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Cato Tugs Stray Back Onto the Reservation; Epstein on reimportation

From LRC, July 29, 2003:

Recent posts (2345), and a wonderful speech by Congressman Ron Paul properly chastised Cato writers for opposing reimportation of medicines, thus adopting a protectionist, anti-free trade, anti-property rights stance.

It must have caused some outcry among Cato’s libertarian supporters. Looks like Cato’s Ed Crane and Roger Pilon decided to get back on course, in their article Conservative Drug Split in NRO. They conclude “Reimportation is right and good”, but they spend a lot of time bending over backward to try to make the protectionist argument look respectable, making for an overlong, convoluted defense of free trade. It should take about a paragraph or three, at most, for a libertarian, free-market group to explain why there is nothing wrong with free trade.

Also from this piece:

The most interesting case we’ve seen opposing reimportation comes, not surprisingly, from the University of Chicago’s Richard Epstein, writing last Thursday for TechCentralStation. Recasting the issue as one of contract, Epstein argues that market segmentation and price discrimination make sense when they enable companies to expand sales in markets composed of people with differing inclinations to pay — provided they’re coupled with contracts prohibiting low-cost buyers from reselling to high-cost buyers. Such a restraint “is not imposed by government,” Epstein says. “It is not antithetical to free trade; it is part and parcel to free trade.” But those contracts are hard to enforce, he continues, “because it is hard to trace drugs that pass through several vendors. Thus, imposing statutory restrictions on reimportation of patented products is an effective substitute for a valid, if ineffective, contractual restraint.”

Epstein, from a version of the article cited above, “Parallel Importation as a Perversion of Free Trade,” July 9, 2003:

American companies, in order to see positive long-run returns, must preserve their ability to price discriminate in American markets, and toward that end when they sell goods overseas they seek by contract to limit the resale of the goods in the United States. Government does not impose this restraint on alienation. It is not antithetical to free trade. It is part and parcel of free trade. If it were possible to enforce contract provisions that required foreign buyers to pay in damages an amount equal to the difference between the United States and the local price of a given drug, the profit would be taken from the arbitrage game.

All too often, these contractual restrictions are worthless because of the difficulty of proving the breach for drugs that quickly pass through the hands of multiple parties. However, imposing statutory restrictions on reimportation is an effective substitute for a valid, if ineffective, contractual restraint on alienation that makes sense in light of the basic domestic decision to grant the full patent monopoly.

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From the links above, plus some others:

Protectionist Cato?

In a recent post, Lew Rockwell notes that Cato’s Doug Bandow opposes free trade in pharmaceuticals. Seems there must have been a memo: now comes Just Say No To Drug Re-Importation, by Cato’s Michael Krauss. Krauss opposes H.R. 2427, which would authorize wholesale re-importation of pharmaceuticals from 26 countries to the United States for distribution to consumers. Warns Krauss, If enacted, it could endanger American lives, imperil national security, and reduce the quantity and quality of drugs available for Americans.”

This is a rambling, confused piece. Here we have a libertarian urging that the importation of commercial products, from willing sellers to willing buyers, be banned–because it could “endanger” American lives? When did libertarians abandon caveat emptor and adopt maternalism? As for how importing drugs can “imperil national security,” maybe someone else can figure out just what Krauss’s argument is, but it seems quite a stretch to me.

The real problem for Krauss is that reimporting allows consumers to avoid some of the monopoly price charged due to the US patent system. Hence, support for intellectual property rights leads once again to the undermining of genuine private property rights, such as the right to trade.

Congress’s actions are also bizarre: they help to create artificially high pharmaceutical prices by giving patent monopolies to American companies. Then, they attempt to solve the problem by allowing reimportation. Why doesn’t Congress simply curtail patent rights in drugs, if they really want to lower the artificially-high drug prices consumers face? Similar with the medicare drug prescription plan: the feds are going to increase our taxes to pay for drugs that are expensive because of the federal patent grant. If the feds are going to make us pay for retirees’ drugs, shouldn’t they at least remove patent protection from them, so that the burden is lower?

6:03 pm on July 24, 2003

re: Protectionist Cato?

Writes Casey Khan: “I guess there was no invention before the US patent office opened.

“Cato adjunct scholar Richard Epstein writes: ‘Patented goods are subject to a lawful monopoly created by the state in order to induce their creation. No one thinks that new pharmaceutical drugs will be invented by private firms that cannot receive a rate of return sufficient to recover not just the cost of fabricating and selling each pill, but also the huge front-end costs that reach (when dead ends are taken into account) under anyone’s estimate in the hundreds of millions of dollars for each new product that reaches the market.

“‘The legal monopoly granted by the patent is the only mechanism that allows the producer to recover those fixed costs, for without it new competitors could produce the same generic compound at a fraction of the price, driving the first drug out of the marketplace.’”

7:36 pm on July 24, 2003

Re: Cato on Drug Reimportation

A follow-up to this post: Cato’s News Release dated July 29, 2003 proclaims its free-trade stance, despite columns advocating protectionism by two of its scholars:

Cato scholars support drug reimportation

“WASHINGTON—Cato Institute President Edward H. Crane and Vice President for Legal Affairs Roger Pilon make the case for the prescription drug-reimportation bill passed by the House late last week in an op-ed published today in National Review Online. Addressing an issue that has split many conservatives and libertarians, Crane and Pilon argue that the principle of free trade and reliance on free markets support the reimportation of prescription drugs into the United States. The new policy can result in more market-based prices, increased price competition, an easing of prescription drug barriers and lower prices for gouged American consumers.”

What is interesting is the comment that this is “an issue that has split many conservatives and libertarians”. A “split” among libertarians on this issue? Really? I am unaware of any libertarians, other than the two Cato columnists themselves (Bandow and Krauss), who don’t view this as an “easy” issue.

10:24 am on July 30, 2003

Epstein and Patents

Re Lew Rockwell’s latest post about Richard Epstein’s pro-patent comments–Epstein writes, “‘Patented goods are subject to a lawful monopoly created by the state in order to induce their creation. No one thinks that new pharmaceutical drugs will be invented by private firms that cannot receive a rate of return sufficient to recover [various costs]. … ‘The legal monopoly granted by the patent is the only mechanism that allows the producer to recover those fixed costs….”

Obviously, this is a utilitarian argument; Austrians and libertarians are well aware of the economic and ethical problems that plague utilitarianism. But besides this, another problem with Epstein’s argument is that there is no logical stopping point. For it is not that “drugs” either will, or will not, be produced. By Epstein’s logic, there will still be some drugs that will not be produced, namely those whose cost can’t be recovered even with patent profits. The current patent term is about 20 years. If it were longer, more monopoly profit could be obtained, thus allowing more drugs, currently not produced, at the margin, to be profitable. So let’s extend the term to 30 years. Or 40. And so on. But why stop there? Why not impose criminal liability for infringement of patent rights–say, life in prison or the death sentence. We could also lower the statutory standards for obtaining a patent, so that more drugs would be subsidized by the patent monopoly. We could triple the budget and salaries for the Patent Office, so that patents are issued more quickly (they take 2-3 or more years, now).

What’s more, even the strongest patent rights in the world simply might not give enough extra profits to justify the generation of some “really useful” drugs. So by using the standard utilitarian reasoning underlying Epstein’s advocacy of patent law (and also undergirding his defense of the power of eminent domain in his book Takings), why not let some administrative commission dole out taxpayer-funded subsidies to the pharmaceutical industry. Yes, taxpayers would be harmed (just as private property owners are harmed by patent law–as the drive to outlaw reimported medicines attests), but drugs that would not otherwise be invented, would be. Presumably the “value” of these drugs would “exceed” the “value” (to whom?) of the money taken from taxpayers.

I better shut up. They might not realize I’m being sarcastic.

More on Cato’s Protectionism

Cato’s incredible advocacy of pharmaceutical protectionism is especially ironic in light of the fact that Bill Niskanen is chairman of Cato precisely because of his free trade credentials. Around 1980 he was fired as chief economist for the Ford Motor Company because he refused to endorse automobile industry protectionism. He became quite the hero to free marketeers, especially Ed Crane. I wonder if he’ll do the same now and resign?

Last week a Cato fellow went on television and advocated military intervention in Liberia. This week it’s pharmaceutical industry protectionism. What’s next — a plea to raise taxes?

(Thanks to Bruce Bartlett for reminding me that it was Ford, not GM, that fired Niskanen).

Re: Richard Epstein and Drug Patents

Posted by Jim Grichar at July 25, 2003 08:37 AM

Epstein and CATO apparently have not thought seriously about what would happen to the pharmaceutical industry and to its r&d; expenditures if patent protection were ended. While r&d; expenditures might decline in the short run, in the intermediate – long run r&d; would rise as new smaller firms entered the market to challenge the few mega-drug firms that use the patent monopoly as a barrier to entry into the industry. With the entry of new smaller firms, r&d; per firm would be focused tightly on areas where a firm could bring a new drug to market profitably before competitors copied it. And enhanced competition would bring drug prices down sharply.

Epstein also apparently ignored the FDA role in delaying even patented drugs from entering the market, a factor that significantly raises the r&d; required to bring a drug to market – the opportunity costs of all that capital tied up in a product that cannot be quickly brought to market are staggering. This factor is an extremely serious barrier to entry for new smaller firms.

As I argued in LewRockwell.com several months ago, the FDA should be totally abolished. In its place, a system of private drug testing organizations would spring up, much like the renowned Underwriters Laboratories. Competitive drug evaluation, combined with liability insurance and the potential for product liability lawsuits would yield faster approval and earlier sale of new drugs. It would encourage new and smaller startup drug firms to enter the market. Competition, not monopoly, would increase the number of useful drugs on the market, increase the quality of those drugs, and reduce the price of those drugs.

Despite complaints from the mega-drug firms about the lengthy FDA approval process, they all know that it is a significant barrier to entry into the industry, and not a one has ever called for its abolition.

Couple abolishing the FDA with reduced or eliminated patent protection and you would see a booming and rapidly growing drug industry no longer dominated by a few mega-firms.

Anderson gives a clueless take here:

Bandow, Cato, and Drug “Reimportation”

I guess that I am reluctant to pile onto Bandow, given I do not know all of the story, and Bandow has written some good things over the years.

As for the “reimportation” debate, it was a fraud all along. The idea that the U.S. could somehow “reimport” drugs from Canada was a non-starter, as it fed upon the fallacy of costs determining prices. (I am surprised that so many people who say they are of Austrian bent fell for this one.) Second, if drugs are shipped out of Canada, then there are fewer drugs left for Canadians, which would mean massive shortages, given that the Canadian government would have kept the same price controls that make drugs artificially “cheap” there in the first place.

I’m not familiar with Bandow’s line of argument on the “reimportation” issue, but I would hope that people understand that this never was a viable option in the first place, so to condemn Bandow for being against this stupid idea is pretty lame, in my book. I do not think that Bandow was being “protectionist” in the classic sense, and I am reluctant to accuse someone of “protectionism” when they have made a career of standing for free trade.

Again, I think that Bandow has written some good things over the years, and it bothers me terribly to see people exulting in his present difficulties.

6:19 pm on December 17, 2005

 

***

See also this Econtalk episode: Richard Epstein on Property Rights and Drug Patents Feb 19 2007 “Richard Epstein of the University of Chicago and Stanford University’s Hoover Institution talks about property rights, drug patents, the FDA, and the ideas in his latest book, Overdose: How Excessive Government Regulation Stifles Pharmaceutical Innovation from Yale University Press.” [actually it’s Epstein’s review of John Calfee’s book]

Update:

Why the Beltway Loves Libertarians

If you want a protectionist argument made, so much better to get a free-trader to do it. Here Cato’s Doug Bandow opposes free trade in pharmaceuticals.

Are American drug prices “free market”? Well, they are, given the anti-competitive FDA, so beloved of the pharmaceutical industry; the anti-competitive patent laws, so beloved of the pharmaceutical industry; and the vast, artificial stimulus to demand from Medicare, Medicaid, and a hundred other welfare programs, so beloved of the pharmaceutical industry.

I could also mention Bush’s $400 billion drug benefit (the vastly understated official cost) and his $15 billion drug benefit for Africa, both written and pushed by the Republican pharmaceutical industry.

Dick Armey’s Republican thinktank, which paid for this NRO article, gets drug money, and on his last day of Congress, he bragged to a friend of mine that he was “starting at $1 million a year as a lobbyist.” Gee, what industry might be among his clients?

re: Protectionist Cato?

Writes Casey Khan: “I guess there was no invention before the US patent office opened.

“Cato adjunct scholar Richard Epstein writes: ‘Patented goods are subject to a lawful monopoly created by the state in order to induce their creation. No one thinks that new pharmaceutical drugs will be invented by private firms that cannot receive a rate of return sufficient to recover not just the cost of fabricating and selling each pill, but also the huge front-end costs that reach (when dead ends are taken into account) under anyone’s estimate in the hundreds of millions of dollars for each new product that reaches the market.

“‘The legal monopoly granted by the patent is the only mechanism that allows the producer to recover those fixed costs, for without it new competitors could produce the same generic compound at a fraction of the price, driving the first drug out of the marketplace.’”

7:36 pm on July 24, 2003Email Llewellyn H. Rockwell, Jr.

Demonizing Those Who Cure Us

“There’s no question that prescription drugs cost too much in this nation,” claims Sen. Jim Jeffords (I., Vt.). He offers no evidence to back his claim, but many Americans agree with him. So do many legislators at the state and national levels, who are pushing a variety of measures to control prices, restrict use, and limit patents.

Among industrialized states, only America offers a reasonably free market in drugs. This offends socialist Rep. Bernard Sanders (I., Vt.), who complains that “in Vermont and all over the United States, alone among industrialized nations, the drug companies can charge any price they want for their product — no matter what the consequence.”

In response, Rep. Tom Allen (D., Maine) would limit U.S. prices to an average of those sold overseas. Some state legislators also have suggested restricting local prices to those overseas, particularly in Canada.

More seductive, however, is the idea — already approved by the Senate — to allow reimportation of American drugs from foreign nations. The proposal, which the House Republican leadership is bringing to the floor this week to pay off Rep. Jo Ann Emerson (R., Mo.) for her vote for the budget-busting Medicare drug benefit, is advanced even by some traditionally free market politicians. Many drugs are cheaper in other countries, most famously Canada and Mexico, so let Americans buy their pharmaceuticals abroad. What could be a better example of “free trade” in action, they ask? “Let’s open markets now,” argues Rep. Gil Gutknecht (R., Minn.)

In fact, reimportation is designed more to import foreign regulatory regimes than necessary medicines. Full reimportation would mean Canadian-style, or even Mexican-style, prices in the U.S. That, in turn, would mean Canadian-style or Mexican-style access to drugs in the U.S.

No discussion of pharmaceuticals is meaningful without remembering the benefits of drugs. Are medicines too expensive? Saving lives, improving health, enhancing quality of life, eliminating the need for hospitalization and surgery — these benefits are all worth paying for. “Three decades ago medical technology was rather primitive by today’s standards,” writes Dr. E.M. Kolassa of the University of Mississippi School of Pharmacy. “Today, physicians have at their disposal medications and technologies that provide for the immediate diagnosis and treatment of most of the disorders that affect modern man.”

Nevertheless, complains Elizabeth Wennar, spokeswoman for the Coalition for Access to Affordable Prescription Drugs, Glaxo, which has cut off Canadian pharmacies supplying American customers, cares nothing for “the quality of care and well-being of seniors who cannot pay the exorbitant American prices for their life-saving drugs.” That’s a strange charge, given the fact that Glaxo created these life-saving drugs in the first place. And they would not have been developed but for prices high enough to cover the R&D costs of failures as well as successes.

But, complain industry critics, drugs cost less in foreign countries. In their view, then, companies obviously are gouging Americans. So let people buy the same products overseas.

However, international comparisons must be viewed with skepticism, since there is no “correct” price. Prices abroad generally reflect the lower incomes in some states and the highly politicized nature of most foreign health-care systems. Exchange-rate variations also matter: for years America’s relatively strong dollar made drugs overseas seem particularly cheap.

Patricia Danzon of the Wharton School also points to issues of patent protection, price controls, and continuing availability of prescription drugs without prescriptions. After adjusting for such factors as well as the role of generics (which are less important overseas), volume discounts, and frequency of use, she and Jeong Kim found, using 1992 data, “that the average U.S. consumer would have paid 3 percent more in Canada, 27 percent more in Germany, 30 percent less in France, 9 percent less in Italy, 8 percent less in Japan, 44 percent more in Switzerland, 9 percent more in Sweden, and 24 percent less in the U.K.”

Consider Canada. Canada’s economy has suffered in recent years, with the currency losing nearly a quarter of its value over the last decade. (Even worse is the Mexican economy; poor people in poor countries have less money to spend on everything.) As a result, many goods are cheaper in Canada than in the U.S.

Even so, Canada is no bargain. Dr. John Graham, director of the Pharmaceutical Policy Research Center at Canada’s Fraser Institute, and Tanya Tabler, a student at the Faculty of Pharmacy at the University of Alberta, recently surveyed prices on both sides of the border. Although costs were lower in Canada, Graham and Tabler observed that given price differences within countries, “a shopper can save almost as much money by bargain hunting within his own area as by crossing the border.”

There’s an even more important issue. The Canadian national and provincial governments restrict prices and access, with predictably negative consequences for the sick. Pharmaceutical controls have sharply reduced Canadian access to needed drugs. Provinces wait months or years before adding medicines to their formularies. Unfortunately, explains Canadian Dr. Bill McArthur, in the province of British Columbia more than a quarter of doctors report that they have had to treat or even hospitalize patients because of government substitutions of medicine; six of ten have seen their patients’ condition deteriorate.

Similar is Europe’s experience. European countries have been left with anemic drug industries. Europeans also have far less access to prescription drugs, particularly newer, more effective products.

The research group Europe Economics found that patients often wait years for access to even life-saving new medicines. Incredibly, the more useful the product and the more people to be helped, the smaller likelihood that European governments will quickly approve it. Explained Europe Economics: countries “facing tight budget constraints will be more resistant to a given price demanded by a company the higher they expect the demand for the product to be.”

Reimportation is an all-around bad idea. Allowing foreign suppliers to meet domestic demand would disrupt company distribution networks and preempt firm restrictions on product resale.

Moreover, reimportation creates safety problems, depending upon who is reselling what to whom. Reimported Mexican drugs have killed consumers; the Royal Canadian Mount Police warn that pharmaceutical conterfeiting up north is an “epidemic.” After years of neglect, the Food and Drug Administration has begun targeting pharmacies which promote reimportation.

Most important, however, reimportation, no less than attempting to equalize prices internationally by legislative fiat, would effectively apply foreign price controls on the American market. This is, in fact, the policy’s objective.

Explains Sen. Byron Dorgan (D., N.D.): “It is not my intention to have the American people go to another country for their drugs. It is my intention to force the pharmaceutical industry to reprice their drugs here in the United States.”

Rep. Sanders is even more explicit: “it is likely that the day after reimportation passes, the pharmaceutical industry will lower their prices in the United States to the same level that they sell their products worldwide.” But why stop at Canada? Mexico has lower prices. Or, better yet, look to Congo or Afghanistan, known hotbeds of pharmaceutical research.

The situation obviously is not fair to Americans. However, U.S. citizens are not paying higher prices to subsidize foreign consumers. Pharmaceutical companies base their prices on local supply and demand. As long as they can cover the marginal cost of marketing an additional pill overseas, they will do so; they will not sell at a loss overseas no matter how profitable the domestic market. And if they could charge more in the U.S. they would do so, irrespective of foreign opportunities. National markets operate independently of one another.

In practice, uniform international prices would be impossible to maintain. Exchange rate vagaries would quickly create price differentials. Trying to maintain uniformity would not only be administratively difficult; it would be economically suicidal, since no business can ignore the economic conditions of the market within which it is selling.

Indeed, forcing firms to choose between sales in the U.S. and foreign nations would encourage drugmakers to stop selling overseas rather than dump drugs at distress prices in America, their largest market. Overseas customers would have access to fewer medicines; U.S. manufacturers would lose sales and revenue; Americans would bear an even greater relative burden of global R&D expenditures.

Thus, reimportation could work only by forcing companies to sell to foreign retailers at lower prices. For instance, Glaxo is cutting off Canadian pharmacies that ship south of the border to prevent reimportation. Which is why Americans hoping for a free, or at least a reduced cost, lunch are so upset. They really want regulation. Reimportation does not reflect free trade; it is the antithesis of free trade.

Pharmaceuticals are expensive. So Congress should “take a stand for affordable prescription drugs,” says Rep. Gutknecht. But doctors’ visits, heart-bypass operations, cancer treatments, and hospital stays also are expensive. Before Americans complain about the price of drugs, they should remember the benefits they are receiving.

Nor is reimportation an answer to rising pharmaceutical costs. In the name of free trade Washington would join other countries in confiscating the wealth of drugmakers. Companies might have little choice but to continue providing their existing wares for less. Firms would not, however, have the same incentive to make new medicines. Which means future Americans would live shorter, more sickly lives. For there are no foreign markets off of which Americans could free ride.

— Doug Bandow is a senior fellow at the Cato Institute and the author of The Politics of Envy: Statism As Theology. This is adapted from a study for the Institute for Policy Innovation.

DOUG BANDOW is a senior fellow at the Cato Institute. A former special assistant to President Ronald Reagan, he is author of Foreign Follies: America’s New Global Empire and Beyond Good Intentions: A Biblical View of Politics.
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