Trading in Trouble: How Drug Importation Undermines Free-Trade Principles and Harms Taxpayers

Introduction

A fact of life in Washington is that many schemes to endanger Americans’ well-being will appropriate the language of conservatism to appear less threatening. A case in point was the Affordable Care Act, a.k.a. Obamacare. By calling government-directed insurance purchasing arrangements “marketplaces,” and calling coercive taxes on those who don’t purchase government-mandated coverage “shared responsibility fees,” the harmful nature of these policies is somehow supposed to be concealed. With Obamacare, this rhetorical exercise has largely failed, but others wait in the wings.

So it is with proposals to mandate importation of prescription medications into the United States at prices essentially set by other governments overseas. Although convulsively anti-free-market politicians push these approaches, so do some self-professed conservatives.^[1]

Certainly there are many opportunities for those with diverse political outlooks to collaborate constructively on issues of common concern. But how can such interests align on the issue of importation? They cannot. For example, some fiscal conservatives assert that importation amounts to little more than “free trade” – the exchange of prescription medications at prices that are reached through the “invisible hand” gently guiding the equilibrium of the free-market around the world instead of just the United States. In reality, that hand is simply an appendage of big government, which in other countries (and to a major degree our own) possesses the iron grip of price controls.

 

Free-Market Pharmaceutical Policy Principles for Conservatives

Importing self-destructive policies from abroad causes collateral damage here at home. That damage extends to, but is not limited to, our own exports, our workers, our shareholders, our efforts to liberalize and strengthen standards of international commerce, and the long-term savings that innovative drug therapies deliver for taxpayer-funded health care programs. In the face of these terrible outcomes, conservatives in Congress should instead embrace what works: our free-market system of drug innovation that remains the envy of the world. But they must also ensure that what works, keeps working.

What does it mean to be a free-trade conservative on the issue of prescription drugs? NTU believes the following principles should serve as guidance:

1) Unlike importation, the current U.S. system represents the best market-based principles. Spending on drugs as a share of overall health care expenditures is comparatively and consistently small, while generic utilization is higher here than in most other countries.

2) U.S. intellectual property protections are key to the culture of innovation here, and should be emulated among our trading partners rather than undermined through importation of drugs priced in countries that do not respect the rule of law.

3) America’s pharmaceutical economy is creating jobs, investment, and exports now … a solid basis for any trade policy. Importation takes our economy in the opposite direction.

4) Trade is about putting consumers in charge and preventing big government from dictating prices and market conditions. Importation is the antithesis of this conservative philosophy.

5) Taxpayers benefit from life-saving, cost-saving drugs that our economy delivers. Importation destroys this dynamic.

6) Whether they have supported Trade Promotion Authority (TPA) legislation or not, importation is the wrong move for conservatives. Importation would mangle the entire framework established in TPA, which specifically calls upon the Executive Branch to pursue trade deals that raise intellectual property standards, avoid price controls, and remove barriers to U.S. goods in foreign markets. TPA opponents would see many of their concerns worsened by the pernicious effects of importation.

The following sections will discuss these and other aspects of importation in greater detail.

 

The U.S. Pharmaceutical Market: A Success Story

The very premise of importation – that a “market failure” in prescription drugs needs correction – is something that conservatives should reject. Instead, they should be celebrating the virtues of a structure that delivers life-saving cures while keeping costs at a manageable level.

Simply put, prescription drug expenses have not driven, are not driving, and will not be driving, the rising costs of health care. Indeed, as later sections will show, drug discoveries hold the key to reducing or controlling overall health expenditures, particularly in government programs.

According to data compiled by the Centers for Medicare and Medicaid services, prescription drug expenditures have held a consistently low share of total health expenditures over the past 55 years: slightly under 10 percent in 1960 and projected to be slightly over 10 percent for 2015.^[2] In years between, the share fluctuated somewhat, but in many cases (e.g., 1980, 1990, and 2000) was even less. What comprises bigger proportions of the nation’s spending on health? The price tag for hospital care amounts to three times more than prescriptions, while physician and clinical costs run roughly twice as much.^[3]

And many of those trends will continue. By the government’s own estimates, prescription drug spending in the year 2025 will be modestly above the 10 percent mark, while hospital costs will still be about three times larger.^[4] One reason why drug costs have held relatively steady is that many Americans utilize cheaper generic drugs where available. From 2010 to 2014, branded and unbranded generic drugs grew from 77.2 percent to 87.5 percent of all prescriptions dispensed nationwide.^[5] Prior studies suggest that generic drug utilization far outpaces that of other developed countries, such as Canada and Japan.^[6] The comparatively high rate of generic drug adoption in the United States results in large savings—more than $254 billion worth in 2014 alone, according to the most recent estimates.^[7]

Instead of buying into the false narrative that prescription drugs are becoming unaffordable and unsustainable in the health care system, fiscal conservatives would do well to concentrate on changing tax, budget, and regulatory policies that have affected many types of spending. These include controlling government administrative overhead and monitoring public health programs. In addition, the administrative costs of private insurers – projected to be nearly as much as they spent on drug benefits in 2015 – are impacted by various government dictates such as those in the Affordable Care Act.

Those seeking to repeal and replace Obamacare should be focusing more of their public outreach on these trends rather than playing into the hands of government-directed price control advocates.

 

Rewarding Protectionism

Another simple standard for any trade agreement is, will it reduce protectionist policies? One especially noxious protectionist scheme involves assaults on property rights, which comprise a cornerstone of conservative economic philosophy.^[8] Importation fails this test miserably.

The cumbersome regulatory process for research and development, combined with high failure rates for new pharmaceutical innovations, creates an extraordinary time and cost burden on the private sector nearing $3 billion for each drug successfully developed, approved, and brought to market.^[9] For this reason, U.S. law provides important intellectual property protections to encourage innovation and protect investments in discoveries.

Over a decade ago, National Taxpayers Union published a study entitled “Stealing Innovation” that cautioned against attempts in Congress at that time to undermine strong intellectual property safeguards for pharmaceuticals.^[10] The authors contended that:

[T]he U.S. offers strong patent protection, and commands the world’s leading share – 45 percent – of all global drug development.^[11] In 2002, the U.S. is expected to market 20 of the top 25 selling drugs.^[12

This solid foundation of property rights, along with the pillars of pricing freedom, consumer choice, somewhat lower taxes, and relatively less regulation, has served as a strong structure for health care in America that could, with proper care and a little renovation, serve as a model for the rest of the world.

What has changed since those words were written? The U.S. has consistently led with about half of all the drugs under development,^[13] while private-sector biopharmaceutical investment in America has far outpaced the rest of the world (several times greater than that in Europe, Canada, and Australia combined).^[14] Although patent protections in U.S. law for drugs have remained relatively constant for several years, by many measurement regulatory burdens have climbed dramatically in numerous areas of industry.[15] Meanwhile, the competitiveness of the U.S. corporate tax system has fallen even further behind the rest of the world, creating an even bigger disadvantage for American businesses (including those in the pharmaceutical industry). NTU has repeatedly called for comprehensive corporate tax reform to remedy this problem.^[16] For pharmaceutical companies, importation would only compound a difficult tax and regulatory climate.

All of these events are taking place in an increasingly challenging IP environment for biopharmaceutical discoveries worldwide. For example, in 2013 India’s Supreme Court stripped the patent for a brand-name cancer-fighting drug, thereby giving the green light for India-based producers to appropriate the formula and profit from generic sales.[17] This hostile climate impacts brand-name producers from many countries that market in India.

Just over a decade ago Canada’s courts embraced a “promise utility doctrine” that has since ripped away two dozen patents on innovator drugs. Perhaps not coincidentally, Canadian pharmaceutical R&D has dropped dramatically (just over 30 percent four years after the doctrine took root), while the country’s ranking in the World Economic Forum’s innovation index has fallen sharply.^[18] The Information Technology and Innovation Foundation (ITIF) branded Canada’s approach one of the “Worst Innovation Mercantilist Policies of 2015,” noting that it “allows Canada’s generic drug companies to unfairly take intellectual property without contributing genuine innovation.”^[19] ITIF also cited Russia for its employment of “subsidies, price preferences, procurement restrictions, and other policies as part of an explicit import substitution goal … .”^[20] While they have been coping with this aggressive behavior, pharmaceutical companies have since 2012 absorbed the ongoing patent expirations of drugs worth close to $100 billion in U.S. sales alone.[21]

Given the hostility toward IP protections beyond America’s borders, and the current domestic “patent cliff,” importation would be a bigger mistake now than ever before. It would validate the decidedly un-conservative idea that property rights are merely obstacles for overbearing governments to sweep away when they find them inconvenient.

 

A Dead-End for U.S. Exports

Many analyses of importation’s effects focus on how it would harm activities within the U.S’s borders. It is important to remember, however, that the detrimental impact would extend to America’s export economy too.

In spite of all the threats from other countries to their basic rights to do business, U.S. drug companies are powerful contributors to our export-based economy. Biopharmaceutical goods exported from our shores had a value of approximately $55 billion in 2015, more than industrial machines, semiconductors, or telecommunications.^[22] By one estimate conducted by the Battelle Technology Partnership Practice, U.S.-based sources provide 70 percent of the capital for all biopharmaceutical ventures here and abroad. [23]

Traditional conservatives who back free trade often believe that first and foremost, negotiations with other countries over such policies are worthwhile because they can help to open up foreign markets to U.S. goods and services.

Importation works the opposite way. Pharmaceutical companies would be even further limited in pursuing the already meager opportunities to recover at least some of their initial investment costs by selling to customers outside of the U.S. (admittedly at lower prices extorted by governments). Ironically, in the name of cheaper prices in the U.S., importation would deprive our own firms and foreign firms with a significant U.S. presence, of the capital and incentives to keep driving the discoveries that other countries want. As a result, pharmaceutical exports, as well as some of the jobs, shareholder returns, and other economic boons behind them, would shrink. That shrinkage would not be limited to the biopharma sector alone, which directly or indirectly supports over 4.4 million jobs.^[24]

Although Canada is a rare exception, most nations that trample on drug producers trample on other industries too. As former FDA Associate Commissioner Peter J. Pitts wrote in The Washington Times, in addition to biopharma, “America’s technology, agriculture, and information-technology industries – among other sectors – are already feeling the effects of India’s current policies. If India continues to erect trade barriers, more and more U.S. firms will be denied a valuable and growing market for their goods.”^[25]

 

Trade Empowers Consumers, Importation Empowers Middlemen

A great advantage of trade is that the free flow of goods and services among nations give consumers the best possible values for their money, in a much larger and more diverse marketplace. With importation, the money would end up in the pockets of “middlemen.”

What Would Milton Do? The free-market economics community understood the flaws of drug importation long ago. In 2003, the late Milton Friedman led more than 160 economists on an open letter to policymakers to express concern about “proposed legislation to remove pharmaceutical companies’ ability to control the importation of their products.” Joining Friedman were some of the most respected advocates for limited government in the economics profession, including Joseph Antos of the American Enterprise Institute, Stephen J. Entin (currently with the Tax Foundation), Merrill Matthews of the Institute for Policy Innovation, Richard Rahn (currently with the Cato Institute), Grace-Marie Turner of the Galen Institute, and John Berthoud, who once served as President of National Taxpayers Union. The signatories observed that: The goal of this legislation will be to reduce prices in the American market by imposing other nations’ price controls on us. If this attempt succeeds, American consumers would get the short-term windfall of lower prices, but they would end up unnecessarily suffering and living shorter lives – because promising new therapies would be delayed or not even developed. Even the threat of price controls reduces the incentive to develop new drugs. Their warning remains prophetic today. Source for text of letter: The Heartland Institute, “Economists Warn of Dangers of Drug Importation, Price Controls,” posted February 1, 2004, https://news.heartland.org/newspaper-article/2004/02/01/economists-warn-dangers-drug-importation-price-controls.

European nations allow for a drug made in one country to be repackaged for sale in another country, supposedly for the benefit of consumers. This “parallel trade” somewhat resembles the mechanics of importation. For more than a decade, data-driven analyses of this scheme have shown underwhelming results. A 2004 study done by the London School of Economics (LSE) on this phenomenon found that the savings to insurers from this practice ranged from 0.3 to 2.2 percent, while the repackaging “middlemen” profited from markups that in some cases exceeded 50 percent.^[26] Subsequent studies conducted under the auspices of LSE experts have only reinforced these findings. A 2005 analysis concluded that “the gains from parallel trade accrue mostly to the distribution chain rather than health insurance and consumers”^[27] while a 2010 review issued a blunt warning: “Drawing on the European evidence, the findings also indicate that opening the U.S. market to parallel imports will not necessarily lead to competition and enhance pharmaceutical cost containment.”^[28]

Other researchers in the U.S. such as the Wharton School’s Patricia Danzon have predicted that similar outcomes would occur if importation were instituted across the United States. In a 2011 analysis, she and her colleagues noted that “intermediaries may capture a significant share of any savings that are available.”^[29]

Free trade recognizes that each participating nation has an economic capability to produce goods and services for the worldwide market more efficiently than others can. Importation substitutes the poor judgment of governments for this dynamic, by dictating prices to fit foreign countries’ own parochial interests.

 

Importing More than Price Controls

In most countries, price controls on prescription drugs are not imposed in a vacuum. They come with all types of policies that are anathema to the liberalization of markets that free trade is supposed to cultivate. Among these are rationing of care, mandates, and bureaucratic decision-making that is far removed from the taxpaying public. A few examples will suffice:

• Thanks to practices that stress cheap pills over longer-term cost savings (in the form of better patient outcomes and shorter hospital stays), socialized-medicine countries create long delays in availability of new cures. 2011 data indicates that in 20 European countries the wait time between marketing approval for a new drug and patient access can be as long as 850 days.[30]
• The New Zealand government’s practices of extortionary price negotiations, “waiting out” patents, and opaque approval processes have led to average wait times of nearly three years from when the bureaucracy’s technical advisory committee recommends making a drug available to when patients can actually have it.^[31]
• The United Kingdom’s National Institute for Health and Clinical Excellence (NICE) has developed a rather arbitrary calculation for the value on a single quality adjusted year of life: roughly £30,000, or just under $40,000 as this paper was being published. Health care systems around the world have various ways of prompting cost-benefit analysis of certain treatment decisions, but as The Wall Street Journal pointed out during the midst of the Obamacare debate, “[t]he core issue is whether those decisions are going to be dictated by the brute force of politics (NICE) or by prices (a private insurance system).”^[32][33] to either “fix” health care because importation does not go far enough, or to “improve” health care further because importation is only part of what should be a more comprehensive policy. Conservatives beware.

 

Creative Destruction or Destroying Creativity?

Conservatives seem to recognize the rare attributes of the American economy, but as examples around the world show – from Hong Kong to Switzerland – economic liberty can take root anywhere. Therefore, some argue, why worry about the displacement effects of importation? Indeed, the upshot could be similar to the pressure of free trade – U.S. companies would either adapt to competitor companies and spread prices around more equitably on the larger market, or they would simply move to a more competitive and hospitable environment.

The reality could be quite different. For one, U.S. drug firms now engaged in price negotiations abroad are doing so with other countries, not other companies. Governments can back up their monopsonys (buying-market powers) with favorable laws, tax dollars, sympathetic courts, and even armies. American companies have no such comparable advantages. The market abroad is already rigged, and importation favors the “riggers.”

Furthermore, companies in the U.S. could respond by simply cutting back on research and development, and steering shareholder resources to less risky activities such as marketing.  One study found that lowering the price of drugs (forcibly) by 40 to 50 percent in the United States would lead to sizable reductions in research and development efforts—from 30 to 60 percent fewer early-stage research projects.^[34]

Some companies could, indeed, move overseas. In the process, while they spent precious time and energy setting up elsewhere, the opportunity costs to our economy, our taxpayers, and patients around the world would multiply. James K. Glassman and John R. Lott, Jr. noted that drug price controls are especially “pernicious” in creating such opportunity costs: “While controls on oil and other products tend to be short-lived, as voters eventually object to the resulting shortages, the effects of drug regulations are more difficult to observe since they mainly affect medicines that haven't been invented yet.”^[35]

Conservatives generally believe that sound public policy should attempt to minimize the impact of government policies on business decisions. This is the very essence of current efforts to reform the U.S. corporate income tax, which imposes the highest statutory (and one of the highest effective) tax rates in the industrialized world. Importation would add to this workload by maximizing government interference in the decisions of an important business sector in the United States.

 

“Trade” that Bilks Rather than Benefits Taxpayers

Merriam-Webster’s online dictionary defines the word “tariff” as “a tax on goods coming into or leaving the country.” Taxpayers therefore gravitate toward tariff reductions in legitimate free trade deals. But why isn’t importation a form of “tariff reduction” that will benefit taxpayers the same way? The main reason is, taxpayers reap illusory savings from cheap pills; they benefit more from pharmaceutical breakthroughs that lower the long-term cost pressures on government health care programs.

For over a decade, serious non-industry-funded studies of importation have turned up few savings advantages to taxpayers or consumers. A 2003 Congressional Budget Office (CBO) estimate of importation legislation found the measure would reduce total public and private spending on prescription drugs by about 1 percent.^[36] Moreover, CBO in 2003 concluded that “savings to federal health programs would be lower—about one-half of a percent of federal spending on prescription drugs—because those programs generally already pay among the lowest prices on the market.”^[37]

Other academic experts, among them Patricia Danzon of the Wharton School, have more recently echoed these concerns. In a 2011 study, she and her colleagues concluded that up-front policing costs for importation would cut into consumer savings, which on net would amount to approximately 0.6 percent of all U.S. drug spending.^[38]

This paper has generally avoided discussions of whether importing prescription drugs from other countries is safe for patients taking them. Yet, there is an important consideration for taxpayers involved in this question. The Medicare Modernization Act of 2003 included a section directing the Food and Drug Administration (FDA) to “promulgate regulations permitting pharmacists and wholesalers to import prescription drugs from Canada into the United States.”^[39] However, the law also requires the FDA to certify “that the implementation of this section will a) pose no additional risk to the public’s health and safety; and b) result in a significant reduction in the cost of covered products to the American consumer.”^[40] No such certification has occurred, and a report released by the Department of Health and Human Services late in 2004 helps to explain why.^[41]

The report estimated that approximately 10 million packages enter the United States with imported prescription drug products; developing an FDA regime to screen all these packages for safety would add up to nearly $3 billion—or approximately the total potential savings from an importation regime, according to CBO.^[42] The significant costs necessary to preserve the integrity of the pharmaceutical supply chain – costs that have only increased due to the proliferation of counterfeit Internet pharmacies – could easily overwhelm whatever price breaks drug importation could produce.^[43]

On the other hand, innovator drugs produced for the U.S. market (without as many drug price controls) have yielded proven savings for taxpayers. In general, even high-priced pharmaceuticals tend to be a better long-run bargain because they replace hospital stays, surgeries, recovery therapies, and other costly activities that would have to occur in their place. A National Bureau of Economic Research study put a fine point on this equation, concluding that every dollar spent on prescription drugs leads to a $2.06 reduction in overall Medicare expenditures.^[44]

CBO has also observed that simple policies designed to increase utilization of drugs that patients should take (but don’t for a variety of reasons) can pay off too. For every 1 percent increase in prescriptions filled for Medicare participants, spending on medical services within the program falls by 0.2 percent.^[45] Even higher payoffs may be possible for those with chronic conditions.^[46]

Medicare and Medicaid are among the biggest drivers of future growth in the national debt, but to be clear, prescription drug coverage within these programs is actually working to help offset and bring down the costs of other troubled components of the federal health care system. For this reason, it would be a serious error for lawmakers to enable bad ideas like importation, which would undercut the use of proven-cost reducing drug therapies. Over the long term, budget deficits could actually rise under such unwise approaches.

 

Undercutting Congress’s Stated Values of Free Trade

Conservatives who believe that importation can fit in their trade policy agenda should rethink their stance … and, reread the most current law governing future trade negotiations.

In 2015, Congress passed the Bipartisan Congressional Trade Priorities and Accountability Act. The final vote on the package took place with the support of 190 out of 240 voting Republicans in the House and 47 out of 52 voting Republicans in the Senate (absences excluded).^[47] The new law specifically directed the Executive Branch to pursue trade deals that will:

• Ensure “that the provisions of any trade agreement governing intellectual property rights that is entered into by the United States reflect a standard of protection similar to that found in United States law”;
• “[A]chieve the elimination of government measures such as price controls and reference pricing which deny full market access for United States products”;
• and “[E]nsure that government regulatory reimbursement regimes are transparent, provide procedural fairness, are nondiscriminatory, and provide full market access for United States products.”^[48] 

As this paper has demonstrated, importation could not possibly be consistent with these aims. Indeed, trade experts have long affirmed this conundrum. Testifying before Congress in 2005, Grant Aldonas, an Undersecretary of Commerce with the International Trade Administration, noted that importation “undercuts what we would otherwise prefer to achieve, which is the full play of market forces between these economies rather than introducing further distortions.”^[49]

What of those Republicans who rejected TPA? Among the most common objections they cited to the legislation were that it disadvantaged American interests in opening markets for exports, cost U.S.-based jobs and losses of capital, and surrendered our economic sovereignty to the policy whims of foreign governments.^[50] Based on a vast preponderance of evidence, each of these misgivings is entirely applicable to importation schemes. Whether they supported TPA or not, conservatives certainly shouldn’t back importation. A much wiser course is to work for policies that help spread the principles of free markets and property rights.

 

Conclusion: Importation Is Trading in Trouble

Throughout its 47-year history National Taxpayers Union has served as the leading “Taxpayer’s Lobbyist” to persuasively argue that tariffs and other barriers to trade effectively act as taxes on commerce. Removing those barriers has delivered, and will continue to deliver, measurable prosperity to our own citizens.

Importation, on the other hand, threatens to deliver human misery, economic stagnation, and fiscal woes. It is a big government response aimed at addressing an outcome that big government created in the first place. The way out of this trap is with genuine conservative solutions that empower individuals, providers, and innovators to reshape health care.^[51]

As these reforms work their way through the policymaking process, it is important to exercise diligent, vigorous stewardship over the elements of our health system that are functioning well – and that begins with the U.S. prescription drug market. As this paper has demonstrated, American pharmaceutical innovation – which rests on sensible regulatory approaches, pricing freedom, and intellectual property protection – contributes greatly to the growth of our economy, the attractiveness of our business climate, and the long-term sustainability of taxpayer-funded health programs.

All of these benefits could easily fade away under importation, which is the very antithesis of free trade. Importation would undermine the entrepreneurial economy, introduce price controls, trample on property rights, abet protectionism, harm U.S. exports, encourage socialistic health care policies, and, ultimately, burden taxpayers.

Conservatives, who believe in free markets, limited government, and expansion of trade, must be especially vigilant now against importation schemes. These include not only stand-alone legislation but also appropriations language, committee instructions, or floor amendments. Make no mistake: importation is not about trading in pharmaceuticals, it’s about trading in trouble.

 

About the Author

Pete Sepp is President of National Taxpayers Union; he has written numerous works in fiscal and health care policy.

 

Notes