President Trump perceives himself as a dealmaker. Indeed, his 1987 book is titled, The Art of the Deal. His preoccupation with tariffs is based on the idea that the United States is being played for a sucker in trade negotiations, importing goods from abroad but facing all manner of trade restrictions when exporting goods to far flung areas. Some of this is true. One area where the United States is being played for a sucker is in pharmaceutical drugs. Americans pay the highest price for new drugs as any country in the world. President Trump wants to do something about that.
Drugs cost more in the United States for a variety of reasons, the primary of which is that the U.S. has almost no price controls. Other countries, such as Canada, the United Kingdom and much of Europe places ceilings on the prices charged in their respective countries. Critics often claim that the U.S. bears the load for research & development, while other countries free ride paying little above marginal cost. Other countries do get a bargain. In that regard, when selling drugs abroad at restricted prices far less revenue flows back to American companies. According to University of Chicago economist, Tomas Philipson, the pharmaceutical trade deficit was $117 billion last year, largely due to price controls. Price controls function as a non-tariff barrier to trade. Imagine if the U.S. imposed price controls on BMW, limiting how much the German automaker could charge U.S. customers.
Drugs also cost more in the United States due to price discrimination. Price discrimination is the term economists use to describe when sellers can segment markets and charge different prices in different markets for the same products. This makes sense when marginal revenue exceeds marginal costs. Price discrimination works especially well when a substantial portion of a product’s cost is intellectual property or fixed overhead. Think Hollywood movies: letting people from poor countries watch a movie for $2 a ticket while charging $20 in the United States is still profitable, even if the average cost per ticket to make the movie was $5. Stated another way, selling the first ticket to see a movie may cost $100 million, whereas the second cost almost nothing. The same is also true of most new drugs. Once a drug is developed and approved by the U.S. Food and Drug Administration, stamping out an additional pill costs a penny or two. This is often true even for drugs like Sovaldi, that retails for about $1,000 a tablet.
Drug makers can sell in markets with price ceilings and still charge unreasonable prices in the United States because of their ability to prevent arbitrage. An example of arbitrage would be if an American drug wholesaler was able to buy Sovaldi in Egypt and import it to the U.S. Sovaldi is sold in Egypt at a 99% discount compared to the same drug sold domestically. Importing a drug by anyone except the manufacturer is against federal law, however. Basically the U.S. protects drugmakers from competing with their own cheaper products sold abroad. Trump has threatened to change this by allowing importation of drugs from overseas.
Most experts doubt whether President Trump’s pharmaceutical trade negotiations will result in lower prices for American consumers. About 75% of drug profits are derived from the U.S. market, while 25% come from abroad. If drug makers are forced to equalize drug prices domestically with those abroad, the most profitable strategy would be to increase prices abroad and forgo sales in poor countries and countries that impose caps on prices.
Read more at WSJ: Trump’s Drug-Price Crackdown, Like His Trade War, Could Be More Bark Than Bite
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