Profits determine whether new pharmaceuticals will be invented

The incentive for American companies to invent new drugs depends on worldwide profits. Some profits come from the U.S. market and some from abroad. U.S. consumers may not like paying the high prices that generate such profits, says Robert J. Barro, a professor of economics at Harvard University and a senior fellow of the Hoover Institution, but everyone in the United States should be happy about foreigners paying high prices. Profits generated overseas raise the incentive to invent new drugs without requiring even higher U.S. drug prices.

So how does Canada fit in? If customers could be separated into distinct markets, drug companies would price at different levels in different places.

According to Barro:
 

• Companies would charge relatively low prices in poor countries because sales at U.S. prices would be close to zero.
   
• For well-off Canada, profit-maximising prices theoretically should be similar to those in the United States.
   
• However, Canada's regulatory agency and the provincial health insurers have managed to hold down drug prices because they set price ceilings, buy in bulk, and negotiate directly with drug companies.
  
  Canadians gain advantage from their regulations because they get existing drugs at lower prices and still benefit from new U.S. drug development.
   
• Potential profits from Canadian sales of drugs are a small part of worldwide U.S. drug company earnings, so the adverse effects on incentives are minor.
   
• Canada, however, is effectively free-riding (or rather, half-riding) on the United States by not paying its "fair share" of the profit incentives for drug discoveries.
  
  If the leakage to the United States became large, as it would if re-importation were fully legal and convenient, drug companies would be unwilling to sell in Canada at 50 percent off. The companies would insist on 100 percent prices or else would not sell there. Thus, Canada has the greatest self-interest in preventing massive re-importation of drugs to the United States, explains Barro.
  
  Source: Robert J. Barro, Drugs Via Canada: The Side Effects Could Hurt,Business Week, August 23-30, 2004.
  
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  For more on Economics of Drugshttp://www.ncpa.org/iss/hea/
  
  FMF Policy Bulletin 7 September 2004