Tuesday, August 25, 2009

Vitter-nomics



At a recent town hall meeting, Sen. David Vitter, tried to rationalize his free-market views with his seemingly hypocritical support of reimportation of drugs from Canada and other countries with price controls.

Why is Sen. Vitter's position hypocritical? Drug prices are lower in Canada than in the U.S. because Canada has the decidedly anti-market policy of imposing price controls. In Sen. Vitter's view, it's okay for U.S. consumers to benefit from price controls, so long as some other government applies them.

Rather than admit this hypocrisy, however, Sen. Vitter argues that the reimportation policy is really a means of making the system of price controls collapse.
My ultimate goal in terms of reimportation is causing that system to collapse.
Sen. Vitter tries to make an economic argument that consumers in the U.S. and other countries without price controls are subsidizing drug costs in countries with price controls. He says that if you cause the price control system to collapse, forcing people in other countries to pay more, subsidies here would end and drug prices here would decrease. However, there are a number of problems with the Senator's logic.

First, suppose that price controls in other countries did collapse. A profit-maximizing firm is going to charge the highest price that it can in each market given the demand it faces, its production costs, and any regulations in those markets. If we ignore the possibility of reimportation, eliminating price controls in other countries doesn't affect the conditions in the U.S. and shouldn't change firms' pricing behavior here. If we account for reimportation, a collapse in price controls might actually lead to an increase in demand in the U.S. market causing prices here to go up.

Second, in supplying an existing drug, a firm is constrained by its marginal costs. Most of the cost in supplying a drug is the up-front development cost. For drugs that have already been brought to market, the marginal costs of each additional pill or shot are miniscule. Firms are able to charge well in excess of their marginal costs for new drugs because they get patent protection which gives them a temporary monopoly. Monopolies can be regulated down to their marginal costs. If we assume that the price controls exceed the firms' marginal costs, there would be no collapse (there might actually be an increase in supply if regulators managed to find the competitive price).

Where things could collapse is in the development of new drugs. Removing the excess monopoly mark-up that drug companies could charge would reduce the incentives for new drugs. So, the "cost" of a reimportation policy is reduced innovation.

For those of you keeping score, Sen. Vitter has now shown that he's willing to abandon his free-market principles and his family values. That doesn't leave him many conservative virtues to fall back on.

1 comment:

Pino said...

I wonder how many drug companies rely on the US market to overcome their "cost to market" costs in order to be able to sustain the price controlled markets elsewhere.

That is, speaking directly to your third point. Innovation would suffer.

Remember, it was the uber-wealthy who, years ago, could afford a DVD player that today can be purchased for 20-30 bucks. Is it fair to Joe citizen when they cost $800? Maybe not, but the whole of creation now benefits because of it.