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The cheap drug trap

ANY DAY NOW, the Senate will pass a bill to legalize the reimportation of drugs from Canada and, over time, 19 other countries, mainly European. The bill has widespread bipartisan support. Indeed, its co-sponsors include Senators Kennedy and Lott, who generally disagree on everything. The fact that they and their colleagues, almost all of them lawyers, are convinced they know how to fix the prescription drug market is enough to raise an economist's eyebrows. And a glance at the 73-page bill's provisions is enough to make an economist's stomach sick.

The impetus for the bill is, of course, the fact that we Americans pay an arm and a leg for prescriptions. Meanwhile, just over the border in Canada, one can buy the same drugs for roughly 40 percent less. With an over-80 mom whose prescriptions cost a grand a month, I feel this pain.

But when I take off my son's hat and put on my professor's cap, I realize that we need to ensure that legalizing drug imports does not end up dramatically limiting the development of new and potentially life-saving medications. The one and only reason that drug companies are pouring billions into research is that when they finally find a medication that works, they can make a great deal of money selling it. Indeed, our patent system grants drug companies and other inventors a complete monopoly over their inventions for 20 years.

In effect, we tell inventors they can charge high prices for two decades as long as they come up with something unique that people want to buy. We also tell inventors to feel free to sell their products abroad at a lower price if doing so generates more revenue and, thus, supports more research.

Canada and many other countries have been very effective in giving drug companies take-it-or-leave-it offers under which the drug companies are forced to either sell their products at a low price or not at all. Rather than make zero foreign sales, the drug companies have buckled under. In exercising single-buyer power, countries like Canada have also been able to play one drug company against the other. For their part, the drug companies, perhaps in fear of antitrust prosecution, have failed to form a single-seller collective to negotiate bilaterally with county buyers. Nor has our government stepped in to assist the drug companies from getting picked off one by one. The result is that foreign countries are getting drugs on the cheap, free-riding on our patent system, and undermining long-term incentives for R&D.

Instead of addressing the real problem, namely that foreign countries are manipulating the market and paying too little, the Senate bill, in effect, lets foreign governments set drug prices not only on behalf of their own citizens, but ours as well. The bill prohibits American companies from limiting drug sales to either foreign importers or foreign re-exporters. It also prevents American companies from selling drugs to foreign re-exporters at a higher price than they charge foreign importers. So American drug manufacturers will have to sell their products to the Canadians, at a price and in a quantity set by the Canadians, and then the Canadians will be free to resell these drugs back to the United States at the same price these drugs are sold in Canada.

While my mom might at first be overjoyed by this result, she'd change her tune if I pointed to all the drugs she's taking that might not be available had this policy been adopted in the past. Indeed, for all its good intentions, the bill has the potential to wipe out almost $100 billion in annual drug company revenues. This plus the prospect of what amounts to the ongoing importation of foreign price controls will have a very chilling effect on incentives for further drug development. Indeed, we can already see the impact of foreign price controls on R&D abroad. Almost all new discoveries occur here in the United States.

In this, as in many other cases of public policy, we have to be careful what we wish for. We have a tremendously innovative and successful drug industry in this country. To develop each of the high-priced drugs that we buy, the pharmaceutical companies pay, on average, almost $1 billion. Like it or not, the drug companies need to recoup these costs, and we need to let them. If we don't, we'll be doing a grave disservice to ourselves in limiting the prospects of new cures for painful and often life-threatening disease.

Laurence J. Kotlikoff is a professor of economics at Boston University and a consultant to the Pharmaceutical Research and Manufacturers of America.  

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