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DBL%20Hendrix%20small.png College chemistry, 1983

Derek Lowe The 2002 Model

Dbl%20new%20portrait%20B%26W.png After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases. To contact Derek email him directly: derekb.lowe@gmail.com Twitter: Dereklowe

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In the Pipeline

« Things I Won't Touch (1) | Main | They Will Do Such Things. . . »

March 4, 2004

Welding the Steering Wheel

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Posted by Derek

Steve Postrel of SMU sent along an interesting comment (which he mentions he hasn't fully worked through), one which takes us right back to drug pricing. Yep, to the cheers of some readers and the winces of others. He believes that my reply in the Feb. 22 "Reimportation's Just the Beginning" post doesn't quite add up:

Your correspondent argued that if the US Congress 1) forbade pharmas from price discriminating and 2) defended pharma IP against Canadian infringement then the Canadian government(s) would find themselves paying a higher price and American prices would be slightly lower. You disagreed, on the grounds that:

"The situation in Canada is: would you rather make a little off your drug up there, or make nothing at all? Companies choose the former - there's no way out. Duane's right that in a more rational situation, the balance between the need for profit and the need for the drug would allow things to reach some sort of equilibrium, but I'm not sure that the warm, windless political conditions needed for that state are ever going to exist."

This argument is incorrect given the reader's premise. If price discrimination were illegal, then the pharma's incentives would be transformed--it would have to set ONE price for both countries. Since Canada is so much smaller than the US, the marginal revenue from lowering the price to grab additional Canadian customers would quickly be more than cancelled by the lost revenue due to Americans paying lower prices. Result: The single drug price for both countries is a little bit lower than the old US price if the Canadians are willing to bargain, and the same as the old US price if the Canadians are not willing to bargain (they simply don't get access to these drugs).

The pharmas gain incremental revenue in the first case and lose incremental revenue in the second case. By prohibiting price discrimination, the US would be improving the pharma's bargaining position vs. Canada by credibly committing them not to cut a special deal. It's like visibly welding your steering wheel in a game of Chicken. The only variable here is whether the Canadian authorities would feel politically safe in just refusing their citizens access to new US drugs.

He's right that I didn't fully take in the premise from Duane's original letter, that price discrimination would be made illegal. I've had a couple of other readers suggest something like this, too. I guess my brain refused to process that one, since (from my prespective) right now we're living in a world where price discrimination has been made mandatory (by the countries getting the cheaper end.) It's quite a stretch. But once past that, I think that this argument follows. In an open market, I think that Canadian (and European) prices would come up, and US prices would come down. Steve goes on to say:

There is the potential for a loss of social welfare here, since some transactions benefitting both parties may not happen under the no-price-discrimination policy (if the Canadians are intransigent). This problem is even more severe in poorer countries where prices now are low not because of government bargaining tactics but because of low incomes. Forcing one price for Boston and Benin is going to eliminate transactions in Benin that mutually benefit the pharma and the Beninese patient.

Yeah, that's the flip side of price discrimination, all right. One of my correspondents in the industry once wrote me that we were heading for a world with two kinds of customers, those who won't pay and those who can't. Obviously you'd have to treat those two groups differently. Postrel's suggestion:

Ideally, then, I'd support a policy that made it illegal to price discriminate between Canada and the US, but legal between the US and Mexico or the US and Benin, and that cracked down on reimportation from the latter nations only. The Canadians aren't that poor; they're just using their collective-purchase mechanism to screw the US consumer (and taxpayer) by not paying as much of the research cost of drugs. The same goes for the rest of the OECD. It's time to weld the steering wheel.

I like this idea, as you'd figure. Practical difficulties exist - for example, there's already a problem with the discounted HIV medications going to sub-Saharan Africa. They're being diverted to the grey market in some cases. The incentive to do that will always exist, naturally, as long as there are multiple pricing tiers. But here's a bigger question: would such outlawing of price discrimination be enforcable under US law? And would it be acceptable under the WTO?

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