Alan Reynolds

When something valuable sells for two different prices, how do you stop people from paying the lowest price? And why would you want to do that?

Congress is debating whether or not to allow Americans to buy prescription drugs from other countries, notably Canada. Many Americans already do that, of course, so the issue is really about making it either easier or more difficult to do what is already being done. Several governors want to make it easier.

I recently received an email asking me to add my name to a letter signed by some prominent economists. It says allowing U.S. citizens to buy drugs from Canada or Europe amounts to adopting their price controls. But one could just as well say that it amounts to taking advantage of the discounts pharmaceutical companies choose to offer to some big buyers -- including the U.S. government and HMOs.

Unfortunately, deep discounts create powerful incentives for arbitrage. To sustain the wide gap between U.S. and Canadian drug prices therefore requires high enforcement expenses. There is no reason U.S. federal and state governments should bear those expenses just to give Canadians a bargain.

The complaint about "importing price controls" assumes that the actual effect of greater drug imports would be to drop U.S. drug prices to the Canadian level. But that could happen only if drug companies were willing to ship tons of drugs to Canada. In reality, several major drug companies have already moved to restrict sales to Canada in order to limit that country's ability to re-export. If that does not work, the Canadian government will have to step in and try to restrict re-exports to the United States.

If the drug companies or Canadians manage to keep cheaper drugs from being arbitraged back into the U.S. market, then officially sanctioning reimportation would have little impact. But if U.S. shoppers instead contribute to critical drug shortages in Canada, then the Canadian government would have no practical choice but to ease up on price controls. To presume the adjustment can only take the form of lower U.S. prices seems presumptuous.

Another overblown rationale for prohibiting U.S. citizens from bargain-hunting is that there is supposedly a much greater danger of being sold counterfeit drugs. Here is what the Food and Drug Administration (FDA) website says about that: "Counterfeits may enter the U.S. distribution system from within the U.S. or from other countries. ... The FDA has seen two highly publicized examples of counterfeit Lipitor and Procrit within the U.S. distribution system."

Health Canada warns that Lipitor drugs "are counterfeit if they contain packaging or labeling that states: ‘Repackaged by: Med-Pro, Inc., Lexington, Neb 68850'." The largest U.S. drug wholesaler, Amerisource Health Corp, is also under FDA and FBI investigation for allegedly being involved with counterfeit domestic drugs. Importing branded drugs is called "reimportation" because it usually involves Canada first importing drugs manufactured in the United States and then sending them back here. Drugs don't become more dangerous just by being shipped north, then south. Besides, most big drug companies have plants in many countries, and many materials going into U.S. drugs are imported.

Mark McClellan, head of the FDA, told the AARP Bulletin, "If you're certain you're buying approved Canadian drugs from an approved Canadian pharmacy, you can have a high level of confidence that that's a good product." It's not safe to buy from an unknown con artist, of course, but that is equally true if the crook has a U.S. address.

Another common rationale for the possibly impossible effort to ban drug imports is that the big drug companies (several of which are based in Europe) say they have to overcharge U.S. consumers because they need the money -- to conduct all the research the FDA demands. This is said to be our unique national burden, like fixing Iraq. One medical writer, Robert Goldberg, explained in The Washington Times that "Americans pay some of the highest prices for drugs in the world ... because of our free market and our willingness to shoulder most of the global costs of new drug development."

Personally, I do not recall being asked about my willingness to shoulder development costs so the rest of the world can get a free ride. That sounds like a bad deal. Besides, high prices for patented drugs can hardly be blamed on a "free market." The whole purpose of a patent is to thwart competition for a dozen years or so. And as soon as the patent runs out, the costly nuisance of a doctor's prescription often becomes miraculously unnecessary (e.g., Claritin and Rogaine).

Patents grant pharmaceutical companies a near-monopoly on branded drugs while the patents last. And any country in which the government is virtually the only customer for such drugs, like Canada, has a near-monopoly on the buying side -- a "monopsony." When a monopsony deals with a monopoly, there is apt to be a great deal of strategic gamesmanship involved, guessing how far the other side can be pushed. This has much in common with poker but little to do with free market competition.

The U.S. drug industry is the envy of the world, and one of the main reasons we are living much longer and better. But the industry is seriously overburdened with regulatory expenses, largely because a 1962 law forced the FDA to try doing one thing to many -- to require that drugs be proven effective prior to much experience, and not just safe. Effectiveness is best left to consumers, pharmacists and doctors, rather than bureaucrats with an incentive to drag their feet. We need to encourage private sources of certification for both drugs and pharmacies -- sources that would compete by building a reputation for being trustworthy (like United Labs or Consumer Reports).

Because coping with regulatory excess involves such high fixed costs, it is also a serious barrier to entry into pharmaceutical production and therefore to competition. Many best-selling drugs have only one or two close substitutes, and compete with marketing rather than price. In short, less drug regulation would give us more competition as a bonus. In the age of the worldwide web, however, retail competition is bound to become increasingly international regardless of regulatory efforts to thwart it. And that makes it strategically problematic for any company to even try charging vastly different prices for the same goods.

Drug companies are and should be free to offer big discounts only to foreigners if they wish. But U.S. consumers are and should be free to shop the world for a better deal.


Alan Reynolds

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