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Wednesday, August 11, 2004

Libertarian Babble about Drug Patents and Reimportation

Via blogger prodigy Matthew Yglesias, I learn that the libertarian Cato Institute favors allowing drug reimportation. I favor it too, as a way of sticking it to the wealthy countries with national health insurance systems. These countries free ride on R&D financed by U.S. consumers of high cost drugs. Widespread drug reimportation would make it harder for pharmaceutical companies to sell cut-rate drugs to national marketing boards, since price cuts overseas would result in cheap drugs in the U.S. too. The result would be cheaper drugs for us, and more expensive drugs for them. Allowing reimportation might even increase drug company profits, by strengthening their bargaining position relative to national drug purchasing boards in Canada and Europe. So drug companies would have more funds and more incentives for drug development.

So I read the Cato report, assuming that it would support my position, and expecting to grudgingly praise it. It turns out, though, that Cato doesn't really support drug reimportation. They just don't want the government to ban it. It's fine with them if pharmaceutical companies ban reimportation or resale. (The report acknowledges that this would require changing U.S. law and the laws of dozens of foreign countries to allow such bans, so it's hard to see what Cato's point is, other than wishful thinking about increasing corporate power).

Worse, Cato's report is incredibly shoddy: it veers back and forth between loopy libertarian arguments (abolish the FDA, allow all "voluntary contracts," etc.) and economically illiterate arguments. The silliest economic argument is that lengthening the life of a patent will lower the cost of drugs:
"The shorter the time the company has to recoup its extraordinary R&D costs, the more it will need to charge per unit sold," asserts Cato analyst Roger Pilon, hence longer patents "would enable the company to recoup those costs over a longer period of time, and, presumably, charge less per unit sold during that period." [pp. 3-4]
Patents were lengthened, from 14 to 20 years, not so long ago. So one might think Cato would offer some evidence. But of course they don't.

The report provides no serious answer to the obvious objection: profit-maximizing firms should ignore sunk costs. The R&D costs are in the past: setting a low price today doesn't affect past costs, so R&D costs don't affect pricing decisions. The cost of production affects pricing decisions, but sunk costs don't.

Assuming production costs are small and constant, companies just look at demand and choose the revenue-maximizing price. If that price doesn't recoup the investment, firms aren't going to raise the price and reduce their revenue! If that price earns them terrifically high profits, way above R&D costs, most firms will happily bank the excess profit. They aren't going to reduce prices so that they just barely cover their R&D costs, as Cato seems to imagine. Really, this kind of analysis is a staple of introductory economics: it's pretty pathetic that Cato's "vice president for legal affairs" doesn't understand it.


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