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Wednesday, December 15, 2004

Ed Haislmaier on Drug Importation Economic and Safety Issues

Ed Haislmaier has some follow-on thoughts to my recent posts (here and here) on drug importation from Canada.

Readers who believe importation of drugs from Canada would save Americans a bundle should particularly note Ed's last four paragraphs.
Regarding the issue of legalizing third-party wholesale importation of pharmaceuticals from Canada, this article in the Financial Times has some bearing, by way of example from another area, on the question of what might happen if the U.S. changed it's laws.

The article discusses how post-9/11 changes in U.S. visa rules are resulting in more international travelers (e.g., ones going from Asia or Europe to Latin America and vice versa), choosing to fly with Air Canada rather than on U.S. carriers and "... choosing to travel via Toronto, Vancouver and Montreal rather than U.S. cities."

The article further notes that:

"The new U.S. visa requirements have also benefited Canada in other ways. Several Canadian universities are seeking to attract foreign students and researchers who might otherwise have attended U.S. institutions.

Canada has also become a base for some offshore outsourcing companies to serve US customers without their employees needing to enter the U.S.

Nevertheless, many other Canadian companies are concerned that tighter border security could severely jeopardize their business in the U.S."

The relevance is that, just as we can't expect Canada to enforce U.S. visa rules, neither can we expect Canada to enforce U.S. "chain-of-custody" regulations with respect to the trans-shipment of pharmaceuticals from manufacturers to wholesalers to pharmacists to consumers if the U.S. decides to remove its controls on bulk drug importation from Canada (a point you made in your last post).

In both cases, the entirely reasonable and justifiable Canadian position is, "We set and enforce our own laws. Your [the U.S.] laws are your problem."

One implication of the article is that disparities between U.S. and Canadian immigration controls might now encourage terrorist organizations to focus more on getting would-be terrorists into Canada first and then across the U.S. border, where U.S. controls are not as effective as at U.S. airports. Now, while we can all agree the U.S. needs better border controls, the larger point is that a change in U.S. law has follow-on effects as people outside the U.S. (including bad guys) react to the change by modifying their own behavior. Thus, it is also reasonable to expect that relaxing U.S. controls on the bulk importation of drugs from Canada would likely encourage those who would tamper with drugs for either profit or malicious reasons to set up shop in Canada.

On a related note, while I realize that your arguments have focused on the safety issue, there is one overriding economic point that needs to be made. Namely, even if all the safety issues inherent in third-party bulk importation of drugs could be satisfactorily resolved, it is still highly unlikely U.S. consumers would see more than a marginal decrease in end-user prices. Rather, the middlemen doing the importing would pocket the lion's share of the price difference. In fact, this is exactly what has been happening in Europe for years as "parallel traders" arbitrage away the price differences among EU countries that set drug prices at different levels.

For example, if a 90 day supply of drug X cost $100 in Country A and the price is set at $50 in Country B, then a parallel trader can buy the pills in Country B for $50 and resell them in Country A for $90 or $95 and make a nice profit. The end consumer in Country A gets only a 5-10% discount, not the 50% discount he sees across the border and wants for himself. To get that full discount the consumer would have to cut out the middleman by going to Country B and buying the drugs directly -- something individual U.S. consumers can and are doing in Canada right now.

Furthermore, even competition among parallel traders won't further lower prices to the end-user so long as the demand for cheaper drugs exceeds the supply. Again, using the above example, unless manufacturers put no limits at all on the quantity they will supply to Country B for sale at $50 (highly unlikely) competing parallel traders will have no reason to lower the prices they charge in Country A. They will simply continue to "shadow price" in the destination market. The most that aggressive competition among parallel traders might produce is the offering of a somewhat higher "black market" price in Country B to ensure supply. For instance, a parallel trader might offer a supplier in Country B $55 or $60 if he diverts his supply to the trader instead of selling it to a competing trader or dispensing it to patients in Country B at the controlled price of $50. While more people are getting a slice of the price arbitrage, the price to the end-user in Country A remains the same.

It's simple economics. When supply exceeds demand, suppliers cut production and/or cut prices. But, when demand exceeds supply, suppliers raise production and/or raise prices. However, if demand exceeds supply but the supplier is under price controls, suppliers have no incentive to increase supply and thus the demand/supply imbalance continues. The inevitable result, if the price difference is large enough, is middlemen enter the market to arbitrage the price difference. If the supply is sufficiently constrained, the middlemen might eventually offer suppliers inducements to violate the price controls in the form of higher "black market" purchase prices, but in none of this does the end-user wind up with anything more than a marginal reduction in the sales price.

Ed

Posted by Amy Ridenour at 1:24 AM

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