect, re-importation of drugs would import something else to the U.S.: price controls, where the lack of such practices is the oxygen that allows pharmaceutical research to thrive.

Drug-price controls are pernicious. While controls on oil and other products tend to be short-lived, as voters eventually object to the resulting shortages, the effects of drug regulations are more difficult to observe since they mainly affect medicines that haven't been invented yet.

Even if people realized that controls were preventing new drugs from being developed, the lags would make the controls difficult to remove. Customers would have to pay higher prices for years before they saw any benefits. Firms would have to be convinced that new controls would not be imposed as soon as the new drugs are released.

This lost innovation would have real health costs. A recent study by Frank Lichtenberg of Columbia University found that life expectancy in 52 countries increased by an average of almost two years between 1986 and 2000 and that launches of "new chemical entities" accounted for 40 percent of that gain.

If Canada and Europe paid market prices for drugs, even more pharmaceuticals would be available to fight disease and save lives around the world. But that's a fantasy; they won't. The best the world can hope for is a continuation of the current process — which is another example of how Americans, often maligned by others for their selfishness, are, in fact, carrying heavy burdens for the rest of the world.

U.S. consumers, however, are unhappy with the status quo. They ask plaintively why they have to pay $270 for the same dosage of Lipitor that's sold in Canada for $180. But if Americans paid less, the system that has helped the entire world live longer and healthier would come crashing down. The irony is that Canada and Europe — by opposing the folly of re-importation — will ultimately improve their health and ours at the same time.

John Lott a resident scholar at the American Enterprise Institute.