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better. There is similarly no reason to deny the achievements of
those who turned others' more fundamental scientific work into
something that could make life last longer and be lived with more
health and vigor in old age.
The costs incurred in turning scientific discoveries into new med-
ications are no less real and no less important because other indi-
viduals and organizations incurred other costs earlier. Nor does the
fact that the taxpayers' money was used mean that the best way to
make decisions about pharmaceutical drugs is to take those deci-
sions out of the marketplace and have them made by politicians. Yet
this non sequitur is what seems to be implied by those who think
that the prior costs of scientific discoveries change the economic
requirements for producing new medicines.
Those in politics or in the media who do not think beyond
stage one may see in government control a means of bringing
The Economics of Medical Care 85


down the prices of existing medicines, without thinking through
whether this will also bring down the rate of discovery of new
medicines. However, these efforts at bringing down prices
through collective action are usually successful in the short run.
That is because seldom is a given medicine the only one that can
be used in treating a given disease, so a drug company's ability to
hold out against the Canadian or other governments is very lim-
ited, when those governments can buy someone else's medica-
tions if they do not get the price they want from a particular
pharmaceutical company. Moreover, in a country with a govern-
ment-controlled comprehensive medical care system, there may
be little or no market for a given medicine from the small, or
non-existent, private sector.
Even in the United States, there are large buyers of pharmaceu-
tical drugs such as health maintenance organizations and the fed-
eral government, who can likewise present a pharmaceutical
company with a take-it-or-leave-it offer at a price that allows the
company to make some money over and above manufacturing
costs, but not nearly enough to cover the high fixed costs required
to develop new drugs.
To those who do not consider the economics of this process”
and that includes not only most of the public, but also politicians,
journalists, and others”it can easily appear that the issue is simply
one of getting lower prices and the case for government-imposed
price controls may seem not only obvious but imperative. In fact,
price controls on pharmaceutical drugs have been common in
countries around the world, with the United States being a no-
table exception. The United States is also a notable exception in
that a wholly disproportionate share of all the new life-saving
drugs in the world are developed in the United States. But few in
politics or the media see the connection between these two facts,
even though price controls on many other things have reduced the
amounts supplied. Yet, even within the United States, there have
86 APPLIED ECONOMICS


always been demands for imposing price controls on American
pharmaceutical companies as well.
Those who do not think beyond stage one focus on the money
that can be "saved" by allowing Canadians to re-export back to the
United States the American drugs they have bought at lower
prices than Americans pay, thereby reducing the costs of medical
care for the American government, individuals and medical orga-
nizations. Not only would there be direct savings by individuals
and organizations importing American medicines from Canada,
the pharmaceutical drug companies would then be under pressure
to lower the prices they charge in the United States as well, after
losing sales because of competition from the sales of their own
medicines being imported from Canada. None of this, however,
deals with the crucial question for those who do think beyond
stage one: Since the fixed costs have to be paid by somebody, if the
development of new medicines is to continue, how can evasions of
such payments of fixed costs fail to reduce the rate of investment
and discovery of new medicines?
It is not simply a theoretical question. The facts tell the same
story. Not all countries have the strong patent protection system
that the United States has, which enables American drug compa-
nies to have a period of monopoly in which to recover huge fixed
costs before the patent expires. Making generic copies of drugs de-
veloped by others is easier in countries without strong patent laws,
and consequently the prices of these generic copies are typically
much lower in such countries than in the United States. But the
development of new drugs is also correspondingly much lower, or
non-existent, in countries where there is less likelihood of being
able to recover fixed costs because generic equivalents keep the
prices down.
Policies or legislation prescribing the substitution of generic
pharmaceutical drugs for similar or identical brand-name drugs
can often reduce the cost to hospitals or health-insurance systems.
The Economics of Medical Care 87

Some demand that all drugs be generic, ending the high prices
and presumably unconscionable profits of the brand-name drug
producers. But here we must beware of the fallacy of composition.
What is true for some cannot necessarily be made true for all. The
overlooked factor is that generic drug producers are essentially
getting a free ride on the costs and experience built up at great ex-
pense by producers of brand-name drugs. Those costs cannot be
made to disappear by government fiat or by the organized pressure
of hospitals and health-insurance companies, even when these en-
tities can force down the prices on drugs that have already been
developed. Reducing the brand-name drug producers' ability to
recoup their costs means reducing the incentives for continuing
the development of new drugs to deal with other diseases and
conditions.
Sometimes the claim is made that the costs incurred by pharma-
ceutical manufacturers are mostly for advertising, not research.
But, however easy it may be for outside observers to dismiss ad-
vertising as an expense that accomplishes nothing for society and
only increases the advertisers profits, that is in fact not the case.
The most wonderful drug ever created will help no one's medical
condition unless it becomes known. Advertising does that. Nor is
making the drug known something that can be done once and for
all, and advertising discontinued thereafter, without consequences.
After the patent for the drug Ceclor expired and its producer,
Eli Lilly 8c Co., cut back on the promotion of it when generic
substitutes began to be marketed by other companies, prescrip-
tions for this drug fell to one-fifth of the former level, because the
generic producers had little or no incentive to advertise, since no
one of them would have a large enough share of the increased sales
to recover the advertising expenditures. As far as the practical ef-
fect on patients is concerned, advertising is as much of an ingredi-
ent in the drug's benefits as any of the pharmaceutical components
themselves.
88 APPLIED ECONOMICS


There is another aspect to advertising that is seldom understood.
When a medication is approved by the Food and Drug Adminis-
tration for one use and other uses are later discovered for it, the
FDA can forbid the pharmaceutical company from advertising the
other uses unless and until it has gone through the long and costly
process of meeting FDA requirements for that new use. Depend-
ing on whether the anticipated additional sales would cover these
additional costs”which can run into many millions of dollars”
the company may or may not try to get the approval needed to per-
mit advertising uses which medical science has already shown to be
beneficial. A classic example is aspirin, which has long been ap-
proved as medication for headaches but may be even more valuable
in other uses, which it has until recent years been forbidden to ad-
vertise:

There is substantial medical evidence that taking a dose of aspirin
can reduce the risk of heart attack in middle-aged males ... by al-
most 50 percent. Indeed, the results are so well known that there ex-
ists a pamphlet, Amazing Aspirin, available for 89 at the checkout
stand of grocery stores, which discusses this benefit at great length.
What is surprising is that neither the package for the aspirin itself
nor any advertising for it indicates that valuable use. Why does
Bayer largely forego the possibility of the increased sales from pro-
viding this information to consumers?
On March 2,1988, at a meeting in the offices of FDA Commis-
sioner Frank Young, all companies making aspirin were told that
they could not advertise the benefits of the product in reducing risks
for first heart attacks. If they did, the FDA would bring legal action.


As a consequence, "the ban on aspirin advertising undoubtedly
causes tens of thousands of needless deaths per year." Obviously,
the Food and Drug Administration's ban on advertising medica-
tion for purposes that the FDA has not approved is designed to
The Economics of Medical Care 89


promote safety. But the purpose of the ban does not change the
consequences. Fortunately, in this case, the FDA eventually re-
lented and allowed aspirin companies to advertise the use of their
product to reduce deaths from heart attacks. However, the deaths
of those who might have saved their lives by taking aspirin, if they
had known about its benefits for those suffering heart attacks, was
a high price paid for the delay.
More fundamentally, when thousands of lives can be saved by
advertising, are those lives any less important than a similar num-
ber of lives saved by the development of an entirely new medica-
tion? Yet many treat it as a condemnation of pharmaceutical drug
companies that they spend so much on advertising. What research
does for the scientific community”provide information they
might otherwise not know”is what advertising does for doctors
and patients. Moreover, because physicians are the ones who pre-
scribe pharmaceutical drugs, they are a more knowledgeable audi-
ence than the audiences for many other kinds of advertising, and
are therefore harder to deceive or to impress with mere puffery.
Moreover, a drug company which attempted to deceive doctors
about a particular drug would be risking an enormously costly loss
of confidence in that company by doctors who prescribe a wide
range of medicines, and who could therefore steer billions of dol-
lars in expenditures away from the deceiving company and toward
its rivals.
The drug approval process attempts to reduce the risks of new
and untried medicines before they are made available to the gen-
eral public. In addition to being reasonably safe for most people,
pharmaceutical drugs must also be shown to be effective for what-
ever medical conditions they are intended to treat. A medicine
that is safe but ineffective is not only a fraud but a danger, as it
may be used for diseases and conditions for which there are alter-
native treatments that are in fact effective, thereby depriving sick
people of benefits that are already available. Yet the question of
go APPLIED ECONOMICS


how safe and how effective, at what cost, must be considered as re-
gards the years of tests and trials prescribed by the FDA's drug ap-
proval process.
The more years that the trials go on and the larger the number
of people in the sample taking the drug, the more reliable the end
results as to both safety and effectiveness”and the more sick peo-
ple will be left to suffer and perhaps die while these processes go
on. A new drug may be tested for effectiveness against a placebo or
against the effectiveness of some other drug. The latter may be a
better process in terms of the validity of the end results but one
such trial involving more than 30,000 people added another eight
years to the testing process. A lot of people can die in eight years”
and yet absolute certainty is still not achievable by human beings,
no matter how much testing goes on. Moreover, these deaths dur-
ing the trial period are not necessarily recouped over the lifetime of
the particular drug or treatment, which may be superseded by new
drugs or treatments for the same diseases in few or many years, as
the case may turn out to be.
The incentives and constraints facing government officials in
charge of testing pharmaceutical drugs are asymmetrical. Ideally,
these officials could weigh the costs and the benefits equally”for
example, stopping the testing process at the point where the esti-
mated number of lives lost while waiting longer for more drug
tests to be completed would exceed the estimated number of lives
saved by getting more data on the drug's safety. But neither the
public, the media, nor the political leaders to whom health officials
are ultimately responsible are likely to use that standard.
If a thousand children die from a new drug allowed into the
market with less testing and ten thousand would die while more
testing was going on, the public outcry over the deaths of those
thousand children would bring the wrath of the whole political
system down on the heads of those officials who permitted the
drug to be approved with "inadequate" testing. But if ten or a
The Economics of Medical Care 91

hundred times as many people die while prolonged testing goes
on, there will be few, if any, stories about those people in the
media.
For one thing, the thousand deaths attributable to the drug ap-
proved by the FDA are far more likely to be provable deaths to
identifiable individuals, whose stories can make headlines, than
deaths to ten thousand unidentifiable individuals whose inability
to get a life-saving drug shows up only in death-rate statistics
comparing what happens where the drug is available and where it
is not available. But statistics are never as dramatic as television in-
terviews with distraught widows or mothers of those have who
died from the side effects of a drug.
These asymmetrical incentives and constraints have led Ameri-
can health officials to ban life-saving drugs that have been in use
for years, if not decades, in Europe”with few, if any, ill effects”
because these drugs have not yet gone through the long and costly
process necessary to get approval under American laws and poli-
cies. Even if the effectiveness and relative safety of these drugs
have been reported in scientific studies published in leading med-
ical journals, that is not accepted as a substitute for the prescribed
FDA approval process. Desperately ill people have been known to
either have the medicines smuggled into the country or, if they
can afford it, go outside the United States themselves to get them.
Sometimes safety precautions can be carried to the point where
they are fatal.


IMPLICATIONS

At the heart of the problems created by price controls on medical
care and attempts to keep down the prices of pharmaceutical
drugs is the belief that prices are just nuisances to be circum-
vented. In reality, prices convey an underlying reality that is not
nearly as easily changed as the prices are.
92 APPLIED ECONOMICS

The costs of unnecessary Caesarean-section births do not go

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