Maine's Dangerous Drug Scheme

Earlier this year, Maine passed a law allowing residents and businesses to import drugs from approved overseas pharmacies in Canada, the U.K., New Zealand and Australia – and the law went into effect October 9th. This is a bad law, unlikely to survive, and unwise in any case.

But before we delve into Maine’s policy, it’s worth casting a glance at international drug pricing trends and strategies, since U.S. drug pricing remains a sore point at the state and federal level.

The U.S. is the only wealthy, developed nation that doesn’t apply price controls of one variety or another to prescription drugs. While actual price differentials between the U.S. and other countries is probably oversold (and fluctuates with exchange rates as well as overall price levels in the economy), U.S. prices are undoubtedly higher than in countries where the government sets such controls. And many U.S. payers understandably bristle at paying some of the world’s highest prices for new medicines

But we can also look at the effects of alternate pricing and importation schemes in Europe to understand how similar programs are likely to play out in the U.S.

Drug importation, or parallel trade as it’s called in Europe, has been statutorily legal since the formation of the European Union in 1957 (Article 81(1) of the Treaty of Rome prohibits any agreements that restrict competition), and it has had several troubling side effects.

In the E.U., wealthy nations, where drugs are more expensive, do get access to cheaper drugs sourced from poorer countries like Greece through parallel trade. But because drug companies can control the supply of their products – sending just enough pills to Greece to treat Greek patients – parallel trade can result in drug shortages in poor countries, since pharmacists often sell drugs from their inventories (at a profit) to redistributors for re-sale in wealthy countries like the U.K. (One way of getting around the re-sale problem is for national regulators to link or "reference" drug prices to a market basket of prices in both poor and rich countries, rather than import the drug directly. But Patricia Danzon and Andrew Epstein, researchers from the Wharton School at the University of Pennsylvania, have found evidence that drug companies are more likely to delay the launch of newer, high-priced drugs in poorer markets to avoid the cannibalization of their profits in wealthier countries due to reference pricing – resulting in "welfare loss, launch lags, and higher prices" in poorer nations.)

There’s also significant evidence that fake and adulterated drugs have, in fact, penetrated the European market, since there is no way to ensure the chain of custody for the thousands of distributors that operate legally in the E.U. And some of those fake drugs have already found their way into the U.S. from the U.K., including fake doses of the cancer drug Avastin.

Sourcing drugs only from Canada, the U.K., New Zealand and Australia (as Maine’s law tries to do) may seem to get around this problem, but it’s unlikely to be foolproof in practice because counterfeiters have gotten so good at making knock-off medicines that it’s challenging for even the drug’s manufacturer (let alone pharmacies or distributors) to tell the difference between real and counterfeit pills outside of laboratory tests. And, again, because the drug’s manufacturer can control drug supply, neither Canada nor any other country could meet any significant percentage of demand for cheaper medicines in the U.S. – at least without sourcing drugs from much less closely regulated sources.

In fact, this is why the FDA has repeatedly said that it could not guarantee the safety of medicines imported into the U.S. from abroad.

Drug importation – really a thinly veiled attempt at price controls – also undercuts incentives for R&D into the next generation of medicines for rich and poor nations alike.

The economics of drug development make pharmaceutical companies extremely vulnerable to price controls, and also make it easy for other countries to free-ride on U.S. investments in drug innovation.

This is because while it can cost over $1 billion to develop a drug that passes muster with the U.S. Food and Drug Administration, every pill after that costs pennies on the dollar. In short, the sunk costs of drug development are staggering, but the marginal costs are extremely low. All of the value of the pill is in the science and the clinical data that allows regulators and doctors to prescribe the pill with confidence. And this is where patents come in. Strong intellectual property regimes help firms recoup the large fixed costs of R&D before a competitor is able to make a cheap generic version to undercut the innovator’s investment and pricing.

But national governments can effectively get around patent protection by offering manufacturers a take it or leave it proposition. You either sell it to us at our price, or you don’t sell it in our market at all (or at least not through government controlled insurance programs).

Faced with an offer they can’t refuse, drug companies will sell much more cheaply in Canada or the U.K. than in the U.S. (where they make the lion’s share of their global profits) to help them recoup their sunk costs and offset the cost of future research. But make no mistake – monopsony pricing undercuts the value of the underlying patent, and reduces incentives to invest in future products.

Price discrimination works in other markets (like airlines, as my colleague Peter Huber eloquently explained several years ago in Forbes) as long as you can charge the poor in economy less and the wealthy in first class more. But it falters when rich countries want the same price that poorer countries get or something close to it.

To sum up: Wealthy European nation’s free ride on U.S. spending on pharmaceuticals and the R&D it generates downstream. This is a classic free rider problem, also visible in the defense industry. European countries spend much less on their defense budgets because the U.S. spends much more to guarantee security on the continent. But if the U.S. gets tired of paying for free loaders, the world will have fewer drugs and less security.

Who really suffers from price controls on large multinational companies? We all do. Research indicates that the returns on pharmaceutical innovation generally accrue to much more to society rather than companies that invent them. (Remember: society continues to benefit from drugs for AIDS, cancer, or heart disease decades after their original patents expire. This is because the average effective patent life for a new medicine is only about 10 years.)

Given the very high financial risks that are required to bring new drugs to market, weakening patent protection through drug importation, price controls, reference pricing etc., reduces the long term gains to public health from lost medical research far more than it saves in the short run on drug prices.

This brings us back to Maine. Will Maine’s importation program have any significant effect on drug development? The effects are probably negligible, in no small measure because regulators are likely to put the kibosh on Maine’s program, as Megan McArdle wrote in Bloomberg recently.

But in the long term, Maine’s efforts – along with those of other states and the federal government – are deeply problematic for future of medical innovation. If every payer pushes for the cheapest price available, investors will flee the industry for more profitable sectors.

And when everyone gets the rebate price, the rebate is meaningless. Either the global price of drugs will have to rise to be closer the U.S. price (with Europe et al paying higher prices) or investment in innovation would be sharply curtailed as U.S. prices fall. Given that policymakers are much more concerned about today’s budgets than tomorrow’s patients, the outlook for innovation could be grim.

But the battle over drug pricing doesn’t have to be a zero sum game.

Cheap drugs are already widely available in the U.S. They’re called generics, copycat versions of drugs that have lost patent protection. Today, 84% of all prescription drugs dispensed in the U.S. are generics. That’s right – 8 in 10. Out of the Top 25 drugs prescribed in the U.S today, a whopping 22 are generic – and many of them are inexpensive, even for the uninsured.

In a Wall Street Journal article on Maine’s program, Nexium and Crestor were singled out as two high cost drugs that Maine could save substantial sums on by importing them from Canada.

Nexium – a proton pump inhibitor for the treatment of acid reflux – is still under patent, which explains why it is so expensive. And Aetna, according to the City of Portland, charges over $600 for a single Nexium prescription. In Canada, Nexium is available for a third of that price – $200. Sound cheap?

Here’s a better idea: how about "importing" generic Prilosec (omeprazole), from your local Wal-Mart for just $17 for a 14-day supply. That’s right: encouraging generic substitution for Nexium would save $183 dollars more than importing Nexium from Canada. The same can be said for Crestor, since generic Lipitor, and other inexpensive lipid lowering drugs are available at your local pharmacy.

In addition to (appropriate) drug substation, other ways to lower drug prices include slashing the cost and time required to develop safe and effective new medicines. In 2011, Michael Rawlins, the head of the U.K.’s National Institute for Clinical Evidence laid some of the blame for high drug prices on the regulators who set the standards for approving new medicines:

A new paradigm for drug development – accelerated drug approvals focused on smaller trials and targeted patient groups, in tandem with enhanced postmarket surveillance – could bring many more medicines to patients at much less cost. Faster drug approvals would leave companies with more effective patent time, and less pressure to charge premium prices quickly to recoup costs before generic competition set in.

Looking even further ahead, as consumer income grows in countries like China and India, innovator companies should be able to spread their costs over a larger and more affluent global patient base, potentially reducing pricing pressures in the U.S. In the E.U., wealthy countries could target rebates and subsidies to poorer segments of the population, allowing drugmakers to charge somewhat more from more affluent patients.

Drug importation is bad for patient safety, bad for drug innovation, and even bad economics insofar as it encourages patients to use more expensive brand name drugs when there are cheaper and effective generic substitutes available

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And rather than bemoaning the high cost of patented drugs, and importing them from abroad, policymakers should find ways to both encourage innovation and drive consumers towards the highest value health interventions – whether that was a pill (branded or generic), a better diet, a gym membership, or other medical intervention.

This would encourage more competition across all health care providers, and a real focus on the total value delivered by the health care system – not just the price of any single component of care. Any other approach is apt to be penny-wise and pound foolish.

This piece originally appeared in Forbes

This piece originally appeared in Forbes