National Symposium on Drug Importation: A Canadian Economist’s Perspective

Published November 18, 2003

It’s a pleasure and privilege to be here. I’ve done a lot of speaking in the U.S. on this issue because it’s an issue of such concern. I hope I can keep everyone’s attention. The Blue Jays actually won the World Series a few years ago, but I guess those days are long gone. So this is the best Canadian entertainment you get nowadays.

The Fraser Institute is a nonprofit charitable organization that does economic and social research on competitive markets and government intervention. We are broadly similar to The Heartland Institute, I believe, in our approach. This issue, which we call exportation to the American market, poses a threat to Canadians, as Professor Entin described. That’s one reason we started looking at it.

I think we have a relatively elite audience here, which in a way is unfortunate. I’m glad we’ve got some media here too. But I’d like to shape my remarks such that they will reach the ears and influence the thoughts of ordinary Americans and residents of Illinois.

The problem here is politicians face terrible incentives when regulating the prescription drug market. Many of you will know that politicians have had negative consequences on the rest of the American health care system, and now they’ve set their eyes on prescription drugs and threaten to screw that up, too.

I remember a couple of years ago I was trying to understand the idea of term limits, because we don’t have that in Canada, and it was explained to me. And I said, that’s all wrong. You don’t need a term limit; you need term minimums. Someone who is elected should have to serve for 30 or 40 years so he suffers the consequences of his actions.

In any democracy with an aging population, the easy political money to coin is to go after the votes of seniors. Reducing prescription costs is one obvious tactic, and you will not see the long-term, negative impact on innovation for 15 or 20 years. So the astute politician really can get away with it. So this message has to go to ordinary people so they can discipline their politicians and hold them accountable, so that stunts like reimportation are not put forward as a real solution to an important public policy problem.

Importation has not become as big an issue in Canada as it is in the United States, but it is becoming a bigger issue because at least five major pharmaceutical manufacturers have said they will stop supplying the Internet pharmacies that are shipping drugs across the border to the United States. One provincial government in Canada, Manitoba, has the cockeyed notion that it is an effective industrial policy to have warehouses that ship prescription drugs to the United States. Manitoba has decided this is an export industry, not realizing it is an industry that is not sustainable, as Professor Entin alluded to and as I will describe a little bit later in my presentation.

Other Canadian provinces and the federal government so far are agnostic; they haven’t quite thought their way through this. One of the reasons I wrote a paper on this subject (1) was to give some suggestions to the Canadian and other provincial governments as to how they should approach this threat to the Canadian drug supply.

Need a Focused Solution

I understand that many Americans are angry about high prescription drug prices, but let’s not forget that the average American senior spends more on alcohol, tobacco, and entertainment than on prescription drugs. The number of people who are making the trade-off between groceries and paying the rent and filling their prescriptions is very small.

Recently published research from the Medicare Current Beneficiary Survey from 1996 to 1999 found that less than 3 percent of the beneficiaries in that survey did not get the medicines prescribed to them. And of that 3 percent, not all who chose not to fill their prescriptions did so because of a financial burden. So you do have a small number of people who are really struggling, and you have to focus a solution on that small number.

One thing I want to bring up that hasn’t been addressed by other speakers is why price differences exist between Canada and the United States, and between the United States and other countries. One element that has been mentioned is regulation. Every country has significant government intervention in their prescription drug market, and it looks different in different countries, but those interventions obviously affect prices. For example, in Canada, it takes 39 weeks longer at the median to approve new prescription drugs. So the new whiz-bang drugs that are getting approved in the United States just aren’t available for sale in Canada.

Another reason Canadians spend less on drugs is that Canadians are poorer than you are in the United States. And when you look across borders, countries that have higher incomes tend to pay higher prices for pretty much everything than countries with lower incomes. That’s not true for many commodities; gold and oil, for example, are the same price everywhere in the world. But as you go down the chain to more developed, differentiated products, you see significant price differences.

The American worker is about one-third more productive than the Canadian worker. Over the years, the Canadian dollar has dropped in value, taking Canadian prices down too. Automobile manufacturers have a problem similar to the problem drug manufacturers have. There’s currently a lawsuit, more than one lawsuit I think, in the United States where dealers are reimporting automobiles from Canada to the United States to take advantage of the retail price difference between Canada and the United States.

A couple of years ago I compared prices for a number of goods across the border. Quicken Basic financial software, which many of you probably have, was 70 percent more expensive in the United States. AOL monthly Internet service was 40 percent more expensive in the United States.

It is important to keep this in your mind as you’re thinking this problem through because there’s no significant difference in government regulations or intervention that influence the relative price of financial planning software or Internet service provision in Canada and the United States. This shows that even if you got rid of all the regulatory differences between Canada and the United States, you would still have significant price differences.

Trade Issues

Another element I want to touch on is free trade versus parallel trade. Now, I don’t know the audience very well. Maybe none of you give a hoot about free trade as an idea, but I do. I think free trade is a very important idea. Reimportation has confused a lot of people, including many conservative Republicans and a host of Representatives. There’s a congressman from Texas, Ron Paul, who’s a really good guy but he’s all wrong on the reimportation issue because he’s confused reimportation with free trade.

Free trade relies on the voluntary cooperation of all parties. You cannot force a manufacturer to act in the long term against his own interests. Free trade means that Pfizer, an American company, can sell Viagra around the world. It means that GlaxoSmithKline, a British company, and Bayer, a German company, can team up to produce a competing product, Levitra, and sell it throughout the world. I just saw an advertisement last night on TV for Levitra. That’s free trade.

Free trade means allowing companies to set their own prices and enter into voluntary, negotiated, enforceable agreements with wholesalers and pharmacies regarding the prices they may charge for the product. Reimporting drugs renders these agreements unenforceable, thereby leading to a reduction in international trade because it gives manufacturers an incentive to reduce international engagements and investments.

As Professor Entin alluded to, we’ve got an $8 billion market, you’ve got a $155 billion market. The manufacturer’s incentive is to make the problem go away by restricting supplies to the Canadian market. Domestically I recommended that our Canadian law should counter that threat by ensuring that the manufacturer, when he sends a drug to Canada for use by Canadian patients, the contracts that manage that distribution are enforceable under Canadian law. And that’s what I’m trying to do back home, because the last thing we need is for the drug makers to make the problem go away by reducing their supplies to Canada.

There are also important implications of parallel trade for intellectual property. Patents are national laws. Pretty much every drug has a different patent term in Canada than the United States. Sometimes the patent in the United States expires earlier than the patent in Canada, and sometimes the patent in Canada expires earlier than the patent in the United States.

When Mrs. Clinton was running for the Senate in her 2000 campaign, she had a list of prescription drugs that were significantly cheaper in Canada versus the United States. One of those drugs was tamoxifen, which at the time was patented in the United States. I believe the patent just expired a few months ago in the United States. But it has long been off patent in Canada.

By advocating that Americans buy Canadian tamoxifen, she was by implication saying that the U.S. patent–I believe Nolvadex is the brand name–was invalid. I doubt she had thought that through, since it implies that U.S. patent law should always be subordinated to patents in other countries that offer weaker protection, or protection for shorter periods of time. Because some countries are notoriously lax in defending patents, she should have come out and said we shouldn’t have patents on prescription drugs at all.

Without patents, as Professor Entin has said, it is unlikely the U.S. would have the level of investment in research and development required to address people’s needs in the future for new prescription drugs. So when you say you favor reimportation, you are saying in effect that you do not like U.S. patents. If that’s your issue, then you should come out and address that issue directly instead of coming at it through the back door.

Safety Implications

In terms of safety, drug manufacturers have strong incentives to play a significant role in preventing counterfeiting, other types of fraud, and activities that threaten the integrity of the distribution chain that connects his factories to his customers. But they only have that incentive if you allow them to manage the distribution chain and to keep the markets differentiated. If you say to the manufacturer it is against the law for him to have input into the distribution chain, and it is against the law for him to profit from managing the distribution chain, then the manufacturer loses all interest, or a significant amount of his interest, in combating the counterfeiting problem.

The amount of government intervention and its cost to substitute for the manufacturer’s interest in managing this risk would be huge. There is simply no way you can inspect every pill that comes across the border. To a large degree, I believe, most of the testing has to be destructive anyway, so the medicine you test it is not available to consumers anyway. And counterfeiters know how to salt their lots so if there’s a sample, the sample will go through. There are a lot of issues here that you really cannot manage without an immeasurably high level of government intervention, once you remove the manufacturer’s incentive.

As a reminder, just to make clear, Health Canada has quite clearly said it has no role to play in the safety of these parallel traded drugs. The Washington Post has reported this, and published a letter from Health Canada on May 1 in which Health Canada officials affirmed they would not and could not ensure the quality of drugs exported to the U.S. So it is definitely a gray market in Canada and a black market in the United States, since it is explicitly illegal in the United States.

Regulation and R&D

The alternative to importing cheaper drugs from other countries into the U.S. is to lower the cost of producing and selling drugs here. I sometimes say the U.S. government, not drug companies, must stop gouging patients. As the state senator mentioned earlier, there’s a lot of clinical testing required by legitimate manufacturers that may be overkill. I believe I quote Senator Rauschenberger correctly when he said, “We make the manufacturers spend hundreds of millions of dollars.” So as citizens you’ve got to think of that and what your legislators are doing.

There’s only one business in the world where the length of the patent is a real issue, and it’s the pharmaceutical business. Other businesses have patents, but they don’t really worry about whether it’s 20 years or 20 years and six months because after three or four or five years, it’s been out-innovated, so the patent on that product becomes irrelevant. It’s been invented around. One reason that doesn’t happen in the pharmaceutical industry is because of very heavy FDA regulation. We’ve got to speed up the innovation, speed up the R&D, which demands a regulatory response from the FDA.

If you look at the last four decades, the proportion of sales allocated to R&D in the brand name pharmaceutical industry has gone up from 10 percent in the 1960s to 18.2 percent in 2002. How much they spend on marketing and advertising–something critics often bring up–is a red herring, because there’s a positive relationship with the amount spent on promotion in America and advertising and R&D. If you cannot sell your thing, you’re not going to invest in R&D to do it.

Tort reform would also help lower drug costs here in the U.S. A paper written by Richard Manning, then a professor at Brigham Young University, published in 1997, (2) argued from the evidence that one-third of the prescription drug price difference between Canada and the U.S. was the more burdensome litigation situation in the United States. The data he was using was from 1992. So whether that one-third difference still holds 11 years later, I don’t know, but it would still hold to some degree.

Also, you’ve got to have more price differentiation within the United States. If it cost 20 cents to manufacture a drug, and you’re selling it for a dollar, and there’s somebody who cannot pay for it at a dollar, but he can pay 30 cents, the manufacturer has an interest in selling it to him for 30 cents. But you have to give the manufacturer the ability to differentiate that customer from Donald Trump who can pay a dollar or more.

Every time the governor of Illinois, or another politician, looks at a low price that’s given to a low-income person and says, “I want that price for all my constituents,” he or she screws up the ability of the manufacturer to offer that low price to anyone, and consequently to meet the needs of truly needy patients. All manufacturers can do is cut off the needy patients and charge high prices to the rest of you.

John Graham is director of health and pharmaceutical policy research at the Fraser Institute in Vancouver, Canada. He has written or coauthored five studies on the different prices of prescription drugs in the U.S. and Canada. His email address is [email protected].


1 Prescription Drug Prices in Canada and the United States – Part 4: Canadian Prescriptions for American Patients Are Not the Solution (Public Policy Source No. 70) Vancouver, BC: The Fraser Institute, September 2003.

2 Richard L. Manning, “Products Liability and Prescription Drug Prices in Canada and the United States,” Journal of Law and Economics 40 (April 1997): 203-243.