"Your flu shots are canceled because this administration was unwilling to play straight with the American people." So said Sen. John Kerry.
Overblown rhetoric aside, Sen. Kerry is right to fault the government for creating this problem. But the lesson that policymakers should take from the flu fiasco also argues against Kerry's own approach to prescription-drug coverage in Medicare.
First, some facts. Companies have been going out of the flu-vaccine business for years. Thirty years ago, more than a dozen companies were in the business. Today, only two companies make the vaccine for America. And this year, the vaccine stocks of one of those became contaminated, precipitating a shortage.
Why do so few companies manufacture the vaccine today?
To start with, the vaccine is hard to make. Every year, vaccine makers must draw up a new vaccine to meet the flu bugs expected to circulate that winter. After the formula is set, workers inject it into millions of chicken eggs, where it grows. Every egg must be injected and inspected by hand. It's time consuming and expensive, and contamination is a constant threat.
But there's more risk still. Even if they put together the right formula, keep out contamination, and get the vaccine out in time, manufacturers often face slack demand. One manufacturer, Wyeth, ended up with 7 million extra flu doses in 2002 and 4.5 million in 2003. They had to be tossed, since a different formula is needed each year. After last year's losses, Wyeth gave up on making flu vaccine.
While costs and risks are high, profits aren't and the market is small. Vaccines account for only 2 percent of all drug sales.
Also, the expenses of litigation and regulation add to the difficulty of doing business in vaccines. In the 1980s, lawsuits drove several vaccine makers out of the market. None of them re-entered even after Congress passed legislation to trim liability.
But do all these factors really explain how we wound up with a vaccine shortage? After all, litigation, regulation, challenging manufacturing processes, and market risk are the norm in the pharmaceutical industry. Never, however, have we run low on, say, aspirin.
But one thing makes the market for flu vaccine different. Over the past 15 years, the government has become the biggest purchaser of flu shots. That explains a lot.
When the government becomes the major buyer of any product, it has the opportunity to negotiate price. "Negotiate," however, is just a nice way to describe what happens. Inevitably, the government strong-arms companies into accepting the lowest possible price -- far less than they would be able to charge in a more diverse marketplace.
In the short term, the rock-bottom prices are nice, but they sow the seeds of serious, long-term consequences. Razor-thin profit margins leave manufacturers with no margin for error. A slight drop in anticipated demand can leave the producers unable to cover their costs, forcing them out of the market.
And new companies won't emerge to pick up the slack in the high-risk, low-reward environment of government-dominated purchasing.
The inevitable result: Sellers gradually exit the market and are not replaced; innovation drops off, and soon there are shortages, forcing the government to ration the product and decide who gets treated -- exactly what happened with the flu vaccine.
Interestingly enough, Sen. Kerry proposes that the federal government "negotiate" prices for a wide variety of drugs on behalf of Medicare recipients. He thinks that the states, too, should start "jaw-boning" drug companies for lower prices for their own mammoth health programs.
Essentially, Sen. Kerry thinks it's time for the government to start setting drug prices. But after this year's flu vaccine shortage, we know how that story ends.
Government negotiation could drive down prices for a few years with little noticeable effect. But when there is a public health crisis -- as happens unpredictably -- what manufacturer is going to have the spare capacity and ability to churn out extra Cipro or smallpox vaccine on short notice? Without a fair chance of making a profit, no drug maker could justify the expense of keeping such capacity at the ready.
And what drug maker could justify the expense, and risk, of developing new drugs?
Sen. Kerry should himself "play straight with the American people" and admit that his plan for buying drugs in Medicare relies on the same factor that caused the vaccine shortage. Fixing the problem won't happen as long as economic sense, and not just vaccines, remain in short supply.
Andrew Grossman is senior Web editor and Edmund F. Haislmaier is visiting research fellow in health policy at The Heritage Foundation (heritage.org).
Distributed nationally on the Knight-Ridder Tribune wire