January 1, 2005 (Vol. 25, No. 1)
Losing High-paying Jobs Among the Risks
The public policy debate over the importationor reimportation if the drugs were actually made in the U.S., sold and shipped to another country, and then sold and shipped back to individual customers in the U.S.of prescription drugs has generally focused on whether the U.S. government can ensure the safety of those drugs. But there is another public policy tied to importation that has been entirely ignored: jobs.
Would legalizing the purchase of prescription drugs from Canada and/or other countries cost U.S. jobs? The answer is an unequivocal yes.
Importation Equals Price Controls
From an economic standpoint, importation is no different than the government artificially lowering prices by imposing price controls. The resulting decrease in drug prices would have direct consequences for the drug-consumption decisions of consumers and for production and R&D decisions made by pharmaceutical and biotech firms.
Importation (or price controls) may also encourage the development of gray or black markets in drugs, especially if certain states successfully impose price controls while others do not. To the extent that prices vary across regions where parallel trade exists (i.e., the ability to trade back and forth without restrictions), intermediaries will have an incentive to engage in spatial arbitrage.
For example, if the controlled price of the anti-cholesterol drug Lipitor is lower in Arkansas than in Massachusetts (which may well be the case if regulated prices in different states are set according to average state income levels), intermediaries would purchase Lipitor in Arkansas and resell it at a higher price in Massachusetts.
These arbitrage activities may result in shortages of (and queues for) drugs in Arkansas and a higher effective price paid for Lipitor on the gray/black market, defeating the purpose of price controls.
Import Intellects, Not Price Controls
One reason the drug industry tends to pay above-average wages is that it needs employees with above-average skills and education. The drug industry has been a brain gain for the U.S., giving well-educated Americans good jobs, but also attracting some of the brightest doctors, researchers, and scientists from all over the world.
Why are those highly educated workers coming to the U.S.? Because all of those other countries with prescription drug price controls have seen their R&D sectors move to the U.S.
R&D funds also keep U.S. medical schools afloat. Industry critics complain that the government is helping to pay for the R&D for new products that drug companies sell for a profit. However, the truth is almost exactly the reverse. The industry pours millions of dollars into U.S. medical schools, many of them state supported, where most of the R&D and clinical trials are done.
Prescription drug R&D is very labor intensive. Impose price controls and the manufacturers will either have to cut back on R&D, which is the lifeblood of the industryand millions of patients around the world, for that matteror they could choose to outsource much of the research to other countries, turning the current brain gain into a brain drain.
According to a story in the Financial Times, Outsourced drug manufacturing in India is worth about $500 million and forecast to rise annually by a third. Furthermore, the story notes that India has plenty of organic chemists, who are strong on research…and who cost two-thirds less to employ than chemists in the U.S.
Estimating the Economic Impact of Importation
The Beacon Hill Institute, in a study for the Institute for Policy Innovation, used a real options theory framework to simulate the effects of price control and importation policies on the valuation of R&D projects.
Using this framework, the authors determined the value and development desirability of a project in each stage of development. For each stage, a firm compares the expected cost of a projects completion to the expected value of continuing a project. If the former exceeds the latter, the project is abandoned. If not, the project continues.
The real options model takes into account the level of and uncertainty in the cost to completion of a project, growth rate of and uncertainty in cash flows resulting from a project, as well as the possibility of failure because the drug doesnt meet safety or efficacy standards.
Suppose that importation had the effect of limiting annual prescription drug inflation to 3.13%, beginning January 1, 2005. The simulation tracks the effect of such a policy on the innovation rate and the number of drugs abandoned for economic reasons after the policy is enacted.
Assuming that development through clinical trials lasts, on average, eight years, drugs entering clinical trials as far back as 1998 will be affected by the new policy (for drugs entering the pipeline before 2005, the effect of the policy will be greater the more recently the drug was introduced).
The study assumed that 130 new drugs enter clinical development each year, which is consistent with the recent statistics on new drug introductions.
The results of the real options investment model indicate that under such a policy the abandonment rate for economic reasons for all cohorts entering in 2005 or after is equal to 37.5%. This considerably exceeds the actual abandonment rate (for economic reasons) in the baseline simulation (20.7%), suggesting that the new policy could have severe consequences for drug innovation rates.
According to the baseline assumptions in the model (an approval rating of 23.5%), a cohort reaching clinical trials, consisting on average of 130 drugs, could be expected to yield 31 new drugs.
Importation schemes would shrink the pipeline for new prescription drugs by reducing the ability of companies to recover their investment in R&D.
In the 12 years following the implementation of a price control policy:
R&D spending by pharmaceutical and biotechnology firms would fall by $14.8 billion, in net present value terms.
Price control policies would lead to the abandonment of an additional 262 drugs for economic reasons.
Under a price control policy, only nine new drugs would likely be approved in a year, a decrease of more than 70% from the current average of 31.
Reduced R&D spending attributable to drug importation would also have a serious negative effect on the U.S. economy and, in particular, on those states such as Massachusetts, whose economies benefit from the existence of strong pharmaceutical and biotechnology sectors.
In Massachusetts, where nearly 10% of the nations pharmaceutical and biotech research and development dollars are spent:
Price controls would destroy 3,957 jobs over the first six years.
By 2010, the loss in economic activity (as measured by value-added) in Massachusetts would total $247 million (in 2000 dollars).
Since the large majority of Americans have some type of prescription drug coverage, importation would reduce the effective price a relatively small number pay for drugs. In return, we would open up the U.S. to massive counterfeit efforts, put patients at risk, undermine the new-drug pipeline, and destroy thousands of high-paying jobs. That is both bad public and economic policy.