Why Milton Friedman Rightly Opposed Drug Re-Importation

Milton Friedman

by Phil Kerpen, Contributing Author: Is government-facilitated re-importation of prescription medicines from Canada – a policy now supported by politicians as diverse as President Donald Trump and Senator Bernard Sanders – an issue of free trade, or a backdoor method of imposing price controls? That's the way the question is usually framed in policy debates, but the great Nobel prize-winning economist Milton Friedman took a third view.

"The issue is patents," Friedman explained in a 2004 interview with Jim Glassman that can now only be found in the Internet Archive. "The issue is a government-granted monopoly and whether that, how extensively the rights that are granted for that purpose extend. The real issue is not really re-importation. The real issue in my opinion is the Food and Drug Administration. The FDA in the United States has followed policy, which means that it costs roughly $800 million to bring a single new drug entity to the market."

That figure has only climbed since, and now stands at over $2.6 billion according to a widely cited estimate from Tufts University that itself is now a few years old and therefore likely a lowball.

"And the question is where is that $800 million going to come from?" Friedman continued. "The answer we have given is that it's going to come by giving the producer of the drug a patent, a monopoly privilege to sell that drug, to exclude others from the sale of that drug. And the question is, are you going to enforce that exclusion? The only way in which that $800 million can be raised is by charging very high prices to some people. Now, the question is given that you're charging those high prices to some people, is it okay to charge low prices to some people? This is a standard case of a monopoly which engages in price discrimination as a way of maximizing its income. It charges high prices where the elasticity of demand is low, it charges low prices where the elasticity of demand is relatively high to the citizens of other countries."

In other words, the company that invests the exorbitant cost of developing a new drug is incentivized to do so by the prospects of securing a United States patent that will exclude anyone else from selling the drug in the United States for a period of time. That exclusive right provides the mechanism for the innovator to recover the cost of developing the drug and return a profit to its investors. When foreign countries, including Canada, suppress prices through government price control policies, drug companies may still choose to sell at those lower prices to maximize their income.

While higher prices abroad would incentivize more research and development and more cures – and we should continue to work hard in trade negotiations to loosen price controls abroad – as long as foreign governments set prices above marginal cost, it is in the interest of drug companies to take the additional profit on top of their main business in the U.S. market. And it is their right, as patent holders, to do so.

Friedman used a thought experiment: "Consider the following case: Suppose somebody in Canada simply counterfeits a patented drug. Does free trade require that the US accept importation of that drug? I think the answer's no, if you're going to enforce the patent, you have to keep out such counterfeits. Well, fundamentally and from an economic point of view, essentially when drugs that are purchased in the United States under a contract that they will be sold in Canada, or instead shipped to the United States, that's the same thing. That's violating the patent law."

"There's no denying the fact that prices are cheaper in Canada. But the purpose of the law, the purpose of the patent was to enable the patent owner to make enough money to pay for the cost of producing the drug. And that's not going to be possible unless you have price discrimination. And price discrimination adds to human welfare, it permits a larger number of people around the world to have the drug than it could otherwise do so."

Moreover, the drug companies would not be obliged to export unlimited quantities of their patented medicines to Canada that would then be shipped back to the United States, competing with their products as a lower, Canadian-government-set price. They would almost certainly restrict supply into the Canadian market or cease sales entirely to prevent undermining their pricing power in the American market. Which means the potential loss of Canadian sales, a reduced return on capital overall, and upward, not downward pressure on U.S. prices. And the excess supply in Canada available for the U.S. market would therefore – despite whatever protocols are in place to assure safety – consist largely of counterfeits.

As the great law and economic scholar Richard Epstein put it in a 2003 essay that likely influenced Friedman: "reimportation is just a costly way (two shipments, not one) to avoid a price discrimination regime that is legal and proper under domestic law. It will not do for American law to let foreign pricing practices dictate our own pricing strategies. Banning parallel imports, alas, does not supply any remedy to the persistent problem of foreign free riding on American innovation, when foreign governments use their sovereign power to limit price freedom in their own countries. The only way to counter that misguided effort is through tough trade negotiations."

It's still true.
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Phil Kerpen is president of American Commitment. Follow him at (@kerpen) and on Facebook. He is a contributing author at the ARRA News Service.

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