Does less restricted drug pricing in the US subsidize the rest of the world?

Great Debates
1

Per the article referenced below many industrialized nations, including Canada, seem to have much lower drug prices via their quasi-nationalized health programs that have drug price ceilings of various sorts. The price differential is so marked that some US states like Illinois are seeking to buy drugs for some of their health programs in Canada. Pharmaceutical companies have apparently agreed to these price ceilings as they sell new, first line drugs to these nations for much less than they sell them for in the US.

Obviously a lot of cash is needed to develop and approve new drugs. Are other nations getting a bit of a free ride research and development wise on the ability of drug companies to charge the maximum of what the open market will bear in the US or is this an incorrect perspective?

Illinois Might Purchase Drugs From Canada, Saving Millions

2

I’m no expert on the pharmaceutical industry, but it seems to me that the problem is exactly the opposite of what you presume. Meaning that the US drug market appears protected from foreign trade, thus US pharmaceutical companies can sell their products for a higher price. When they go abroad they are challenged by a global and more competitive market, and therefore has to lower their prices.

Where I live, and as far as I know in other parts of Europe as well, pharmaceutical companies sell their products for whatever price they like. As for prescription drugs, in countries with “health programs” (national health care) the government is simply picking up some of the cost when the consumer buys prescription drugs at the drugstore.

The reason behind rising health care cost in the US seems IMO to be that it’s not really a market-driven system. When consumers pay for health care with insurances instead of based on actual consume, then sellers can charge whatever they like and send the bill to the insurance company. The concept of insurance is to be protected against something that could happen (car accident), not something that will happen to everyone (become ill).

3

You’ve got it 100% right.

4

Paradoxically, lower drug prices in other countries may actually LOWER drug prices in the United States.

What the drug companies are doing is called “disciminatory pricing” (not 'discriminatory in a bad way, but in the sense of not treating your customers as one bloc).

Think of it this way: How do you price a product? Let’s say you have a new CD by Warren Zevon. At what price do you sell it? Well, there are a lot of very rich Warren Zevon fans who would pay $1000 for a collection of new songs from him. But then you lose the hundreds of thousands of sales from people who can’t afford that.

On the other hand, if you sold it for $1, you could probably make millions of sales, but you’d leave a lot of money on the table from the people who would have paid more but didn’t have to.

The ultimate pricing scheme would be one where, A) you could keep people from re-selling products amongst themselves, and B) you could set the price for each person based on what the product is actually worth to them. The poor could pay $1, and the rich $10.

But in a free market, you can’t do this. You can’t sell the same product to one person at one price and another at a different price. And even if you could, you’d be immediately undercut by the poor people re-selling the product.

Nevertheless, discriminatory pricing is so valuable that manufacturers do all kinds of things to achieve it. For example, this is why Toyota has a Lexus division, and most electtronics companies take the same basic electronics, improve the specs slightly, put a different faceplate on them, and sell them as premium brands. This allows them to set one price for the wealthy, and a lower price for the poor.

If you can’t discriminate on price, you have to compromise and set a price that maximizes profit. You lose some people on the bottom who now can’t afford it, and you leave money on the table by providing the product to the rich at a price lower than they are willing to pay. But you make up for it by volume in the middle class.

Back to pharmaceutical companies. Within the United States, they can’t engage in discriminatory pricing. The market is homogenous. But borders give them the ability to set different prices, and export restrictions prevent the cheap products from moving to the high-priced areas. So this allows them to charge more in the U.S., and less in Africa. The prices in both countries are set by supply and demand, which maximizes profit.

So, what happens if the barrier goes away? Well, the company will start to face competition from its own product being sold back into the country at a lower price. How does it prevent that? Well, it can either raise prices in the other country, or lower them at home. But if both prices are set by supply and demand, the company will lose profit either way. But my guess is that the domestic market is so large that the most effective thing to do will be to simply raise prices in other countries, which will cut demand and lower sales. That in turn lowers profits.

Now, the big thing here is that the demand for these drugs in the U.S. may be relatively inelastic, which means it doesn’t move much with price. In which case, the companies may seek to regain the lost profit by raising prices in the U.S. If they can’t do that without losing enough sales to lower overall profitability, then all they can do is leave prices where they are, but factor the lower profitability into their decisions for R&D and other new drug development plans.

Either way, I don’t see re-importation resulting in widespread availability of cheaper drugs.

5

Drug companies can’t raise prices easily in other countries. If they could they would charge what they do in the US. It isn’t supply and demand in foreign countries. Foreign gov’ts have socialized medicine and determine what price they will pay. The price is much less than what the drug companies want but still much higher than their marginal cost. If it costs a drug company 10 cents to make a pill then they’ll sell it for 25 cents if they can rather than sell none at all. In the US maybe they’d sell it for $1. The price has to be higher than marginal cost, though, (on average) to cover the upfront cost of development.

The OP had it exactly correct. Drug companies make huge profits from US sales and much less from foreign sales. They are (foreign countries), in effect, a free rider. The US market pays for the drug company profits, which then go to fund new drugs. Also the expected profits from a drug take into account the windfall profits to be made in the US during the 17 year patent protected period.

It’s not that there is “no competition in the US”, that is the reason for high drug prices. There is no competition by definition, on patented drugs during the patent protection period. AFter the period is up, there is plenty of competition through generics. This is true in foreign countries as well though.

So what happens if US consumers want (and get) lower drug prices via importation etc.? Well, in the short run they win and the drug companies lose. In the long run the drug companies lose and the consumers have less new drugs coming to market as the lower prices won’t cover the 1 billion dollars it costs to develop a new drug.

6

What Sam said.

Do you have a cite for this? It may be true in some countries, but I haven’t heard of any Europen or Asian countries telling drug companies they wont get paid in full for their products.

7

I don’t have a cite. But in European countries the gov’t is typically the largest if not the only purchaser. So prices are set by negotiation. There is no competition per se, for a drug that is in its patent protected period.

The drug company could, I suppose set a take it or leave it price, but then the foreign gov’t is free to “leave it”. There doesn’t seem to be as much pressure to have the latest and greatest drugs as there is in the US.

There was a show on PBS about this not too long ago. I can’t remember the name though.

8

I’m sorry bri1600bv, but I’ll have to ask you to go and get a cite for this. You said: “in European countries the gov’t is typically the largest if not the only purchaser”. In which European countries? I’m asking because in those European countries I have lived (granted, it’s not that many) I have paid for my medicine myself with my own money at the drugstore. The only difference is that for some drugs the government is picking up part of the tab (doesn’t that happen for elderly in the US too), but the manufacturer still gets paid in full.

Governments might negotiate a cheaper price when they buy drugs for use in public hospitals, but that’s different - I bet private hospitals are doing the same. I don’t know of any European country where the government is buying drugs which are later sold at drugstores. I think you have the wrong idea of what national health care really is, could you elaborate?

9

bri1600bv is generally correct. If you want to sell a drug in a particular country, you have to play by that country’s rules. Rule #1 is the drug has to be approved by that country’s version of the FDA, or whatever cooperative might exist between a group of countries. Rule #2 is you have to abide by whatever price control exists in that country.

One thing I’m not sure about, though, is how much domestic (US) prices would come down if price caps were lifted abroad. I mean if someone pays $5 for a viagra pill in the US and $1 in, say, Italy now, why wouldn’t pfizer charge $5 for a pill in the US, and charge $5 a pill in Italy if the caps are lifted, if they can get it?

by Alien:

The manufacturer gets paid the full amount that has been negotiated for that particular country - not the full market value.

10

Here’s the cite.
In Canada, the government determines drug prices, not the market.
In France, a drug company may set any price. However, if they want the national health care system to reimburse the customer for the cost of the drug - IOW, if they want anyone to actually buy the drug - they must charge a lower, government-negotiated rate. Because they are “negotiating” with a monopoly, the prices are considerably lower than in the US.
Germany’s government sets the price of older (introduced pre-1995) drugs.
Italy’s system is roughly the same as France’s, except that there are no negotiations - the maximum drug price is a 12-nation European average price.
Britain regulates drug prices by setting maximum profits a drug company can earn in Britain, though individual drugs prices are not regulated.
Japan’s government determines drug prices.

So yes, astro, American consumers are subsidizing Canadian, European and Japanese consumers. It’s like a balloon - drug companies need to cover their R&D costs, cover their manufacturing costs, and make a profit. If prices are squeezed down in one country, they’ll inflate in another country.

Sua

11

Price competition. For most drugs, even drugs under patent, there is usually an alternative. For every Wellbutrin, there is a Prozac. If prices are freed in other countries, drug company profits will increase in those countries, and drug companies will be able to afford to cut US prices to gain market share.

Sua

12

An interesting article on drug pricing in Europe.

http://www.nzz.ch/2003/07/10/english/page-synd4022158.html

13

This is only partially true; there’s two vital things you’re leaving out.

  1. Other countries cannot logically be a free rider or else drug companies would not bother to sell there. Clearly, the pharmaceutical manufacturers are making SOME money in Canada, Europe et al., or they simply would not have any reason to ship drugs there.

  2. Sam’s point about price discrimination is a critical one. Americans will pay higher prices than Canadians to some extent because Americans have more disposable income and seem willing to pay more for medical care. Americans, in fact, have more disposable income than just about anyone; all other things being equal, the equilibrium price for a given drug in the USA will be higher than in most other countries. This doesn’t account for the entire difference between US and Canadian drug prices, but it does account for a little bit of it, and the extent to which this matters becomes even more pronounced if you compare the U.S. to countries that aren’t as wealthy as Canada. Price discrimination is a powerful thing. You’re NEVER going to make as much money from the average Spanish consumer, even if Spain abandons all price controls, until such time as Spain’s economy is pe capita equal to the USA.

Clearly, overseas customers must also pay for funding new drugs if they’re buying drugs. If the drug companies aren’t making a profit off them they wouldn’t be selling to them.

They may not pay AS MUCH per customer, but overall the income is doubtlessly quite substantial from overseas, being as there is a much larger market outside the USA than in.

14

Rather than subsidizing R&D American prices are subsidizing advertising. The budget for advertising in companies is often bigger than the R&D budget.

15

Well there is alot of advertising, that’s true. But if a drug company will make less money b/c of it’s less free to charge what it wants, then there will be less reward for the R+D dollars, and many drugs simply won’t be researched. The profits are the reward for the R+D with or without advertising.

As per RickJay’s point about drug companies making money in Canada, etc. You’re right, they do.

If pills cost 5 cents to make and Canada offers them 20 cents, they’ll take it. Meanwhile in the US we might pay 50 cents. But the 5 cents is a marginal cost; ie the cost of one more pill. To get up and running takes roughly a billion dollars. So in order to make back the initial billion they need to price higher than say, 5.01 cents.

Logically, they’d take any price higher than 5 cents a pill, even though the average cost (with R+D) might be 20 cents or whatever. Of course the average cost goes down with more pills being made too.

So you’re right, Canada is paying for R+D too, just not as much.

16

While it is certainly true that drug companies make a profit in Europe and elsewhere, it does not change the fact that lower (government-mandated) prices overseas drives up prices in the US. Because drug companies make less profit than they otherwise would overseas, there is less margin for price competition in the US, so prices remain higher.

Actually, discriminatory pricing has absolutely no role to play when the customer is not actually paying for the drugs. If the government is paying for the drugs, as in France, Italy, Britain, Japan, etc., discriminatory pricing is irrelevant.
It may(and probably will) be that, if foreign governments were to deregulate drug prices - and stop paying for the drugs - we would discover that Spanish customers simply aren’t willing to pay the same price Americans are for drugs, and the cost of Lipitor in Spain will be lower than in the US.
But that is a hypothetical; the current fact is that drug prices are lower in other industrialized countries because foreign governments mandate that they be lower - and US customers end up paying more.

Sua

17

Why do people keep saying that countries that have negotiated a better deal are being subsidized by the U.S.? Are the members of Sam’s Wholesale Club subsidized by patrons of regular stores? The U.S. pays more because it’s willing to pay more.

18

Good post SuaSponte. It appears there is some sort of governmental control on drug prices in several European countries, so I was wrong. The reason for my scepticism was that those drugs I’m familiar with comes with pretty much the same price tag as in the US, and I’ve been paying for it myself. But then again, I’ve never had any need for heart medicine, cancer treatment etc, probably big sectors for American pharmaceutical companies.

19
  1. The drug industry is somewhat unique in that (a) it must spend a larger percentage of its revenues on R&D, and (b) most of those R&D expenditures are effectively wasted, because most drugs do not survive testing and development. So drug companies have to make large profits on the relatively few drugs that actually make it to market. If drug companies cannot make those large profits in Europe, etc., they have to make them in the US, in order to continue to fund R&D;

2)Because if drug companies were earning more profits abroad, they would have more leeway to compete against each other in the US on price, thus lowering drug prices in the US.

Sua

20

I’m just going to do a drive by because it’s late here. SuaSponte, your point 1 is where the issues are. They’re complex. A key point to remember in this debate is that the people who are actually consuming and prescribing the drugs are not typically the ones directly paying for them, and that this makes a big difference in the operation of markets.

This argument, however:

can’t be right. Companies look to maximise profit, not meet some desired level of profit. Increased profits from other places would not give firms “leeway” to reduce prices - it would just allow them to increase profits. OTOH it might make some lines of currently unprofitable drugs profitable.