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The Quick Fix

Canadian drugs are cheaper, but the cost of buying them may be higher than you think.

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In late October, Republican state senator Chris Lauzen of Aurora took the train to the Loop to speak at a symposium sponsored by the libertarian/conservative Heartland Institute. The topic was bringing in low-priced prescription drugs from Canada, and the seven other speakers that day argued that reimporting drugs would be either useless or counterproductive--the same thing Heartland's president, Joseph Bast, has since contended in an October 31 Tribune op-ed piece. Lauzen was the only one in favor of the idea.

Not long into his speech Lauzen, a soft-spoken, rail-thin certified public accountant with an MBA from Harvard, pulled out the audited financial statement of pharmaceutical giant GlaxoSmithKline and began critiquing it line by line. "They spend two and a half to three times more on selling and general administrative expense than on research and development," he said. "They hide behind their research-and-development expenditure, which is $4.8 billion, to justify their pricing policies--which generate $10 billion in profits. Before I was a senator I took care of 200 small businesses, and I never saw profit margins like that."

Lauzen and four other suburban newcomers entered the Illinois state senate in 1993 and were collectively known as the "Fab Five"; the others were Peter Fitzgerald of Inverness (now in the U.S. Senate), Steve Rauschenberger of Elgin (Fitzgerald's would-be successor in the Senate), Dave Syverson of Rockford, and Patrick O'Malley of Palos Park. The avowedly conservative Illinois Leader has described them as "very conservative," and Lauzen has championed measures limiting abortion rights and property taxes. In a September press release he quoted from Macbeth as he blasted the Democrats' stewardship of state government: "Hell is murky....What need we fear who knows our deeds, when none call our power to account?"

In short, Lauzen isn't likely to be a minority of one at a Heartland event. His defection shows just how strongly the tide of public opinion is running against the orthodox free marketeers on this issue--everywhere else Lauzen goes he's in the majority.

Lauzen considers himself "a pro-profit kind of guy," but only "as long as there's a level playing field and ample competition." He doesn't see one in the pharmaceutical business, nor do his constituents, who've been giving him an earful. Ahead of him in line at the train station that morning was a breast-cancer patient who asked him to explain why tamoxifen costs ten times as much here as it does in Canada.

Lauzen's solution to the problem is to promote the Illinois Health Alliance (an enterprise in which he claims no financial involvement), which offers information about pharmaceutical companies' discount programs and access to cheap Canadian drugs. He prefers this kind of nongovernmental approach, but he also supports Governor Rod Blagojevich's and U.S. representative Rahm Emanuel's attempts to make it possible for the state and federal governments to buy drugs in Canada: "I anticipate speaking on their behalf on the senate floor."

Emanuel and Blagojevich were invited to the October 23 event but didn't attend. As they might well have expected, most of the speakers saw the drug-price issue in terms set by the University of Chicago school of economics--the strongly free-market-oriented worldview that animates most of Heartland's thoughts. (No pharmaceutical company representatives spoke.) The most lucid was Stephen Entin, a U. of C. product who has the dry, precise manner down pat. A former congressional staffer and Reagan administration official, he's now president and executive director of the Institute for Research on the Economics of Taxation in Washington, D.C.

Drugs and software share a peculiarity, explained Entin. The costs and the risks of creating a new drug or computer program are huge, but once the first one has been created, manufacturing more individual items costs almost nothing. If you charged almost nothing for a product, you'd go broke, because you have to cover everything that went into creating that first item--including the dividends to persuade investors to put their money into your chancy venture and the leads and alternatives that didn't pan out.

If anyone were free to copy a product as soon as it appeared and sell it for little more than the cost of manufacturing it, no one would be able to charge enough to pay for the research needed to create new drugs or software, and soon no one would do any. This kind of no-holds-barred competitive market would pretty much prevent the creation of new drugs and software as we know them.

The patent office--not a free-market idea--exists because we value pharmaceuticals, software, and innovation in general. A patent offers its holder a temporary monopoly so that he or she has a chance to recoup the cost of all the up-front effort it took to create something of value.

U.S. patents now last 20 years. In theory, if this period were shorter, drugs would become cheaper--but then we wouldn't get as many new and innovative ones. If it were longer, we might get more innovation, but the resulting products would be high priced for longer.

The decision about how long drug companies should have the exclusive rights to manufacture their creations is ultimately a social decision about how we want the market to work. It's not a decision the market itself can make. It's a decision politicians make, says Entin, based on how much they value current affordability versus future innovation. As an economist he can't say how long a patent should last; all he can say is that someone has to pay the bill for innovation--if nobody does, then there won't be much.

Drugs sold in Canada are cheaper than drugs sold here mainly because the Canadian government, like most other governments in the developed world, decrees that they will be. Pharmaceutical companies can make some profit selling overseas at these mandated prices--but not enough to pay for their research and development. So they charge Americans (whose government doesn't control prices) a lot more, which lets them make enough money to develop new drugs.

Reimporting price-controlled drugs from Canada could save money in the short run, some of the economists at the symposium conceded, but in the long run it will cause new drug development to dry up. Such an outcome, Entin says, would "snatch disease from the jaws of victory." Of course if the companies exercise their legal right to send fewer drugs north of the border it might not even lower prices much.

John Graham of the Canadian-based Fraser Institute offered the audience some tentative specifics. He reckoned that widespread importation from Canada would cause drug companies to cut their research and development spending by 15 to 47 percent, or between $5 billion and $15 billion a year. Research wouldn't exactly dry up, but that's still a huge drop.

If reimportation won't solve the problem, what will? It's not hard to see that there are lots of people in America--the poor, the elderly, the uninsured middle class--who can't afford to pay their share of the burden of research and development this country is being forced to pay. As a solution, Entin offers Chicago-school orthodoxy: when people can't pay for food, he says, we don't pass laws regulating food prices. Instead we give them food stamps to use in the existing market. But he admits he doesn't know of any lobby group embracing Chicago-school economics that also advocates more generous welfare provisions on these grounds.

Entin and the other speakers expressed frustration at the current situation, and they had harsh words for Canada, Europe, and other jurisdictions that use governmental power to keep their prices low and leave it to American consumers to pay the entire cost of creating new drugs. "Consumers in developed countries with socialized medicine are shirking their responsibility to help fund medical research," Entin wrote in a July 22 publication of the Institute for Research on the Economies of Taxation. Economists call them free riders. Yet the exasperated economists at the symposium had few suggestions as to how the U.S. could make the free riders pay their fair share.

Chicago-school economics often seems to describe a beautiful closed world--shake the glass ball and the snow always falls back down. It has little to say about what happens to snow elsewhere or whether snow is actually a good idea.

"I worry that what's being defended here is the status quo," Lauzen told the symposium's audience after hearing Entin and others, meaning that their comments didn't address the problem of the many Americans who can't afford the drugs they need. "The status quo is unacceptable. It's wrong, and no matter how you slice the economic theory we all know it's wrong."

Lauzen is between a rock and a hard place, because he knows that government price controls are also wrong. As Grace-Marie Turner of the Galen Institute pointed out at the symposium, "We've been trying price controls for 4,000 years, and they haven't worked yet." And, as she and the other economists were quick to observe, reimporting drugs from Canada at the low prices set by the Canadian government is a way of importing Canadian price controls--a way for politicians to control American drug prices without having to take the heat for doing it themselves.

In Lauzen's view, Chicago-school economics misses a big piece of the story. American drug prices, he says, show that "there is something the matter with this market." And he thinks he sees one of the problems--fat--in that "selling, general, and administrative expenditures" line of GlaxoSmithKline's audited financial statement, which is two and a half times what the firm spends on research and development. "They're pillaging us," he says, "because they know they can get away with it!"

The market system is supposed to be self-correcting, because greedy companies will be undersold by competitors. But Lauzen argues that because drug companies have patent protection, the self-correcting is limited. None of the other speakers at the symposium had anything to say about how drug companies might abuse the elegant logic of patents. That's not part of the glass-ball world.

Lauzen and Entin cordially discussed the issue for almost half an hour in the hallway. "I was deeply impressed," Lauzen said afterward. "He made a lot of sense. But I'm not sure he's had the experience of going eyeball to eyeball and seeing the tears" of people squeezed by drug prices. Lauzen's hope is that reimporting drugs from Canada will put market pressure on the pharmaceutical giants to cut some fat. "I know they'll find a way," he says. "A little less glass office towers, a little older corporate jets."

But what if the corporations decide to cut muscle instead of fat? What if they keep their office towers and jets and instead save money by not researching less remunerative drugs for rare diseases or for impoverished Africans?

"They might do that," Lauzen acknowledges. He says that if they do, he thinks it might be time to reach for a big gun and reconsider U.S. patent laws. "I believe in a free global market. But it should be free for the little old lady from Peoria to participate in too. If it's only free until she tries to buy drugs from Canada, then we should strike back.

"If the drug companies exercise their monopoly in a benevolent way, OK, then maybe we can be coconspirators. But if they hurt us with a monopoly they've been granted, then maybe it's time to shorten the term on drug patents" and bring competition into the market that much sooner.

Would that competition encourage drug companies to do more with less, or just to do less? It certainly wouldn't be the first time an industry predicted disaster and later learned to live with new regulations or a changed economy, but no one knows. Someday someone may do the economic research and answer that question. Meanwhile today's prescription-drug users have the votes. Their grandchildren, who might suffer if fewer new drugs are developed, don't.

Lauzen says he's called the CEO of the UK-based GlaxoSmithKline three times to discuss the issue. The CEO hasn't called him back, but last time Lauzen checked the company's Web site it had made its financial statements less legible to Americans, by changing the figures from dollars to pounds.

Art accompanying story in printed newspaper (not available in this archive): illustration/Slug Signorino.

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