Would drug importation from countries such as Canada be welfare improving for the U.S.? In the short run, the answer is yes. Lower prices will made pharmaceuticals more affordable and more pharmaceutical consumption closer to the static equilibrium level. In the long run, however, lower drug company profits may lead to less innovation in terms of new chemical compounds brought to market.
Frank Lichtenberg tries to test whether or not drug importation will decrease pharmaceutical innovation by using disease incidence (i.e.: the market size for the drug to be created) as a pseudo-experiment for what would happen under a drug importation scheme.
Lichtenberg looks specifically at chemotherapy drugs and finds that the elasticity of the number of chemotherapy regimens with respect to the number of cancer cases is 0.53. In words, “a 10% decline in drug prices would therefore be likely to cause at least a 5-6% decline in pharmaceutical innovation.”
Yet is market size truly a good proxy for what will happen if pharmaceutical trade barriers are destroyed? I would guess not. If pharmaceutical companies care at all about patient health and not just profits, then it is more likely that these companies will try to find cures for diseases where a large number of people are affected. Even if drug companies are profit maximizing, creating a cure for a serious, high-incidence disease (such as cancer) may have positive reputational effects for the company, thus enabling them to increase the price or increase the quantity sold of other drugs.
Further, the number of drugs that treat a given disease may be less important than whether or not there is at least one drug which does a good job of treatment. Copycat drugs may not be welfare enhancing, but would certainly be positively correlated with market size.
- Lichtenberg, Frank R. (2006) “Importation and Innovation,” NBER Working Paper #12539.