Drug Reimportation Distorts a Market That's Already Messed Up

(Bloomberg View) -- Senate confirmation hearings tend to follow a certain traditional format. Senators from the president’s party ask incisive, hard-hitting questions like, “Tell me, Mr. Smith, how is it that you have managed to singlehandedly save the auto industry, devote hours every week to your work rescuing orphans from house fires, and yet still remain so well-dressed, charming, and devastatingly handsome?” Opposition senators, meanwhile, pull out the howitzers.

Senator: “I have here a report from www.gruesomeliesaboutpublicfigures.com that says you like to puree puppies in a blender and drink them as a breakfast smoothie. Why do you do that, Mr. Smith?

Mr. Smith: “I don’t drink pureed puppies for breakfast.”

Senator: “So you’ve stopped pureeing puppies for breakfast. Was that because you were afraid that it would become public and derail your nefarious secret plan to devastate the U.S. economy from your perch at the Department of Agriculture? Or did you just get tired of puppy blood? ”

It’s entertaining viewing, but not really all that informative. And it has little impact when the nomination comes to a vote, which tends to break down on party lines. Mostly, it’s just a way for senators to get themselves on the teevee.

This week's hearing on Alex Azar’s nomination for HHS secretary, however, featured a little bit of a format change. Azar took some friendly fire hits from a Republican, Rand Paul of Kentucky, over drug reimportation. The senator ultimately said that he couldn’t support Azar’s nomination unless he was convinced that Azar would be open to allowing Americans to buy drugs from abroad.

What’s the big deal? After all, a statin is not a fine French wine or a ripe Dutch cheese. It’s exactly the same stuff you get here.

Ho, ho, ho, I’m kidding, of course. People want to buy drugs in other countries because they’re precisely the same stuff you get here, only cheaper. And Rand Paul thinks that it’s a violation of free-market principles to prevent them from doing so.

He has a point. The patent, after all, is a pretty hefty violation of the idea of a perfectly competitive market; it’s essentially a government-granted monopoly, and in general, economists aren’t very fond of those.

Yet there is an argument for patents and copyrights. There are certain products for which the major cost of production simply consists of the intellectual labor needed to invent the product in the first place: the research to discover the drug, the hours spent tinkering on a new motor, the painful pounding of the keyboard until all the words are down in approximately the right order to make someone want to pay to read them.

Unfortunately, as soon as that product goes onto the market, it is often quite easy for competitors to copy what you’ve done -- and since they do not have all your expensive development overhead to defray, they can undercut your price, so that the person who did the most important work gets none of the recompense.

If you make it uneconomic for people to do this sort of valuable labor, they won’t, or at least they will do only what they can manage in their spare time from more remunerative work. The result would be a poorer, less innovative society. So we give creators a temporary monopoly on their “intellectual property” in order to let them enjoy some of the profits, and encourage others to do similar work. We can argue about the particular details of patent law or copyright terms. But it’s hard to see how a breakthrough drug or a major motion picture could be made without them.

Nonetheless, a lot of libertarians are suspicious of the idea of intellectual property at all. And they are particularly suspicious of the protections that pharma has enjoyed from competition with foreign countries that themselves have robust patent regimes. It’s easy to see why Paul wants to tear down those barriers, and not just because his constituents would probably enjoy having access to cheaper drugs.

But would that be a real victory for the free market? Drug prices in other countries aren’t low because the markets there have more robust, unfettered competition; they’re lower because of government price controls. What Paul is proposing is not to “free” the pharmaceutical market, but to import exotic price controls into domestic markets.

And so what? If other countries are enjoying artificially cheap drugs, why shouldn’t America hop on the gravy train?

Longtime readers know the answer: innovation. The U.S. provides a disproportionate share of the profits on drugs, which means that we are providing a disproportionate share of the incentive for innovation. If we import those price controls, consumers would benefit right now from lower prices, but sick people in the future will suffer from diseases that we could have cured, if only we hadn’t killed the goose that lays the golden eggs. Given that more people will be alive in the future than are now, from a utilitarian perspective, this is a humanitarian disaster.

But there’s another answer, which is that importing pharmaceutical price controls might not even work.

Imagine you’re a pharmaceutical firm that’s currently selling some number of drugs to Canada, with a population about the tenth of the size of the U.S. You don’t make much margin on those drugs, because the government controls the price, but hey, “not much” is better than “nothing.” You may be suffering a little leakage back into the U.S. as Americans seek drugs from Canada, but thanks to import controls, it’s pretty manageable.

Now let’s say the import control is lifted, and your most lucrative market is suddenly threatened. What do you do?

Well, you can’t just raise the Canadian price to American levels, because Ottawa won’t let you. You could, on the other hand, conveniently develop problems in your supply chain that prevent Canadian pharmacies from buying more drugs than they need to treat their 36 million citizens. You could, in fact, do the same thing in each of the countries from which the U.S. has authorized reimportation. It’s a safe bet that the governments of those countries will go to strenuous lengths to ensure that domestic pharmacies don’t start depriving their own citizens in order to ship life-saving treatments abroad.

Or if you run into legal trouble making that stick, you can simply refuse to sell high-margin drugs to small-population countries where American consumers are likely to be seeking drugs. That’s a high-risk move: It means substantial foregone profits, and running the risk that one of those countries will break your patents and authorize domestic production. But given the differences in margin between the U.S. and Europe, in many cases, it may be worth running that risk. Especially since you probably wouldn’t have to do that too many times before all other countries got the message that they’d be better off keeping domestic drugs from reaching the U.S.

This is arguably a worse result than simply slapping price controls on in the U.S.; it means a loss of research-incentivizing profits in those countries, and needy patients going untreated. And as Rand Paul should know, that’s pretty much what we’d predict from price controls: One way or another, they tend to produce shortages. And the more you try to hide what they are, the more distortions you introduce, which tends to make the shortages worse.

From a policy perspective, Paul might be on sounder ground simply proposing that the U.S. impose price controls of its own. Senator Paul would never do that, of course; calling for price controls would hardly be a good fit with his libertarian, free-market ideals. But if he wouldn’t call for direct government controls of the domestic market, then he shouldn’t be trying to smuggle in foreign ones cloaked in the language of the free market. That’s an even bigger departure from his usual stance than critiquing the nominee of his own party. And it’s one he should rethink.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of “The Up Side of Down: Why Failing Well Is the Key to Success.”

To contact the author of this story: Megan McArdle at mmcardle3@bloomberg.net.

To contact the editor responsible for this story: Philip Gray at philipgray@bloomberg.net.

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