Missing the Point of Medicare Reform: Why Drug Reimportation Is BadPolicy

An updated version of Web Memo # 128 (June 18, 2002) on reimportation.

As part of the fierce congressional debate on Medicare prescription drug legislation, some Members of Congress want to establish a policy to guarantee Americans "cheap" prescription drugs by allowing them to import drugs subject to the price controls of Canada and other foreign countries. This is bad health care policy.

Reimportation of drugs from Canada, or any other country, does not address the real problems of the relatively small population of seniors who are without drug coverage.[1] It does not provide those seniors with a reliable source of coverage, and it avoids the fundamental problem facing all seniors: that Medicare is unable to adjust to the changing needs of its beneficiaries. Therefore, Congress must reform the Medicare program and, in the interim, should consider targeting assistance to seniors who currently do not have prescription drug coverage in a way that does not jeopardize reform.[2]

Besides the fact that reimportation is a distraction from the real task before Congress-comprehensive reform of the Medicare program-there are many other compelling reasons why reimportation is bad health care policy.

Why Drug Reimportation Is Not A Free Trade Issue
Some congressional advocates of drug reimportation argue that it is a "free trade" issue. They say this because it would allow individuals to purchase their prescription drugs at the best available price. However, one of the fundamental tenets of free trade is that there is a level playing field and a free market upon which suppliers of goods and services are able to compete. Prescription drugs priced in Canada clearly are not based on fair market value; they do not reflect an equilibrium price between supply and demand. Therefore, the proposed policy does not create a truly competitive and level market for pharmaceuticals.

When government is the single or major purchaser of pharmaceuticals and other health care services, as it is in Canada, prices are fundamentally distorted. The government leverages its bulk purchasing power to "negotiate" prices with pharmaceutical manufacturers. However, since there is only one major purchaser of these goods and services and no real consumer-based market for these products, the government retains the ability to dictate a fixed price with little or no regard for real market prices.

Legislating Perverse Incentives
Reimportation is likely to engender some perverse incentives. Consider the following two scenarios in reference to Canada:

Pharmaceutical manufacturers would limit or cease to sell their products to Canada. Pharmaceutical manufacturers sometimes choose to sell their products at less than market value because their loss ratio is minimal in smaller markets, like Canada. However, under reimportation, if the U.S. begins to import more drugs from Canada, the existing loss ratio in Canada would increase and earnings in the U.S. market would decrease. To protect against this increased loss, pharmaceutical manufacturers would have a direct economic incentive either to limit any surplus sold to Canada or to stop selling their products to Canada altogether. As John Calfee, resident scholar at the American Enterprise Institute, neatly describes the possible affects:

Suppose Canadian drug prices are two-thirds the level of U.S. prices. Drug companies would face two choices: They could ship the U.S. supply of their drugs to Canada, reducing their revenue by one-third. Or they could tell Canadian authorities they will no longer sell at discounted Canadian prices, reducing their revenue by less than a tenth-reflecting the smaller market size and lower Canadian prices.[3]

Many pharmaceutical manufacturers may be more likely to forgo the smaller Canadian market for the larger market in the U.S. However, manufacturers would be faced with an additional penalty. If a pharmaceutical manufacturer were unwilling to sell its products at the government-determined price, the country could, in some cases, allow a generic manufacturer to produce and sell a copy without the approval of the patent holder.[4] This would undermine intellectual property rights-a serious unintended consequence.

Canada would stop selling to U.S. citizens. If reimportation was implemented and pharmaceutical manufacturers continued to sell their products to Canada, the Canadian government might choose to stop allowing U.S. citizens to "free ride" off their health care system, especially if supplies were limited by the manufacturers. If fewer drugs were available to Canadians, and it is possible that none would be available to American consumers. This would defeat the entire intent of the policy.

In the end, regardless of the scenario, the effect of reimportation in all probability would be the opposite of that intended by its proponents: Prices would be more likely to increase in Canada than they would be to decrease in the United States.

Government Manipulation of the Pharmaceutical Marketplace
Some congressional champions of drug reimportation no doubt envision their policy as the first crucial step in adopting similar price control measures in the U.S. market. Based on roughly 4,000 years of economic history, the passion for price controls on goods and services routinely emerges as a short-term economic policy and, at least, in the short run, a politically attractive proposal. Politicians invariably point to opinion polls in which a majority of respondents favor government caps on prices for various goods and services, including drug prices.

The inescapable problem, of course, is that it is no easier to repeal the economic laws of supply and demand than it is to repeal the physical laws of gravity and motion. There has never been a system of price controls enacted that did not lead directly to a shortage of the quality or quantity of goods and services, including medical goods and services. Price control strategy is really a supply reduction strategy. The chief attractiveness of the price control strategy is that it does indeed achieve less spending on such goods and services simply by ensuring that there is going to be, as a matter of public policy, fewer of them available.

In the area of health policy, a price control regime could have a devastating affect on the quality of health care that U.S. citizens receive. In the case of drugs, it would guarantee delayed and limited access to pharmaceuticals. In countries where government market involvement is high, there is less access to lifesaving drugs and treatments than in those countries without government interference.[5]

Even in the U.S., several states, through their ever tighter administration of the Medicaid program, have begun to adopt similar approaches either through complicated "cost containment" mechanisms (formularies, pre-authorization, etc.) or by forcing additional discounts from manufacturers (supplemental rebates).[6] Although these policies do "control cost," it is still true that the greater the government's control over the financing and delivery of these drugs, the greater the risk to an individual's access to life-enhancing, or even lifesaving, pharmaceuticals.

Government interference, particularly price regulation, in the pharmaceutical marketplace has further side effects. Like all such policies, it results in massive cost shifting. In other words, it imposes additional costs on those countries, like the United States, that champion free markets nationally and internationally. The U.S., in effect, is forced to compensate for other countries' distortions of the market. In the case of prescription drugs, the United States is on the receiving end of government-engineered cost shifting. Thus, the U.S. is almost always paying a greater share of the research and development costs that go into creating a new pharmaceutical product. A recent study by the Tufts Center for the Study of Drug Development found that pharmaceutical manufacturers spend $897 million to develop a new drug and that only an estimated 21.5 percent of drugs that reach human trials (Phase 1) will be approved for marketing.[7] It is this crucial investment in research and development that brings the lifesaving drugs and treatments to the market, and that is supported by market-oriented countries.

The Case For Safety First
In the end, there still remain significant safety concerns surrounding reimportation. In several recent testimonies, officials of the Food and Drug Administration, as well as representatives of other government agencies, have noted the potential dangers associated with reimportation, including individual importation, the purchase of drugs from foreign sources over the Internet, and counterfeit drugs entering the United States. In testimony on this subject last year, William Hubbard, Senior Associate Commissioner for Policy, Planning, and Legislation at the U.S. Food and Drug Administration, stated:

Currently, new drugs marketed in the United States must be approved by FDA based on demonstrated safety and efficacy…. This "closed" regulatory system has been very successful in preventing unapproved, adulterated or misbranded drug products from entering the U.S. stream of commerce. Legislation that would establish other distribution routes for drug products, particularly where those routes routinely transverse a U.S. border, creates a wide inlet for counterfeit drugs and other dangerous products that can be injurious to the public health and a threat to the security of our nation's drug supply.[8]

 

Similar concerns have been echoed by current Health and Human Services (HHS) Secretary Tommy Thompson and former Clinton Administration HHS Secretary Donna Shalala.[9] Even the representatives of the Canadian government have recently clarified their position by stating that they could not guarantee the safety and effectiveness of drugs exported from their country.[10] This is especially troublesome as counterfeit drugs entering the U.S. pose genuine risks.

Conclusion

The problem of prescription drugs for senior citizens is invariably a problem of access. It is not price. Indeed, through insurance mechanisms, it is clear that seniors can get significant discounts on the prices of both brand name and generic drugs.

Furthermore, the problem of access to prescription drugs, as virtually every major study has shown, is confined to a minority of senior citizens. Reimportation is not a substitute or fallback for comprehensive and serious Medicare reform: the kind of Medicare reform that would fully integrate prescription drug coverage into a normal system of health insurance in which plans offer a variety of benefit packages to satisfy the needs of consumers.

Members of Congress should not ask seniors to rely on another country's flawed health care system for their health and safety. Members should resist the temptations of a snappy "quick fix" that does not address the root problems, but only creates others. The complex Medicare legislation now being considered by the House and Senate has enough "unintended consequences" already.