TCS Daily


Free Riding Isn't Free

By James K. Glassman - February 23, 2004 12:00 AM

Editor's note: What follows are remarks to a forum on "Price Controls and the Economics of Medical Innovation," at the Keck Graduate Institute of Applied Life Sciences, Claremont, Calif., Feb. 19, 2004. The forum was sponsored by the California Healthcare Institute.

First, I want to thank the Keck Graduate Institute and the California Healthcare Institute for organizing this important conference. Thank you, Sheldon Schuster. Thank you, David Gollaher.

This is such a distinguished panel. Of the eight people up here, only David Dreier and I don't have "Dr." in front of our names.

David Dreier, the chairman of the Rules Committee, is the most staunch, most intelligent advocate of sensible economic policies in Congress. I wish you research geniuses in the audience would figure out how to clone this guy.

As John Martin said, he and I traveled to Africa together, along with Elias Zerhouni, Tony Fauci, Hank McKinnell of Pfizer and many others. Someone joked that if this plane goes down, AIDS research will be set back for decades. We saw inspiring work being done to fight AIDS in Africa, and your government is devoting tremendous resources in this battle. But there is another message from Africa, too. Roger Bate, my colleague -- at both the American Enterprise Institute and my website, TechCentralStation.com -- has done research that shows that HIV/AIDS drug development is trending downward. This could be a harbinger for other drugs. It is the natural reaction of drug companies that find their innovative work under unfair political attack. The result: fewer drugs.

I come from Washington, D.C., and my message today is simple: You are in trouble.

You have the very best FDA commissioner possible. Mark McClellan, whom you just heard, is not just an M.D. but a Ph.D. economist. God knows where we would be without him. And God knows where we would be without a Republican Congress, without people like David Dreier and Speaker Dennis Hastert.

The threats to innovation are real. They are growing. They are led by demagogues making inaccurate and unprincipled arguments -- either disingenuously or ignorantly. I know this first-hand. A few weeks ago, I moderated a debate in San Francisco between Congressman Gil Gutknecht, a Republican who is the head demagogue in the House on the issue of reimportation, and Milton Friedman, who opposes reimportation of drugs from price-controlled countries like Canada. Friedman had all the economic arguments, but Gutknecht scored points, no doubt about it.

In this effort, the demagogues are being assisted by the media. For example, look at that Time magazine cover story of Feb. 2, titled "Why We Pay So Much for Drugs." It had all the sophistication of a high school term paper, but it reinforced the image of healthcare innovators, not as lifesavers but as greedy special interests.

The focus now is Canadian importation. Mark McClellan is holding the line, but how much longer. The safety argument, as Dr. McClellan implied, just won't hack it.

It is bad enough that Europe and Canada control the prices of your products through monopsony (or single buyer) power and through threats to property rights. Now, there is a clamor to import those price controls to the United States.

The result: The country that is now responsible for the vast majority of new drug launches each year will go the way of, say, Germany, which, with few exceptions, is no longer a serious player in developing new drugs.

Research by Carmelo Giaccotto and colleagues, published by the AEI-Brookings Joint Center for Regulatory Studies, estimated that, if price controls had been in effect in the United States between 1981 and 2002, there would be between 330 and 365 fewer new medicines on the market today.

Research by John Vernon concluded that price controls applied in the U.S. today would lead to a cutback in new medicines by two-thirds within 50 years.

But 50 years is a long time from now, and I am afraid the importation movement has immediate momentum.

David Dreier called me a pundit, but I would more accurately say that I am an advocate, or a polemicist. So here are seven pieces of advice on how to present our message:

  1. Price controls kill. The Bain & Co. study, released at Davos on Jan. 22, compares the U.S. and Germany. Because of price controls on drugs and the inevitable rationing that accompanies such controls, Germans spend more time in the hospital than Americans and lose more working days through sickness. Germans suffering from heart disease and breast cancer have higher mortality rates. There is a triage here. Europe kills its citizens and makes them sicker because it restricts access to drugs it considers too expensive. I am in the process of writing a major article for a major national magazine on this subject. But just consider these facts: In Germany, 30 percent of diabetes patients are not treated with drugs at all. In France, most patients with multiple sclerosis and eligible for treatment with beta interferon, do not receive such treatment. Only 18 percent of European patients with severe depression get treatment with antidepressants. This is the future for America if price controls are exported to this country.

  1. The economic development argument is powerful. The Bain study shows that, while Germany saves $19 billion in drug costs through price controls, it loses $22 billion due to reduced R&D spending, bad health outcomes, loss of high value-added jobs (and the tax revenue associated with them), and so on. Free riding isn't free. The economic argument works in California too. Price controls will kill the goose that lays the Golden State's golden egg. That goose is you -- members of CHI.

  1. Try to change minds in Europe and Canada. It is their citizens who are suffering now and will suffer far more if importation of price controls succeeds. I have written articles for the Wall Street Journal Europe and the Globe & Mail in Canada making this point. Europeans and Canadians understand it. Also, as John Martin said, private companies need to get tough in their negotiations in Europe and Canada and not accept the low prices imposed on them. That could change minds quicker than oped pieces.

  1. Repeat with me, "Free Rider. Free Rider. Free Rider." Europeans, Australians and Canadians are doing something immoral. They are not shouldering their responsibility for R&D. In the past ten years, R&D spending in Europe has doubled, but R&D spending in the US has quintupled. As Bain says, free riding can't go on much longer. It is an unsustainable model. By pointing to the unfairness, both at home and abroad, the model may collapse sooner.

  1. Americans, ultimately, need to understand a little economics. We shouldn't be shy about educating them. Price controls never work long-term. Why? Because when you set a low price, you reduce supply. Few producers want to make things if the price is artificially low. This reduced supply puts further upward pressure on prices -- increasing the gap between the controlled price and where the natural price would be (where the unfettered supply and demand curves cross). Governments, then, must respond by reducing demand by refusing to allow people to have life-saving or life-enhancing drugs and medical devices. The Time magazine article, remember, asks why drugs cost so much, but it never examines the two components of price, familiar to anyone who took Economics 101: supply and demand. Supply, even now, is constrained in the U.S. by the high cost (over a billion dollars) to bring a new drug to market. Milton Friedman, in that debate a few weeks ago, said that the FDA is partly to blame here, though I know that Dr. McClellan is doing what he can. Demand is intense for a drug that can save your life. And why shouldn't it be? Herbert Lichtenberg's research shows that new compounds add three weeks of life every year and that the cost of extending life through drugs in a single year is $4,500. Question: What is it worth to extend your life for a year? $4,500? Or maybe ten times that, or more? What's remarkable is not that drugs are so expensive, but that they are so cheap. They are a stupefying bargain.

  1. Make common cause with the rest of innovative industry - now under attack as well. The drug and medical device sector is not alone. Successful businesses are always under fire.

  1. How to get drug prices even lower? Simple. Increase supply. If Europe ended price controls, more companies would enter the market, pushing down prices. If the FDA streamlined its standards, costs of bringing new drugs to market would fall, increasing supply. If property rights were protected, the cost of capital for investment in new drugs would fall, increasing supply. That is the answer.

And now, I believe I have gone on long enough. To repeat: This is an extremely serious threat, not merely to an industry but to the health of Americans. It is time to fight back.

Thank you.


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