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The U.S. pharmaceutical industry is under attack. Special interest groups and politicians rail over what they say is unconscionable profiteering. Is this fair criticism of an industry that has brought to market so many revolutionary drugs to fight illnesses such as heart disease, cancer and AIDS? Or is it simply politics mixed with a dose of economic illiteracy? The United States is, after all, the only country in the world where drug prices remain largely unregulated. Cries over unfair drug prices are about to be answered: New laws, in the form of direct price controls or legalized reimportation from price-regulated markets such as Canada and the European Union, appear to be on the horizon. The Senate likely will pass a reimportation bill this year. On June 2, Senator Judd Gregg, R-N.H., introduced S. 2493, to amend the Federal Food, Drug and Cosmetic Act and legalize pharmaceutical reimportation. The issue of reimportation is not new. Prior bills allowing reimportation became law as early as 2000. But they contained a provision requiring the secretary of Health and Human Services to certify that imported drugs will pose “no additional risk” to consumers. So far neither the Clinton nor Bush administrations have been willing to endorse such a claim, thus reimportation has remained illegal. Neither S. 2493 nor H.R. 335 (approved by the House in July 2003) contain such a “poison pill” provision. While legalizing reimportation may be inevitable, it might not generate the cost savings proponents expect. If so, direct price controls will surely follow. Indeed, the passage of the 2003 Medicare Modernization Act will soon result in the U.S. government having purview over more than half of this country’s drug expenditures. The pressure to regulate drug prices will be enormous. It appears as if price-regulated drugs, either through reimportation, direct price controls, or both, will soon be inevitable. But will reducing drug prices be in our best national interest in the long run? Or will it only serve to appease the special interest groups in the short run? If it is the latter, the costs and consequences will not be felt immediately, or even in a few years; the consequences will be felt many years into the future, by generations of Americans who will not benefit from the pharmaceutical innovations that might have been. For example, instead of having a cure for Alzheimer’s in 10 years, we may have to wait 30 years. This is because under a system of price controls (or legalized reimportation) firms will reduce investment in research and development (R&D). Other business investment opportunities will become relatively more attractive, and resources will flow out of pharmaceutical R&D activities. This is basic Econ 101. A future of reduced R&D But exactly what would this mean for America? Less R&D (and more of something else) is not automatically a bad thing. It depends on the value of what is given up (R&D) and the value of what is gained (something else). A tradeoff exists between short-term access to today’s medicines and the rate of innovation tomorrow. In economic jargon, this is referred to as the tradeoff between static inefficiency costs (limited access to today’s medicines) and dynamic inefficiency costs (limited incentives for research and development). The delicate balance between these two types of costs is what the U.S. patent system tries to strike. It does this by awarding limited-term patents and letting firms price their products freely. In political speeches, however, dynamic inefficiency costs are seldom given the same consideration as static inefficiency costs. This failure to recognize the tremendous value of pharmaceutical innovation will almost certainly lead to policies that impose costs on our economy and on our citizens that greatly exceed the short-term benefits of lower drug prices. This is because recent economic research suggests that the United States may already be underinvesting in pharmaceutical and medical research (the rate of drug innovation and its contribution to the health of Americans over the past few decades has been staggering). Reducing R&D through price controls or reimportation would take us even further in the wrong direction. Yet critics of the industry maintain that less R&D would be OK if it meant cheaper drugs today. They do not have the evidence on their side. Instead, they have something far more powerful: political myopia. Political myopia persists because politicians rely on today’s voters to win re-election. Election cycles are short-term, whereas the pharmaceutical R&D process is more long-term (the average drug takes more than 14 years to bring to market). Also contributing to the myopia is the fact that the benefits of regulated drug prices are easy to appreciate and measure: We know how we might spend $20 saved on a prescription. It’s harder to do that with future costs. What will we, our children and grandchildren, have to give up in the future so that we may save the $20 today? A cure for cancer? It’s an inherently more difficult question. And no politician-assuming he’s still around- will be held accountable in the future for what might have been developed had he or she not voted for legislation controlling drug prices “way back when.” In a series of recent research studies by myself and colleagues, we have estimated the present-value costs to the U.S. economy of drug-price regulation or legalized reimportation to be in the trillions of dollars. Clearly, caution is called for before such legislation is passed. John A. Vernon is a professor of finance in the School of Business at the University of Connecticut. This article is adapted from his testimony before the U.S. Senate Committee on Health, Education, Labor and Pensions on May 20 and in part from research conducted with his university colleagues Carmelo Giaccotto, Joe Golec and Rex Santerre.

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