Canada to block US drug exports

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Canada is planning to tighten their rules to make it more difficult for Americans to to import drugs from across the border. The incentive seems to be that US drug companies are starting to restrict their shipments to Canada in an effort to disincentive export. Obviously, this creates shortages.

Anyone who understood economics always understood that this was the likely outcome of drug reimportation. The reason that the Canadians are paying cheaper prices for drugs is that the US drug companies have been practicing price discrimination. They can sell to Canada at a cheaper price because it's a distinct market from American consumers. However, this only works in environments where there's no ability for arbitrage, which of course is exactly what reimportation creates. Canada has to get control of the drugs being sold to it or risk the drug companies refusing to continue giving them a discount.

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6 Comments

Is this actually "continue giving them a discount" or "begin to apply a surcharge"? The economics of this are such that the price to manufacture the drugs is deeply contested. For some classes of drug, the U.S. government pays for the development, so it would appear that the cost to manufacture would be the only thing to use in determining whether price gouging is being applied; yet many argue that allowing the drug companies to double dip on these drugs allows them to carry out other research.


My own take is that the drug companies are interested only in research for drugs that have long term customers in rich nations, and that any work they do outside of that comes either from government contracts or funding from NGOs. And in the latter case, when the research does turn up something they have to be further paid to actually produce the drug.


To return to the point a bit, this will only drive the trade to some other country. It will be less well known and less trusted to Americans than Canada is, but the trade will go on.


From an economic perspective, there's no interesting difference between "continue giving them a discount" or "begin to apply a surcharge". It's purely a matter of what you think the nominal price is. Since I live in the US, I think of the nominal price as the US price and the Canadians as getting a discount.

Since the marginal cost of production for most pharmaceuticals is practically zero, the drug company sets whatever pricing strategy it expects to make the most money. You can call that gouging if you like, but that's an ethical concept, not an economic one. The cost of the research that went into the drug really doesn't have anything to do with the price the drug company charges, except that drugs on average have to make more than it costs to develop.

WRT your final point, the drug companies don't actually care to totally eliminate reimportation. They just want to make it difficult enough that it doens't seriously cut into their US market. How much reimportation they're willing to live with is a function of the price differential between the US and whatever country the drugs are being reimported from. However, if it ever gets to the point where a large fraction of the drugs in the US are actually drugs that were originally sold in some cheaper market, then the drug companies will have a heavy economic incentive to either restrict supply to that market or stop offering a lower price there.

With respect to your second paragraph, "My own take..."

Your first sentence sounds like you're accusing the drug companies of wanting to make profits. Good for them! What else do you think should motivate people to be investors in drug companies?

As for governments and NGOs, if they didn't negotiate the price they were willing to pay as part of the R&D contract, too bad for them. Of course, if they did set a low price as part of the contract, maybe the drug companies wouldn't have researched those drugs. That pesky profit motive again. My guess is that the potential (not certain) profits were part of the carrot that the governments and NGOs used to get the companies to do the research.

If you think you can do better, there's nothing stopping you from starting a non-profit drug company.

To Kevin's point, I'm not accusing them of wanting to make profits; everyone expects that. I'm saying that the pricing is significantly distorted by how the research it takes to make a drug figures into the cost. The advertisement, production, and distribution costs are much like any other commodity. But the government's behavior in drug research and drug approval significantly warps typical market behavior. Further, the monopolies granted for drugs developed under U.S government research often have no rational basis in patent law. The U.S. government, having paid for the development of a drug to fight a specific disease then grants a monopoly license on that to a company that either had no hand at all in the development or was paid on a work for hire basis. These are granted at least nominally because the U.S. government believes the monopoly serves the public interest. What is more, the public interest being served is often unrelated to the drug and disease in question. This isn't governed, in short, by profit motive but by state-sponsored activity at pretty much every level from getting the scientists to take on the task to getting the drug produced


To EKR's point, "From an economic perspective, there's no interesting difference between "continue giving them a discount" or "begin to apply a surcharge", I'd have to disagree. The economic aims of the two represent very different tactics; the overall strategy may be "to make money", but discounts (especially loss-leader discounts) are a different kettle of fish than normal profit pricing. To me, this means there may be a signficant difference between "end a discount" (which may indicate that the tactical aim of developing a market or eliminating a competitor has been accomplished) and "apply a surcharge".


Skippy said in his first post:

"My own take is that the drug companies are interested only in research for drugs that have long term customers in rich nations,..."

This is clearly the profit motive. You say in your second post that you don't have a problem with this motive. OK. So this implies that you have no problem with what drug companies charge for drugs developed with internal R&D funds.

The rest of the first post sentence was:

"... and that any work they do outside of that comes either from government contracts or funding from NGOs. And in the latter case, when the research does turn up something they have to be further paid to actually produce the drug."

As I said in my first post, this is wholly a government issue. The drug companies are merely responding rationally. It seems to me that you therefore don't have a quarrel with the drug companies' behavior.

It appears that what you meant to say in your first post was that importaion is not the primary issue, but rather the rights governments and NGOs negotiate in their research contracts with drug companies.

Skippy,

You seem to be using "discount" to mean "pricing below marginal cost" and surcharge to mean "pricing above marginal cost". This doesn't map very well to the usual meanings of the terms. For instance, the marginal cost of Microsoft software is very close to zero, and yet we routinely speak of Microsoft offering an "academic" or "employee" discount. To my mind, a discount is a price offered to someone that is not available to the general public. A surcharge is a price charged to someone which is above that paid by the general public.

Note that the usage of above/below marginal pricing is particularly problematic in the case of information goods like drugs and software. Nearly all drugs are priced substantially above the marginal cost of production. So, you can argue if you like that Canadians would be being charged a surcharge if they were charged the American price, but they're almost certainly already paying a surcharge if we're comparing to marginal cost of production.

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