TCS Daily

Who Should Define What's 'Reasonable'?

By Doug Bandow - May 11, 2005 12:00 AM

Politicians are always looking for a new goose to pluck to win the political favor of their constituents. Today everyone from congressmen to city councilmen treat the drugmakers like a flock of geese.


At least Congress has national jurisdiction. Not so the Washington, D.C. city council. But its members apparently believe that they, too, should regulate the pharmaceutical industry.

The city council has given preliminary approval to legislation that would create a new "illegal trade practice" -- selling drugs for more than city politicians decide is fair. The bill would allow Washington, D.C. to seize the companies' patent rights in response.

It's a truly nutty idea. Imagine letting the city council of Chicago decide on fair automobile prices. The government of Dubuque, Iowa could set the fee for heart pacemakers. Miami's city hall could rule on the price of books. Springfield, Illinois could vote on what steel manufacturers charged, while Springfield, Virginia could price helicopters.

Every city council in America could set at least one price, though the politicians left with potato chips might feel slighted compared with the lucky councilmen who got commercial aircraft. Still, running the national economy would be a lot more fun than filling potholes on city streets.

Of course, most local politicians realize that national price-setting like this would be a bad deal. But they seem to have different rules for medicine.

Cities and states across the country have been pushing to "reimport" pharmaceuticals from price-controlled foreign markets. Moreover, D.C. city councilman David Catania, chairman the health committee, originally pushed an even worse bill, which would have used eminent domain to seize pharmaceutical patents.

Never mind the issue of federal preemption in granting patents. The Constitution requires payment of "just compensation" -- which means taking companies' products would cost the cash-strapped District billions of dollars.

So Mr. Catania redrafted his legislation to treat drug "overpricing" as an "illegal trade practice" and authorize the city to mandate compulsory licensing, that is, effectively give patents to other firms. City politicians would decide which prices were fair and which were not.

One standard would be charging prices above those in "Europe, Canada, Australia, and other high income countries," In a world in which most industrialized states have nationalized their health care systems and controlled drug prices, this standard is impossible not to meet.

One medicine could cost less in Portugal, another in Albania, and another in South Korea. All apparently would demonstrate an "illegal trade practice" and thus empower the District to hand off a company's patent. It would be more honest if the city simply said that any price higher than any one any where in the world was considered to be unfair.

But this isn't all. Prices would be considered to be inflated to "the extent to which past sales have more than adequately compensated the producer for all costs of research and development, including risk factors, cost of capital, and a reasonable profit margin."

Fairly applied, this standard points to relying on market prices. "All costs of research and development" should include R&D costs, including for the many substances that never become
marketable drugs.

"Risk factors" are many -- dry holes, unexpected costs, regulatory barriers, health side-effects, litigation, crackpot political threats to seize patents. As for a "reasonable profit margin," the greater the risks of the process and the higher the value of the products the more obvious the justification for higher profits. Again, the market is the best measure of "reasonable."

Alas, Mr. Catania obviously believes in the eternal "free lunch": slashing prices would have no impact on the availability of drugs. After all, he complains, the industry enjoys "exorbitant profit margins," which they defend through their "ability to threaten an end to drug innovation."

Any number chosen by government as a price (or "reasonable profit") would be inherently arbitrary. But the riskiness of R&D investment with its uncertain payoff makes drug price controls
particularly inappropriate.

Unfortunately, new medicines don't magically appear on the ground every morning like manna from heaven. The U.S. pharmaceutical and biotech industry spends about $50 billion annually on R&D.

Failures far outnumber successes. Often several firms spend millions or billions of dollars seeking remedies to the same diseases but only one company succeeds. Sometimes none does.

Only one of every 5000 to 10,000 substances makes it to market and reaches patients. Just 30 percent of those which do make it actually earn enough to cover their own development

But only paying for themselves isn't enough. The sales of these few drugs must cover everything -- the dry holes, administration, new lab equipment, regulatory compliance, lobbying against bad ideas like those introduced by Mr. Catania.

Estimated drug development expenses have been rising sharply, going "from slightly over $100 million per successful drug in the 1980s to about $800 million in 2003," notes a report by the Institute for Policy Innovation.

Costs aren't likely to abate anytime soon. Explain researchers John Vernon, Rexford Santerre, and Carmelo Giaccotto: "FDA drug development costs continue to increase in response to a growing demand for more clinical information and more clinical trial data." Those costs even make it difficult for drugmakers to pursue substances that appear to help a limited number of users, especially when negative side-effects appear.

How could any arbitrary government-imposed price reflect all of these considerations? Even businessmen suffer from market uncertainties.

Nor is it possible to determine product value before actual sales. Financial projections often are erroneous. Some medicines expected to be big sellers flop; some produced with only modest expectations flourish.

If businessmen so often guess wrong with their own money, what kind of results could one expect from politicians who spend other people's money? Politicians who are most concerned about winning votes in the next election a year or two hence rather than ensuring the availability of medicines a decade or two hence.

Yet price controls remain politically attractive because in the short-term they can cut medical expenses without reducing product availability. Since the cost of making an extra pill is so low, companies have a financial incentive to supply their products even when politicians attempt to ruthlessly loot the international medicine chest. That's why so many foreign countries impose price controls, giving rise to the fiction that companies are overcharging in America.

Thus, drugmakers will continue to manufacture existing medicines, while the inevitable impact on R&D won't be evident for years. The harm inflicted on most patients won't ever be obvious -- it consists of losing something that has yet to be created.

Ensuring adequate access to life-saving medicines is an important goal. But there's no political short-cut. Good medicine will never be cheap.

Government price-setting and theft of patents would sacrifice Americans' future health. That is far too high a price to pay to help reelect election-minded politicians, whether in Congress or city council.


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