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20–046 PDF 2005

S. HRG. 109–87

DRUG IMPORTATION: WOULD THE PRICE

BE RIGHT?

HEARING

BEFORE THE

COMMITTEE ON HEALTH, EDUCATION,

LABOR AND PENSIONS

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

ON

EXAMINING THE PRICE OF DRUG REIMPORTATION, FOCUSING ON IMPLICATIONS FOR UNITED STATES CONSUMERS, PRICING, RESEARCH

AND DEVELOPMENT, AND INNOVATION

FEBRUARY 17, 2005

Printed for the use of the Committee on Health, Education, Labor and Pensions

(

(II)

COMMITTEE ON HEALTH, EDUCATION, LABOR, AND PENSIONS

MICHAEL B. ENZI, Wyoming, Chairman

JUDD GREGG, New Hampshire

BILL FRIST, Tennessee

LAMAR ALEXANDER, Tennessee

RICHARD BURR, North Carolina

JOHNNY ISAKSON, Georgia

MIKE DEWINE, Ohio

JOHN ENSIGN, Nevada

ORRIN G. HATCH, Utah

JEFF SESSIONS, Alabama

PAT ROBERTS, Kansas

EDWARD M. KENNEDY, Massachusetts

CHRISTOPHER J. DODD, Connecticut

TOM HARKIN, Iowa

BARBARA A. MIKULSKI, Maryland

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

PATTY MURRAY, Washington

JACK REED, Rhode Island

HILLARY RODHAM CLINTON, New York

KATHERINE BRUNETT MCGUIRE, Staff Director

J. MICHAEL MYERS, Minority Staff Director and Chief Counsel

(III)

CONTENTS

STATEMENTS

THURSDAY, FEBRUARY 17, 2005

Page

Enzi, Hon. Michael B., Chairman, Health, Education, Labor, and Pensions

Committee, opening statement ........................................................................... 1

Aldonas, Grant D., Under Secretary for International Trade, U.S. Department

of Commerce ......................................................................................................... 3

Prepared statement .......................................................................................... 7

Isakson, Hon. Johnny, a U.S. Senator from the State of Georgia, opening

statement .............................................................................................................. 23

Goldberg, Robert M., Ph.D., Director, Center for Medical Progress, Manhattan

Institute for Policy Research, New York, NY .................................................... 26

Prepared statement .......................................................................................... 28

Zycher, Benjamin, Senior Fellow in Economics, Pacific Research Institute

for Public Policy, San Francisco, CA .................................................................. 31

Prepared statement .......................................................................................... 32

Pollard, Stephen, Senior Fellow and Director, Health Policy, Centre for the

New Europe, Brussels, Belgium ......................................................................... 36

Prepared statement .......................................................................................... 38

Outterson, Kevin, Associate Professor, West Virginia University College of

Law, Morgantown, West Virginia ....................................................................... 50

Prepared statement .......................................................................................... 53

ADDITIONAL MATERIAL

Statements, articles, publications, letters, etc.:

Response to Questions of Senator Enzi by Grant D. Aldonas ...................... 75

Response to Questions of Senator Kennedy by Grant D. Aldonas ............... 75

Response to Questions of Senator Enzi by Robert M. Goldberg ................... 77

Response to Questions of Senator Hatch by Robert M. Goldberg ................ 78

Response to Questions of Senator Kennedy by Robert M. Goldberg ............ 78

Questions of Senator Hatch to Richard Carmona .......................................... 79

Questions of Senator Hatch to Tim Pawlenty ................................................ 79

Questions of Senator Hatch to Robert Goldberg ............................................ 79

Questions of Senator Hatch to Stephen Pollard ............................................ 79

Response to Questions of Senator Enzi by Kevin Outterson ........................ 80

Response to Questions of Senator Enzi by Benjamin Zycher ....................... 85

Response to Questions of Senator Kennedy by Benjamin Zycher ................ 87

Questions of Senator Enzi to Stephen Pollard ............................................... 89

Questions of Senator Hatch to Stephen Pollard ............................................ 89

Questions of Senator Kennedy to Stephen Pollard ........................................ 89

Ellen R. Shaffer and Joseph E. Brenner, CPATH, prepared statement ...... 90

Joel Lexchin, prepared statement ................................................................... 92

Donald W. Light ............................................................................................... 94

(1)

DRUG IMPORTATION: WOULD THE PRICE

BE RIGHT?

THURSDAY, FEBRUARY 17, 2005

U.S. SENATE,

COMMITTEE ON HEALTH, EDUCATION, LABOR, AND PENSIONS,

Washington, DC.

The committee met, pursuant to notice, at 10:00 a.m., in room

SD–430, Dirksen Senate Office Building, Hon. Mike Enzi (chairman of the committee) presiding.

Present: Senators Enzi, Alexander, Burr, and Isakson.

OPENING STATEMENT OF SENATOR ENZI

The CHAIRMAN. I call this hearing to order. I want to welcome

everyone to the second in a series of hearings on the issue of drug

importation. Today’s hearing will focus on the recently released report by the Department of Commerce on pharmaceutical price controls in other countries and their implication on American consumers.

Like many Americans, I am concerned about the affordability of

prescription drugs. As the new chairman of the committee charged

with protecting the public health, I am looking forward to continuing our study of whether we can import lower-priced prescription

drugs safely and without importing price controls that would jeopardize American pharmaceutical research and development and ultimately American consumers.

The Senate Health, Education, Labor, and Pensions Committee

has jurisdiction over any legislation to amend the Food, Drug, and

Cosmetic Act and remove the restrictions on importing drugs. As

chairman of the HELP Committee, I am interested in developing

a bill that creates an environment where consumers can trust that

medications can be imported without compromising the integrity of

the drug distribution system or their own personal safety.

While I am open to new and creative ideas to make importation

possible, I am very concerned about placing undue restrictions on

trade. Limiting the right to buy and sell freely is a bad business

and it ultimately harms consumers. We should not constrain the

rights of businesses and individuals to respond to the forces of supply and demand.

I am concerned that Americans are paying higher prices to fund

the pharmaceutical research and development that benefits the

citizens of all nations, but our response should not be restrictions

that penalize rational business decisions and limit consumer access

to new drugs.

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We shouldn’t tell companies with whom they must do business,

how much they should sell for, how much they should sell, and at

what price. I don’t want to impose those terms on my home State

industries and I doubt my colleagues on the committee would want

to do that in their own States.

Importing drugs while fixing the terms of trade is equivalent to

importing price controls on prescription drugs, and importing price

controls could endanger the future of drug innovation by limiting

the financial resources available for drug research and development.

Finally, we must not ignore some simple facts. Canada has only

one-tenth of the population of the United States. Our pharmaceutical market is larger than Canada’s and Europe’s combined.

There is simply not enough excess supply in other countries to

meet our needs. Because of the size difference, other nations are

preparing to take actions to ensure that drugs purchased and intended for their citizens don’t flow into the United States and disrupt their supply chain.

Instead of artificially controlling drug prices or starving our

neighbors and allies of life-saving medications, we ought to give the

marketplace a chance to work toward equity in global pricing. That

would be a true and sustainable approach that doesn’t threaten the

next generation of pharmaceutical breakthroughs in the process. If

we can agree on this issue, I am optimistic we can move forward

on a rational and reasonable drug importation plan.

I hope to find out from our witnesses today what the true cost

of importation would be and if that price is right for Americans.

I do appreciate the work that has been done on this study that

we will be reviewing in the next few minutes. I am always delighted to have some reports that have numbers. In fact, there are

never enough numbers for me. As the accountant, I really get into

that sort of thing. I notice that the crowd today isn’t nearly as big

as it was yesterday. It probably has to do with numbers.

I helped write the AIDS bill for the United States, and as part

of the research on that we found that the average drug, or some

treatments in the United States for that cost about $10,000 a year,

and that is giving a reasonable return to the pharmaceutical company, of course. Now, in Africa, they are being provided at $600 a

person. People over there can’t afford it because they are making

$50 a year, and you can’t pay $600 when you are only making $50.

So the pharmaceutical companies have been donating drugs over

there. We don’t have a supply system over there that will get those

out, and so we have ones that are expiring in the warehouses.

I have always been kind of fascinated by this pricing situation

and all of the sorts of things that affect it. I remember when I was

growing up, my mom heard a rumor that there was going to be a

shortage of toilet paper and she mentioned that to a few of her

friends and they all went out and bought toilet paper, and sure

enough, there was a shortage of toilet paper.

[Laughter.]

The same thing happened with sugar one Christmas. They heard

that there was going to be a shortage on that, and by the time the

whole community was alerted and went out and bought their

sugar, there was truly a shortage.

3

Now, Wyoming is a little bit more isolated than a lot of places,

so the supply can’t recover quite as fast as it might be able to in

some of the bigger markets, but I see that as a possibility with

these smaller countries that we are dealing with and the sort of

thing that we are doing here.

I would mention that Senator Kennedy is attending the Armed

Services Committee hearing this morning, so he won’t be able to

be here. We will have, I am sure, other Senators as the morning

progresses, but our purpose here, of course, is to build a record

using the tremendous resources of a variety of witnesses that we

will have this morning.

At this point, we will proceed. I want to thank Mr. Aldonas, who

is the Under Secretary of the International Trade Administration

with the Department of Commerce for being here today and for the

outstanding work that he has done and for him to comment on that

work.

Mr. Aldonas.

STATEMENT OF GRANT D. ALDONAS, UNDER SECRETARY FOR

INTERNATIONAL TRADE, U.S. DEPARTMENT OF COMMERCE

Mr. ALDONAS. Thank you, Mr. Chairman, first of all for explaining a market phenomena I have never understood. Being from Minnesota, whenever there is a snowstorm in Washington, DC., and all

the canned goods disappear because we are going to be home for

a day or so has always surprised me, coming from a place where

we figured out how to remove the snow.

[Laughter.]

But in any event, at least now I understand how that happens.

I want to thank you for holding the hearing and giving us a

chance to testify about the Department of Commerce report, ‘‘Pharmaceutical Price Controls in OECD Countries: Implications for U.S.

Consumers, Pricing, Research and Development, and Innovation.’’

I welcome the opportunity to explain the findings.

If I could, Mr. Chairman, I would like to submit my written testimony for the record and summarize my findings here.

The CHAIRMAN. Certainly. Your entire statement will be included, as it will be with all witnesses today that will be testifying.

We do hope that they summarize so that we can cover as many

questions as possible. Of course, the report will be a part of the

record, too.

Mr. ALDONAS. Thank you, sir. I want to begin by thanking the

professionals at the Commerce Department, particularly John

Menes, Terry Lebat, Adam O’Mallion, Mary Frances Desinsky, who

were really the core of the team that produced this report. I get the

benefit of standing before you and having all that intellectual firepower behind me, so I want to express my appreciation.

I also want to say that having been Under Secretary for 4 years,

I have had the luxury of working with these people. It really is the

finest group of analysts I have had the opportunity to work with.

A lot of hard work went into the report. That is reflected, I think,

in my written testimony. We got a lot of great cooperation from the

economists at HHS. At CEA, we are lucky, in a sense, to have

someone at the CEA who was a health care economist who could

help us in terms of developing the methodology. We spent a good

4

deal of time trying to solicit public comment, certainly from recognized experts in the field, reviewing their studies, getting written

testimony, and then holding a public hearing, as well, and offering

an opportunity for rebuttal after that public hearing. We kept the

record open.

I don’t mean to underestimate the challenges. I respect, Senator

Enzi, from knowing you from my own experience on the Finance

Committee, how much you do appreciate numbers and focus on

numbers and I am very conscious that what we are working with

here is, as with any study, are some significantly methodological

choices, and that flows from what I was surprised by, which was

a lack of data available in the public domain. We ended up, to

produce this study, along with our colleagues at HHS, having to

sign a contract with IMS, which is really the only holder of pricing

data in this area, and that presents some unique challenges because in one sense, you are buying the data before you can fully

work your way through all of the methodological challenges, and

that imposes certain constraints on the study.

So I really regard the study as a very useful set of guidelines.

I am always concerned as a lawyer that we not fall prey to what

I call the fallacy of misplaced concreteness. The numbers are what

they are. They are estimates. But they do suggest some interesting

directions in terms of policy and the implications of what many of

our trading partners do in the OECD.

What I want to do is really just divide my summary into three

parts. The first is what we found in terms of OECD country practices. The second is the effect of those practices on prices, earnings,

R&D, and the production of new and innovative medicines. And

lastly, the implications of those findings, not only for American consumers and for consumers in the OECD countries, but also for the

developing world, where as you rightly point out, much of what

goes on in R&D, whether it is in the United States or Europe, has

a cascading and potentially positive effect on the rest of the world.

On the other hand, if we are shortchanging R&D, we can also have

a very negative impact on the availability of drugs and new and

innovative medicines in the developing world, as well.

First, with respect to the OECD country practices, each of the

countries we examined relied on some form of direct price control.

The methods differed. They involve reference pricing, approval

delays and procedural barriers to new drug approvals, restrictions

on dispensing and prescribing, volume limitations on the amount

of a particular drug that can be purchased, and various reimbursement controls. The methods prevent companies from charging a

market-based price for their products. They tend to be non-transparent in terms of the way the methodologies are eventually imposed.

It is generally something where a lot of data is provided to a

board without a lot of impact or interchange from any companies,

whether generics or the innovative companies, and a fairly arbitrary decision comes out that oftentimes rewards generics by splitting the economic rents that would otherwise be available from a

patent, which interestingly enough doesn’t offer much in the way

of incentives for the generics to compete. There is an awful lot of

money left on the table for them that wasn’t due to their efforts

5

or their creativity or their marketing. So in one sense, they are undercutting right there the competition that might otherwise flow

from generics in the market.

Needless to say, the methods prevent companies from charging

not only market-based prices, but they also impose, and this is

probably the most surprising thing I found in looking at the practices, a number of barriers to the flow of information. Properly understood, all markets are about information. Prices, in fact, are

nothing more than distilled information about the value of products

on the marketplace.

In most of the OECD countries, there were very significant barriers to generic drug manufacturers or even off-patent branded

drugs to provide information to prescribers and to consumers about

the efficacy of their products or about the cost. So ultimately, to the

extent that individuals in the marketplace would be able to make

informed judgments about the availability, that was, in fact, illegal

in many of these cases.

Second, in terms of the direct effects of the OECD government

practices, the direct restraints they impose on prices of innovative

medicines, not surprisingly, result in prices that are significantly

below market prices charged in the United States, on the order, at

least under our estimates, of between 18 and 67 percent, based on

2003 pricing data.

Nor is it surprising that by limiting the profits earned by innovative drug makers on their patented products, OECD government

policies have a significant impact on the earnings that are available for research and development. Our analysis suggests that

price controls and other OECD government practices sharply reduce the earnings generated on patented drugs to on the order of

$18 to $27 billion in 2003, and you would expect to see that same

number on an annual basis. Given the roughly, say, third of earnings generated by innovative drug companies that go to R&D, we

estimated that OECD price controls result in about a $5 to $8 billion reduction in R&D spending annually, which equates to roughly

three or four fewer drugs per year.

OECD government practices also have a negative effect on the

ability of generics to deliver cost savings through the market. We

estimated that higher utilization of generics among the OECD

countries might have resulted in between a $5 and $30 billion savings to their consumers in 2003 alone.

One of the points that I want to reinforce here, Mr. Chairman,

is the fact that while the argument is often about the choice of social model, that wasn’t really a factor in terms of these findings.

The truth of the matter is you could use the power of generic competition regardless of the social model you choose, whether it was

a national health care system or you allowed the market to work

without government intervention. The fact of the matter is, you

would want to have that competition in the marketplace regardless. So in many senses, this was inhibiting the results that you

would achieve under any model of health care.

Finally, and it is probably most important than the exact figures

we estimated are the implications of our findings. Perhaps most

importantly, in terms of the mix of policy choices that the OECD

governments confronted, they seem to have got the mix exactly

6

wrong. They not only provide less in the way of innovation that has

driven innovative pharmaceutical companies out of Europe, certainly to the United States—we benefit from that investment, but

implicitly, what they have done is short-changed the competition

that would flow from further innovative medicines.

When you are talking about prescription drugs, most of the competition comes from a newer generation of drugs rather than prices

at that market. The generics set an outward boundary on the substitutability of drugs. And so in this instance, what they are doing

is limiting the nature of competition that flows from further R&D

and new drugs that come on the market.

The second area, of course, where you have this same sort of implication is with respect to the generics. To the extent that a reference pricing system rewards the generic makers for nothing they

have contributed by splitting the profits available between the patent holder and the generic company, in effect, what you are doing

is reducing the incentive to compete based on price. It has a profound effect ultimately on what they provide to the market.

Over half the drugs in the United States that are consumed are

generic drugs. In fact, we could do a lot better in the United States.

But in most of the OECD countries, that number is far lower, and

so you are not getting the pop that you would expect out of the generic industry.

The last thing I always want to underscore, because I know that

the debate about drug prices tends to be about to reduce drug company profits and about lowering prices in a given market. That is

really inconsistent with the nature of the global economy we are

living in. To be honest, when you look at what the OECD countries

have done, it is very much a ‘‘beggar thy neighbor’’ policy. There

are distributional effects, and as far as I am concerned, moral questions that arise from the fact that they impose these sorts of drug

controls.

What I mean by that is by shorting the innovation in the marketplace, they not only have an impact on competition that affects

U.S. consumers, it affects the rest of the world. If we are going to

lower the transactional cost related to providing pharmaceuticals

worldwide, certainly, you have to be thinking about the developing

world, as well. So while the reductions that price controls might

impose in Germany may have an impact on their spending, overall,

it is not helping the world in terms of the drugs available or the

power that generics could deliver to the market.

One fact, I think, illustrates that, and that again is that we do

have a debate in this country about drug reimportation, and I was

surprised to find, not in our study but in the counterpart that our

friends at HHS did, was that you could actually find generics available in the U.S. market at half the price you could find from an

online pharmacy in Canada. So the idea that the price controls are

working in a way that actually provides significant cost savings is

anomalous given that what you see is generic prices in the United

States that my relatives in Minnesota could take advantage of, as

opposed to getting on a bus from Menomen and driving up to Winnipeg.

I don’t mean to address the question of reimportation directly.

Mostly what I want to reemphasize is that what Congress has done

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1Section 1123 of the Medicare Prescription Drug, Improvement, and Modernization Act of

2003, P.L. 108–173. 2See H.R. No. 108–391. 3The overview of drug price regulatory systems corresponds to Australia, Canada, France,

Germany, Greece, Japan, South Korea, Mexico, Poland, Switzerland, and the United Kingdom. 4The prices effects analysis corresponds to Australia, Canada, France, Germany, Greece,

Japan, Poland, Switzerland, and the United Kingdom. 5Submissions were received from AdvaMed; Alberto Frati, M.D./Mexico; BIO; Consumer

Project on Technology Response; GphA; AEI (Kevin A. Hassett); Aidan Hollis, University of Calgary; Industry Trade Advisory Committee (ITAC) 3; Jana Thompson/Indiana; Donald W. Light,

Ph.D., University of Pennsylvania and Joel Lexchin, M.D., York University; Novartis Corp.;

Continued

to generate much stronger generic competition in the United States

has actually had a profound effect, and that is something that

would be the right mix of policies to suggest to our OECD trading

partners, as well.

Let me stop there. I am happy to take any questions you have.

[The prepared statement of Mr. Aldonas follows:]

PREPARED STATEMENT OF GRANT D. ALDONAS

INTRODUCTION

Thank you, Mr. Chairman and members of this committee, for inviting me to testify today about the Department of Commerce report, Pharmaceutical Price Controls

in OECD Countries: Implications for U.S. Consumers, Pricing, Research and Development, and Innovation. I welcome this opportunity to explain both our findings and

methodological approach.

It is no secret that governments of Organization for Economic Cooperation and

Development (OECD) member countries maintain a variety of practices that reduce

the return on sales of innovative pharmaceuticals. To examine the effect of such

practices on prices, revenues, innovation and, ultimately, on consumers, Congress

directed the Secretary of Commerce to conduct a study, in consultation with the Department of Health and Human Services, the Office of the U.S. Trade Representative, and U.S. International Trade Commission, of drug price controls in OECD

member countries and the implications for American consumers.1

Specifically, Congress requested that the study include the following:

• Identification of the countries that use price controls or other such practices,

with respect to pharmaceutical trade. • Assessment of the price controls and other such practices that the identified

countries use. • Estimates of additional costs to U.S. consumers because of such price controls,

and the extent to which additional costs would be reduced for U.S. consumers if

price controls and other such practices were reduced or eliminated. • Estimates of the impact that price controls, intellectual property laws, and

other such measures have on fair pricing, innovation, generic competition, and R&D

in the United States and each identified country.2

This report we issued responds to Congress’ request. It details the effect of price

controls imposed by various OECD member governments on pharmaceutical prices,

R&D, innovation, and American consumers. The study examined the drug price regulatory systems of 11 OECD countries 3 and involved a quantitative analysis of

prices, revenues, and R&D effects, based on data available for nine OECD countries.4

To complete the project, we brought together a talented team of professionals including economists from the Departments of Commerce and Health and Human

Services (HHS), and the United States Trade Representative (USTR) and sought

input from the Council of Economic Advisers (CEA). We also consulted closely with

experienced academics in the field of health economics. In the early months, interagency meetings were held with economists from HHS, USTR and CEA to share research and flesh out methodological issues. These meetings included discussions

about the various methodologies used in previous academic and government studies

that addressed similar, but not the same, questions posed by the Conference Report.

As those discussions on methodology proceeded, we gathered as much in the way

of factual information as possible, as well as the views of outside experts. The Department of Commerce published Federal Register notices requesting input from industry, non-profit organizations, trade associations, and the general public. The Department received written testimony from 18 sources.5 In addition, the Department

8

Kevin Outterson, West Virginia University; Pedro Reyes Ortego/Mexico; PhRMA; U.K. Department of Health; Dan O’Day, Chairman of the Pharmaceutical Committee of the American Chamber of Commerce; The Manhattan Institute for Policy Research; and The Amyotrophic Lateral

Sclerosis Association. 6PhRMA, AEI (Hassett), and Dr. Donald W. Light.

held a public hearing on August 3, 2004. Three interested parties requested the opportunity to speak.6 The Department left the record open for an additional 10 days

following the hearing in order to provide an additional comment period for submission of further comments based on information provided at the hearing or in earlier

submissions. Every attempt was made to ensure that all interested parties had the

opportunity to provide comments and to address comments from other groups.

The information that we gathered during this development process provided us

with the data and tools necessary to make well-informed decisions about the best

way to approach the Conference Report questions. Our extensive efforts enabled us

to develop a balanced methodology for estimating the impact of foreign drug price

controls on consumers, R&D, and innovation. The report, given methodological and

data challenges, provides our best approximation of the impact these pricing systems have on consumer welfare and industry innovation.

My comments today describe the study’s findings, with detailed information about

the methodology used to develop each result. In some cases, the findings will not

be surprising. Numerous studies have shown U.S. patented drug prices to be more

expensive, on an aggregated basis, than drug prices overseas. Other findings reveal

that the policies OECD countries use to control pharmaceutical prices impede competition in these countries and, arguably, globally. Competition drives innovation.

In attempting to reduce the burden on health care budgets, OECD countries inadvertently employ policies that dampen the incentives for innovation, thus reducing

economic and health benefits for consumers. These restrictive policies deny health

benefits by reducing the range of choices, and ultimately raising costs for consumers, by limiting competition from generic drugs. I will discuss this in more detail

later in my remarks.

PRICE CONTROLS ARE WIDESPREAD

The study examined the drug price regulatory systems of 11 OECD countries and

found that all rely on some form of price controls to limit spending on pharmaceuticals. The principal methods these governments employ are: reference pricing,

approval delays and procedural barriers, restrictions on dispensing and prescribing,

and reimbursement. These methods prevent companies from charging a marketbased price for their products and tend to be non-transparent; the criteria and rationale for certain pharmaceutical prices or reimbursement amounts are not fully

disclosed, even to the pharmaceutical companies marketing drugs.

The most direct method that relevant OECD governments use to control prices

is setting sales prices and outlawing sales at any other price. Governments are often

the dominant market participant and may negotiate favorable prices with manufacturers, by leveraging this monopsonistic power. Such negotiations generally result

in prices that are lower than they would be in a free market. OECD governments

in our study also set the reimbursement prices for new drugs at levels well below

free market prices. Since any charge above the regulated price is borne by consumers, the reimbursement price often functions as the de facto market price, whenever

such mechanisms are employed. Finally, some OECD governments regularly cut the

prices of drugs already on the market.

OVERVIEW OF HOW THE DETAILED ANALYSIS OF PRICES AND REVENUES WAS

CONDUCTED

In order to estimate the impact of these price controls, a detailed study of pharmaceutical prices for nine OECD countries was conducted. The nine countries represented both the largest OECD markets and a range of population wealth. To conduct the study, the Department of Commerce, in cooperation with HHS, purchased

revenue and related data for all products containing the active ingredient in the 60

best-selling products in the United States from IMS Health, a leading provider of

data for the pharmaceutical industry.

The analysis focused specifically on patented pharmaceuticals, which are produced

by research-based pharmaceutical companies and biotechnology companies. The

study assumed that, in the absence of drug price controls, average prices in the

OECD countries for innovative pharmaceuticals would be equal to U.S. prices adjusted for differences in per capita income. These adjusted prices were then used

to estimate revenues, in the absence of drug price controls.

9

7 IMS Health is a leading provider of business intelligence services, strategic consulting services, and data for the pharmaceutical and health care industry.

PATENTED DRUG PRICES IN OECD COUNTRIES ARE BELOW U.S. LEVELS

We found that patented drugs that were best sellers in the United States sold for

less in other OECD countries. The study also showed that aggregate pharmaceutical

prices in the analyzed markets were 18 to 67 percent less than U.S. prices, depending on the country. These results were consistent with recent academic research in

this area.

Developing the appropriate data set to conduct international price comparisons

presented a number of challenges. For example, since innovative drug manufacturers fund most private R&D spending, any attempt to analyze the effects of foreign

drug price regulations on the development of new drugs requires understanding how

price regulation affects revenue for such firms. Because their revenue depends primarily on patented drugs, the study uses a set of the best-selling drugs with patented active ingredients (molecules) from the total IMS Health data set7 to serve

as the basis for price comparisons and to clarify the implications for revenue and

R&D spending.

Defining the patented data set was additionally complicated by the fact that patent expiration dates vary across nations, and the patent expiration date itself is not

a reliable indicator of when generic competition begins, as those two dates don’t always coincide. In the United States, by contrast, the Hatch-Waxman Act expedites

generics’ entry into the marketplace, so the patent expiration date is a good proxy

generally for the beginning of generic competition in the United States. Other countries lack similar incentives, and generic competition may occur much later as a result. For example, in some countries, if a generic competitor does not enter the market after an innovative product’s legal patent expires, the innovative product will

continue to benefit from exclusivity in the marketplace, and there will be no price

change. We resolved this difference by identifying and applying the effective patent

expiration date—the year when a generic manufacturer enters the market—rather

than the legal patent expiration date.

The second step involved classifying the information in the patented data set in

a fashion that would ensure the comparison of similar products’ prices. The IMS

Health data set contained products that varied across countries. So, we had to determine the best way to classify products across countries. There are many ways to

classify pharmaceutical products. Most studies have classified products at the molecular level, which is both the broadest and the most basic definition of any product.

Other studies have used more detailed approaches, comparing products by brand

name, therapeutic use, dose form (tablets, capsules, injections), strength (milligrams) and package size. We found that comparing products at more detailed levels,

such as strength and package size, severely limited the data set available for analysis. Therefore, this study compared products in the United States and partner countries at the molecular level.

The on-patent drug data set includes details that are reported at the ex manufacturer levels, before hospital or pharmacy markups or dispensing fees are taken into

account. This is an important condition because data at the manufacturing level

offer a more reliable basis for comparison internationally than do pharmacy or hospital prices. For example, manufacturing level data does not require further adjustments for differences in tax frameworks or other markups that tend to vary across

countries.

Since the IMS Health data set excluded prices, it was necessary to estimate prices

based on two other variables in the data set: revenues per molecule and amount of

drug consumed (volume). While revenue data were provided in U.S. dollars, the

price calculation was complicated by the existence of two alternative volume indicators: standard units and kilograms of the active ingredient. While both volume

measures are widely accepted in the academic literature, each generates a different

price for the same product.

A standard unit is equivalent to a standard dose of medication, and it is derived

from other IMS Health volume measures. Kilograms are the amount of active ingredient in a molecule. While neither measurement has proven superior to the other,

each has its own drawbacks. The standard unit measurement, for example, varies

across countries, as the smallest common dose in one country is not necessarily the

same in another. A second difficulty is the implicit assumption that all pills have

the same value to the patient, independent of dose. The drawback to using the kilogram measure is that it can vary according to the individual sample because potency in molecules varies.

10

Given this challenge, we decided to present a range of results based on both

standard units and kilograms. Interestingly, the differences between the aggregate

prices, based on the two volume measures, were moderate for all countries except

Japan. The consistency between the standard unit and kilogram measures is a function of the consistency between the standard dose and the amount of active ingredient in a given medication. This discrepancy is due largely to the Japanese tendency

to prescribe relatively weaker doses at higher frequencies, as documented in prior

studies. That is, since the Japanese tend to prescribe a dose of medication (standard

units) with smaller amounts of active ingredient (kilograms) at higher frequencies,

prices vary greatly depending on the volume measure.

Despite these data quirks, we included Japan in further analysis because (1)

Japan is the world’s second largest pharmaceutical market and (2) Japanese prices

measured in standard units or kilograms were consistently below U.S. prices. The

second point was crucial to our decision to include Japan because it showed that

the Japanese data were telling a consistent story about Japanese drug prices relative to U.S. prices, increasing our confidence in the Japanese data. If the two Japanese price indices revealed a divergent pattern (one index higher than U.S. prices

and the other lower than U.S. prices), then the reliability of the Japanese data

would have been called into question and we would have had to exclude it from further analysis.

Another important detail in our price computation methodology was the decision

not to make adjustments for off-invoice manufacturer discounts related to patented

drugs. This constituted a break from previous studies, which have tended to factor

in such discounts, as U.S. manufacturers are known to provide discounts to managed care and government buyers. Previous studies have estimated the discounts to

be between 8 and 11 percent.

The decision not to adjust U.S. prices was based on a recent Department of

Health and Human Services (HHS) analysis of discounted U.S. price data from the

Center of Medicare and Medicaid Services (CMS). CMS, a division of HHS, collects

data from manufacturers about the prices they charge for drugs distributed to pharmacies. These prices factor in discounts and other adjustments, including those that

may be excluded from invoices. HHS compared average manufacturers prices (AMP)

for sales of brand-name drugs to non-Medicaid retail purchasers (CMS data) and the

U.S. invoice prices collected by IMS Health. This analysis found no meaningful difference between the non-Medicaid U.S. prices reported by IMS Health and CMS.

The final step in comparing prices across countries was to produce a price index.

There are three generally accepted methods of indexing prices: Laspeyres, Paasche,

and Fisher. The methods vary by the quantity (volume) used to weight the prices.

The Laspeyres index weights prices based on U.S. volumes, measured in kilograms

(or standard units), while the Paasche index uses foreign volumes. The Fisher price

index is the geometric mean of the Laspeyres and Paasche indices. We decided to

present the Fisher price index, as it avoids a result that is too dependent on either

domestic or foreign consumption patterns. However, we also included the results of

the Laspeyres and Paasche calculations, for the sake of transparency and because

both sets of results are used to calculate the Fisher price indices.

WITHOUT PRICE CONTROLS, REVENUES AVAILABLE FOR R&D COULD BE

SIGNIFICANTLY HIGHER

We found that by depressing prices for patented pharmaceuticals, the price controls in OECD countries yield lower revenues for those patented products than

would otherwise exist in a competitive market. Our estimates indicate that, after

extrapolating to a broader set of OECD countries, the diminished returns are in the

range of $18 billion to $27 billion annually. Adding them back would represent a

25 to 38 percent increase in revenues over actual 2003 revenues from sales of patented drugs in the OECD countries considered in this study.

In order to estimate revenue change in the absence of price controls, it was necessary to first estimate prices in such an environment. The market for innovative

pharmaceuticals is defined by several characteristics that must be considered when

estimating prices in the absence of price controls. First, the high cost of developing

and testing a new drug means that no profit-maximizing firm would make the necessary investment to bring new and innovative medicines to the market, in the absence of patent protection. To overcome this obstacle, countries offer patent protection as a reward for innovation, conferring the right to use the resulting chemical

compound for a specific period of time. Such patent protection affords innovative

pharmaceutical manufacturers significant pricing power.

Typically, trade in pharmaceuticals cannot take place except through authorized

channels. Direct manufacturing costs constitute a relatively small percentage of the

11

overall expense, so prices can vary considerably and still remain above the costs of

production, not including R&D. As a result, pharmaceutical firms can be expected

to charge different profit-maximizing prices in different markets. That is, given the

low cost of production and the absence of trade, the profit-maximizing price can vary

across countries because the patent holder will charge a price that reflects demand

within each market.

While a variety of factors influence demand for different drugs in different countries, one consistent factor affecting demand is income. Thus, we made the assumption that U.S. pharmaceutical prices are the benchmark for unregulated prices, and

relative levels of per capita income determine variances in prices, among developed

countries. It is not assumed, however, that variances in prices for each molecule are

determined solely by income levels, only that the aggregate prices would vary based

on relative income levels.

Prices for pharmaceuticals in the absence of price controls were calculated at the

individual drug level, by multiplying each price by a uniform adjustment multiplier.

The uniform adjustment multiplier, designed to capture the difference in price between the free and controlled markets, is calculated by dividing the ratio of foreign

per capita income to U.S. per capita income by the ratio of aggregate patented drug

prices (i.e., the ratio of foreign to U.S. patented drug prices). The mechanics behind

the uniform price adjustment multiplier are straightforward: a price adjustment

multiplier greater than one indicates that prices are below what would be expected

in an unregulated market. Our calculations uncovered only two cases in which the

uniform adjustment multiplier was below one (Greece and Poland), indicating that

prices are likely at, or above, reasonable levels relative to each country’s income

level. A further reduction in drug prices in these countries would suggest that some

individual drug prices could drop below the direct cost of production—an unlikely

scenario. Given these atypical specifics, and further research that indicates these

markets are relatively competitive, we decided to exclude them from further analysis.

These new, market-based prices were then used to compute new revenues. It is

worth noting that in conducting this calculation, we did not adjust volumes to reflect

changes in consumption related to higher drug prices. It was not possible to determine a justifiable and economically sound method for making upward or downward

adjustments to consumption for such a scenario. For example, we could have assumed that following the removal of price controls, volumes would rise to levels observed in the United States, adjusted for differences in population. However, prescribing practices vary significantly across countries. Therefore, we assumed the increased drug prices would not affect sales volumes.

The final step in estimating the impact of foreign drug price controls on the global

revenues of innovative pharmaceutical manufacturers involved extrapolating the

revenue changes from the patented data set to the total patented market in 11

OECD countries (Australia, Belgium, Canada, France, Germany, Italy, Japan, the

Netherlands, Spain, Sweden, and the United Kingdom) for the year 2003. As mentioned earlier, we chose these 11 OECD countries because they collectively represented a significant share of the pharmaceutical revenues generated in developed

markets for the year 2003.

HIGHER REVENUES WOULD MEAN MORE RESEARCH AND DEVELOPMENT AND NEW DRUGS

The study uses published academic research to estimate the impact of increased

revenues on pharmaceutical R&D. By limiting the return that would otherwise accrue to companies that make risky investments to develop new drugs and bring

them to market, the price controls that OECD countries in the study maintain also

reduce pharmaceutical R&D globally; research and development spending exists at

lower levels than would be the case if these countries maintained market conditions

similar to those in the United States. The study estimates that this reduction falls

in the range of $5 billion to $8 billion annually, once prices are fully adjusted. This

represents between 11 and 16 percent of current private R&D worldwide, based on

figures from the CMR International (CMRI).

Based on the estimated cost of developing a new drug, an increase in R&D spending of $5 billion to $8 billion could lead to three or four new molecular entities annually, once markets fully adjust. The U.S. Food and Drug Administration approved,

on average, 30 new molecular entities between 2000 and 2003.

The long-term effects of higher revenues and prices for consumers are linked to

R&D and innovation. Both economic theory and empirical evidence indicate a close

correlation between revenues and profit margins on the one hand and R&D expenditures on the other. We relied heavily on the economic theory and empirical research

on the relationship between revenues (cashflow) and R&D expenditures to provide

12

the foundation from which we then estimated the amount of R&D funding that

would be available, in the absence of price controls. This included work by Henry

Grabowski, John M. Vernon, and John A. Vernon, who developed the parameters

for estimating how an increase in revenues following the deregulation of price controls would presumably impact R&D and the number of new drugs available in the

marketplace.

We made a few key assumptions about how innovative drug manufacturers would

interpret increased revenues, most critically that innovative drug manufacturers

would believe that increased revenues from price deregulation were permanent. If

they did not view the price changes as permanent, but rather as short-term windfall, there would be much less incentive to make long-term investments in increased

R&D spending. In addition, we assumed there would be a fixed corporate tax rate

of 33 percent on all additional earnings, and that pretax profits would not be consumed by additional production and distribution costs. The principle weakness in

this assumption is that a portion of the increased revenues might be devoted to

marketing.

The empirical work necessary to predict industry R&D investment decisions includes examining several financial factors, both separately and together, including:

cashflow, profit margins, prices, and a number of other non-financial factors. Several

studies that analyze the effect of changes in cashflow and profits on U.S. pharmaceutical R&D spending are most relevant to the questions posed in the Conference

Report. The most recent of these studies are by: Henry Grabowski, John M. Vernon,

and John A. Vernon. We used John A. Vernon’s cost and profit margin parameters

and his regression equation to estimate the impact a change in revenues would have

on R&D spending.

The regression equation developed by John A. Vernon required data for expenditures on pharmaceutical R&D and revenues. Consistent and comprehensive data on

expenditures and revenues are difficult to find. So, we consulted two independent

sources for R&D expenditure data, PhRMA and CMRI. The most widely used source

for R&D expenditure data is PhRMA. The association provides data regarding R&D

expenditures by all PhRMA members, including non-U.S. firms within American

borders. It also provides data about worldwide R&D levels, but it excludes R&D expenditures by non-U.S. PhRMA members outside the United States. PhRMA also

provides pharmaceutical revenue data on the same basis. CMRI produces data on

global pharmaceutical spending for R&D. This figure is based on the R&D expenditures of ‘‘traditional’’ global pharmaceutical companies, and as such, their contribution to biotechnology expenditures will be captured by the estimate.

The expenditures by specialized biotechnology companies, on the other hand, are

not included in the data. CMRI figures differ from PhRMA figures because they include R&D performed outside the United States by non-U.S. pharmaceutical companies. However, CMRI does not provide any information regarding revenues, which

means two different data sources informed our analysis: PhRMA’s revenues data,

combined with CMRI’s R&D expenditures. In order to avoid inconsistencies, we used

PhRMA data because it provided the most complete and consistent set of pharmaceutical expenditures available for R&D and revenues.

We realized that the estimated increase in R&D would not be devoted exclusively

to the development of innovative drugs. Research by the Tufts Center for the Study

of Drug Development suggests that only about two-thirds of total out-of-pocket R&D

spending furthers the development of new medicines. The other third is spent on

post-approval, long-term safety and efficacy studies in broader patient populations,

or specific patient groups, and for the development of new indications and/or new

formulations. For the purposes of this analysis, we assume that increased spending

on R&D will be allocated for new active substances and other purposes in the same

proportions as current spending on R&D, i.e., approximately two-thirds, one-third.

Various studies have been done regarding the cost of developing new drugs; the

most recent and often cited study is that by DiMasi, Hansen, and Grabowski, who

report that the total cost per new drug was $802 million in 2000. The estimate reflects capitalization of the out-of-pocket costs to 10 multinational pharmaceutical

firms developing self-originated new molecular entities (NME) with a mean approval

date of 1997, including losses on unsuccessful research. Assuming the same rate of

growth in the inflation adjusted capitalized costs of drug development, between this

most recent work and a comparable earlier work, the authors estimated that the

capitalized cost for drugs approved in 2001 would be $1.1 billion. Applying these

same assumptions would suggest that the cost of drugs approved in 2003 was about

$1.3 billion in 2003 dollars.

13

U.S. CONSUMERS WOULD BENEFIT FROM THE ELIMINATION OF PRICE CONTROLS ABROAD

Due to time and data constraints, we could not complete a rigorous investigation

of the short- and long-term effects of a price deregulation on U.S. prices and consumers. However, we were able to posit some conclusions about the impact price deregulation would have in the short- and long-term. In the short term, the deregulation of OECD prices is not likely to have any impact on U.S. drug prices. This conclusion can be explained largely by the basic characteristics of the pharmaceutical

industry. Price, expected revenues and profits are all critical factors in making investment decisions to launch R&D efforts. The nature of pharmaceutical markets

and economic theory suggests that the prices in one market will behave relatively

independent of prices in other markets, absent more fundamental changes in the

competitive forces operating in those markets.

In the long term, the ‘‘increased competition’’ in the U.S. market as a result of

an increase in the flow of new drugs, could have some effect on U.S. prices. Relaxation of foreign price controls, if coupled with appropriate reform of foreign generic

markets, could potentially bring about significant gains from the flow of new drugs

leading to improved health outcomes, even without increasing foreign spending on

prescription drugs. This conclusion was based on written comments and testimony

submitted to the Commerce Department that suggested increased competition would

lead to long-term changes in U.S. prices.

USING MORE GENERIC DRUGS AT LOWER PRICES IN OECD COUNTRIES MEANS

POTENTIAL SAVINGS

Analysis by the Departments of Commerce and HHS found that higher utilization

of generic drugs at lower prices could result in significant savings to OECD countries. The estimated savings, after extrapolating to a broader set of OECD countries,

range from $5 billion to $30 billion annually. This range of potential savings suggests that if prices of on-patent drugs rose to competitive market levels, then a more

competitive generic market could significantly, or even fully, offset any additional

cost to OECD countries.

Specifically, we examined how foreign price controls impact the off-patent (generic) drug market, using a second data set from IMS Health composed of 29 of the

world’s top selling off-patent drugs. HHS did much of this analysis, on behalf of the

Department of Commerce, because HHS had access to proprietary data from the

Center for Medicare and Medicaid Services (CMS) that illuminated the analysis of

generics. HHS analyzed both the prices and utilization of generic drugs across the

same nine OECD countries that the Department of Commerce examined in its empirical analysis of innovative drug prices.

Generic drugs were defined within this data set as those drugs not produced by

an innovator or licensed company. All drugs using the same active ingredient are

treated as one product. The quantity sold is measured as the total kilograms of the

active ingredient (with an adjustment for the salt factor) or number of standard

units. U.S. prices in the IMS Health data set were discounted by approximately 24.2

percent. This discount is based on a comparison of U.S. prices from IMS and average manufacturer prices (AMP) collected by CMS, which include off-invoice discounts, rebates, and charge-backs. HHS found that the AMP collected by CMS were

24.2 percent lower than the invoice prices in the IMS Health data set. Finally, Fisher price indices—averaging the price indices using both U.S. and foreign weights—

were constructed.

HHS went on to consider a scenario in which foreign countries would shift their

usage of generic drugs to match U.S. proportions and adopt policies that foster U.S.

prices for generic drugs. HHS found that such a shift in generic drug prices and

utilization would yield potential savings, which varied according to the volume

measure used to estimate prices. We then extrapolated the estimated potential savings from the data set of 29 molecules to the total generic market in 11 OECD countries using market share data from IMS Health.

CONCLUSION

OECD governments in various countries have relied heavily on government fiat

rather than competition to set prices, thereby lowering drug spending, as price controls are applied to new and old drugs alike. Such controls, when applied to new

drugs, reduce company compensation to levels closer to direct production costs, leaving less revenue available for R&D efforts. Collectively, individual nations’ efforts

to limit prices can diminish investments in R&D that would provide substantial

health benefits to all. Improvements in health care and life sciences are important

for health and longevity worldwide. The development of innovative pharmaceutical

14

products plays a critical role in ensuring these continued gains. To encourage the

continued development of new drugs, it is essential that we preserve sound economic incentives to develop and market new health technologies.

The CHAIRMAN. If you have some more, you are certainly welcome. I have some questions here, too, but I am fascinated by what

you have said, even though I can only listen about half as fast as

you can talk.

Mr. ALDONAS. Sorry.

[Laughter.]

The CHAIRMAN. So I kind of need to check a couple of things——

Mr. ALDONAS. Sure. Please.

The CHAIRMAN [continuing]. That you said. I think you said that

OECD restricts the ability to even advertise generics so that people

can realize they are on the market.

Mr. ALDONAS. A number of countries do. In fact, it is actually illegal in places like Germany to actually provide that information

to consumers and to doctors. The generic companies, indeed, all the

companies, are barred, in effect, from competing on price, and competing on—what you really hope the generics would do is let the

market set the outward boundary in terms of substitutability, and

so, in effect, if an innovative drug company was simply changing

the pill from pink to blue, the market, if there was strong generic

competition, wouldn’t reward that. On the other hand, if there was

real innovation, it probably would reward that.

Without that level of competition in the marketplace, you are undercutting the power of the market to deliver those sorts of benefits, and again, that is regardless of the health care system that

you choose. So when they interpose that barrier to the information,

they are really undercutting the ability of the market to deliver

any sort of cost savings and rely instead essentially on government

bureaucrats to make the decision about what is substitutable in the

marketplace.

The CHAIRMAN. I appreciate your comments on the fact and the

fact that we could use more generics in the United States.

Mr. ALDONAS. Absolutely.

The CHAIRMAN. I am a huge believer in the local pharmacists

and am glad that we have made some mechanisms for them to be

able to provide advice to their customers and find that that has

made a significant difference in drug savings. That local person,

that hands-on, that interest, because they actually know the person, seems to make a huge difference.

Mr. ALDONAS. If I could just reinforce it, it has nothing to do

with the study, Mr. Chairman, but I was out at my local CVS in

Arlington and actually saw that in practice. There was a woman

ahead of me. I opened up a conversation with her, just as we were

waiting. She was living on a fixed income. She looked at the price

of what had been prescribed by her doctor with respect to blood

pressure medicine, balked, and it was really the pharmacist who

said, ‘‘Well, we don’t have to go that direction. Let me get the doctor on the phone and we can sort out a lower price that would be

within your budget.’’ So I have got to tell you, I have great faith

in that same sort of—it is somebody who is working to provide a

service to their customer and provide that kind of information. It

helped, at least in that one instance.

15

The CHAIRMAN. Of course, I would be interested in the pharmacist being properly compensated for all the effort he has to go

through.

[Laughter.]

On research and development, you had some interesting figures

on what kind of a reduction there could be in the research and development, and I think you mentioned $3 to $5 billion, which would

be four to five drugs on the market, which points out how expensive it is to develop drugs.

Mr. ALDONAS. That is true.

The CHAIRMAN. I was fascinated to hear you say that some of the

pharmaceutical companies have been driven out of Europe by some

of the restrictions they have over there and that had been a benefit

to us in the United States. If research and development were to

drop off significantly—I am saying this facetiously—that would

solve some of our insurance increase problems, too, because a lot

of the increase that we complain about on our insurance is because

there are new treatments and preventions that are out there, but

they cost a lot of money.

Mr. ALDONAS. Sure.

The CHAIRMAN. If we cut all those off, then that would keep it

relatively at the same price that it is now, but I haven’t found anybody that wanted to buy that kind of an insurance policy yet.

There are also some fallacies in what is being done out there. I

have a pharmacist friend in Star Valley, Wyoming, and, of course,

I am hoping that the whole world visits Star Valley. They rely on

tourism a lot. It is south of Jackson Hole, which is where the Tetons are, which is just south of Yellowstone Park.

But he is a pharmacist there and he had a Canadian come in and

had to refill his prescription. The Canadian was upset the whole

time he was in there because he knew he was going to pay these

higher United States prices, and if it hadn’t been an emergency, he

wouldn’t be doing it. And then he got his prescription and found

out that it was $3 less than he would have paid in Canada, so

there is some rumor out there, just like my toilet paper and sugar

example I gave earlier.

I do want to thank you, too, for flying back from Canada for this

hearing. I know how difficult travel can be and appreciate that.

Mr. ALDONAS. Honestly, Mr. Chairman, it is not the travel, it is

that if there is a problem that is less tractable than drug pricing,

it is lumber from Canada, so I am relieved to be back.

[Laughter.]

The CHAIRMAN. Another topic I am very interested in, so I will

be anxious to see your numbers on that.

[Laughter.]

It is my understanding that some countries hold down prices on

the drugs in two ways. One is they make everybody that has a

similar drug bid against each other. For example, if it is a heart

medication, all of the heart medications that do something similar

have to bid against each other and just one of them is selected. So

in Canada, you would have one rather than maybe five different

treatments. Is that correct?

Mr. ALDONAS. That is true, and I think what you end up with

is a smaller range of choices for consumers. It is also why you see—

16

and this is anecdotal, not a part of our study—but having spent a

lot of time in Canada over a 25-year career, it is remarkable, the

number of people who, when they want the truly innovative medicine, will come to the United States ultimately for their health

care, and it is because of the limits on the range of choices that

they face as a result of those sorts of practices in the marketplace.

The CHAIRMAN. The second way they would hold them down, it

is my understanding that if, say, the heart drugs didn’t come in,

one of them come in at a low enough price, then they would declare

it a generic and be able to put it on the market at their own price.

Is that——

Mr. ALDONAS. Yes, there are instances of that, and I have to say,

the perverse nature of that is that all these governments have

signed up to an agreement inside the World Trade Organization

that essentially says they are going to provide 20-year patent monopolies. We have an agreement worldwide about what the nature

of patent protection should be.

And what people have a tendency to forget is that when you impose these sorts of price controls, or what you essentially do is

deem a product to be generic, what you are in effect doing is eroding the protection that you have guaranteed as a part of that WTO

agreement. The idea that innovation is important seems to go out

the window.

And again, I always want to come back to this point, is that, in

effect, what they are doing is saying that the outlays they have as

part of their government budget are more important than the

knock-on effects in the rest of the world. I am not sure that they

actually realize the extent to which they are shortchanging not just

the European market in the case of the OECD countries, but the

U.S. market and the developing world in terms of new and innovative medicines. That is a powerful point to be made to our friends,

particularly in Europe, when they criticize the health care system

here and the sorts of things they do on AIDS funding.

The CHAIRMAN. Thank you. My time in the first round is expired,

but I have my patent expert here.

[Laughter.]

Senator Burr.

Senator BURR. I am just anxious to—when you said Canada, I

assumed that Grant had come to tell us he had solved the lumber

issue.

[Laughter.]

Mr. ALDONAS. I wish.

Senator BURR. We welcome you and I encourage you on all the

endeavors that you are working on. We thank you for the work.

Yesterday, I was focused, and today, I will stay focused on what

I believe is a potential huge mistake that we could make up here,

and that is to ignore patent protection for a particular industry because of a quest and belief that we can do that because we want

cheaper pharmaceutical products.

Let me just ask you, you are on the front line. You know the

guys sitting at the table, whether they are in Beijing or wherever

in the world. What do we do to their ability to negotiate for somebody to recognize the intellectual property that we protect in this

country and how they infringe on that? What does that do to their

17

ability on everything they negotiate if we just throw U.S. Code out

the window and say, ‘‘For pharmaceutical companies, we are not

going to respect their patents?’’

Mr. ALDONAS. Well, the fact of the matter is it undercuts our position with respect to all of the intellectual property arguments we

make. Senator Burr, you and I talked about this before, about the

extent to which, increasingly, the American economy depends on

innovation. One of the reasons we stay so focused on intellectual

property across the board is to try and make sure that other companies are living up to their obligations under the WTO. Any weakening in the United States is seized on by our counterparts as saying, you do the same sorts of things. Why are you complaining,

whether it is about CDs or whether it is about drugs.

It is not something that is easy when you are trying to make the

argument and insist that other countries respect these rights if, in

effect, we are undermining them in any way, shape, or form, and

it is not to get into a debate about some of the furthest reaches of

patent policy in terms of business systems and business procedures, something like that.

We are talking about here particularly pharmaceuticals at the

core of what we think of as our patent system, and so I think rather than trying to discourage the enforcement of those rights, we

need to be vindicating them here as well as being able to make a

clean-hands argument when we go abroad to demand patent protection and copyright protection from our trading partners.

Senator BURR. Is there any economic sector where there is not

a situation where we are having to go to a country and talk to

them about infringement on our patents?

Mr. ALDONAS. No. In fact, you can do it all the way from pharmaceuticals down to things that you and I have talked about before

with respect to the textile industry. One of the most significant efforts we are making right now on intellectual property in China is

on design patents in the textile industry. If our guys are going to

compete, they are going to have to compete at that level in this

new world that we are entering into textile-wise.

And so when we go to bat for companies, we are very conscious

of the fact that whether it is basic manufacturing all the way to

research pharmaceuticals, the IP is essentially what is going to

drive our ability to compete.

Senator BURR. Let me ask whether Commerce specifically has

looked at the potential economic impact on this country were we

to ignore patents on pharmaceutical products, the effects that

would have on the illicit products that would come in because we

wouldn’t be able to negotiate an agreement.

Mr. ALDONAS. We haven’t. This report, Senator Burr, was focused solely on the practices in the OECD countries and the implications of their practices for this market as opposed to what would

happen if you imposed price controls or allowed reimportation into

the United States.

The one cautionary note to raise there, of course, as the President has said, if you could do it safely, he is a free trader.

Having said that, one of the cautionary notes you really have to

raise is there is almost an expectation that if everybody else is

doing price controls, that we could do it, too, and that ultimately,

18

you would end up with lower prices across the board. In fact, what

you would do, essentially, is drive this industry out of the R&D

business. You would be pushing capital into other markets rather

than encouraging the same level of R&D if you imposed price controls or allowed reimportation into the United States.

That is my sense of what would happen economically, but it is

not something that we have actually studied. And frankly, it would

make sense as a piece of follow-on work to much of what we have

done here, Senator Burr.

One of the things that I was mentioning to the chairman just at

the outset was the fact that I thought this was a very good first

step. I think that we faced a number of methodological challenges,

which we acknowledge. We definitely have to have more in the way

of both data as well as analysis to get a full picture of what is

going on, both in the United States and abroad.

But most of what we see in terms of the implications for the

United States would be consistent with what you are suggesting,

is rather than encouraging the price effects and the consumer savings and getting the kind of innovation that we currently have, you

would end up with both higher prices and less innovation if what

you did was essentially drive the industry out of the market and

move capital to other industries.

Senator BURR. When you have explored areas where we have not

been clear in our commitment to enforce patents, how big a truck

do they drive through that opening in countries where their intent

is to be an expert in knock-offs?

Mr. ALDONAS. Well, a good example would be something that I

know has had an impact on everybody here in the Senate, was

when we had to go after drugs on anthrax or things like that and

had to use the power that is available under U.S. law essentially

to try and reduce the price. That argument, even though it was a

unique situation, was immediately turned around by all our interlocutors on the intellectual property front to say, ‘‘You do it, too.’’

Even though it was a very, very narrow exception, and they wanted

to say, no, that exception ought to apply to every bit of what they

do, and every drug, regardless of the disease.

That is the sort of advantage they try and take of those sorts of

arguments, and it is hard to keep an entirely clean record. But the

fact of the matter is, every time you take a step in that direction,

it puts a dent in it.

And I know, based on the recent experience of going to China

with then-Secretary Evans to make the political point that all the

pressure we had been bringing to bear had nothing to do with elections and we weren’t going to stop bringing that pressure to bear

on China on a host of different issues, the most important issue

was intellectual property protection, and having clean hands and

being able to say what the benefits were in the U.S. market from

that did have an impact in terms of Premier Wen and Vice Premier

Wu Yi and President Hu when we had our discussions with them.

It was important for them to know that we weren’t going to let up

so that they knew the pressure was going to keep coming for them

to be able, frankly, to try and drive policy down to the provinces

and try and encourage the enforcement of the intellectual property

laws. So it goes all the way from sort of how you interact with a

19

country’s leaders all the way down to the enforcement at the local

level.

Senator BURR. Thank you. Thank you, Mr. Chairman.

The CHAIRMAN. Fascinating.

[Laughter.]

It really is. I am learning a lot here.

I need to go back to a few more basics, though, for the record.

So could you describe some of the different modes of price control,

including direct and indirect price caps, reference pricing, profit

controls?

Mr. ALDONAS. Yes. I am going to tick through a list, Mr. Chairman, that covers most of what we saw.

The principal methods that the OECD countries use to control

pharmaceutical prices and cost are referencing pricing, approval

delays, procedural barriers, dispensing requirements, and prescribing restrictions and reimbursement controls.

Reference pricing and other price controls try and control the reimbursement level, not the manufacturer’s price. In the process,

the price is determined based on prices in other countries, an international reference price, or relative to existing therapies in the

same country, what is known as a therapeutic class reference price.

With international reference pricing policies, they don’t factor in

differences in per capita income which influences price differentials

across countries, nor do they take into account the impact on other

countries of price controls that have won the final reimbursement

price.

Therapeutic class reference price is more along the lines of what

you described earlier, Mr. Chairman, where you take a range of different pharmaceuticals, not all of which are directly comparable in

their efficacy, but group them in a therapeutic class and one which

will have less efficacy will naturally command a lower price. But

in effect, what you will end up doing is averaging even the true innovative medicine that has gone a step beyond in technology with

the price of that generic brand or the off-patent branded product.

So in a net effect with all the reference prices system, there is

sort of an averaging that goes on that knocks down the amount of

economic rents that would flow from innovation or from a patent

for the patent holder and takes those economic rents and implicitly,

through that price device, provides it to the generic maker. That

has the effect of fattening the profits for the generic company, reducing the incentive to compete on that side, as well as cutting the

innovation that somebody is going to fund on the pricing side.

A second area where they impose controls is direct controls on

volumes, where they control the quantity of a new drug that can

be sold in a country. It is the harshest form of sort of rationing that

goes on. At some point, the quota runs out and there is no more

of that medicine available regardless of its efficacy in treating specific diseases.

They impose profit controls. It is a little bit like a cost-plus contract over at the Defense Department in that sense. They essentially just tell you how much you are going to be able to earn on

that, regardless of what the market would allow you to command

under that system.

20

A good example is the U.K. currently places limits on the profit

a company can earn from all sales in the U.K. National Health

Service. In one sense, it is the assertion of buying power, but you

are really talking about a monopsony in the case of the U.K. National Health Service.

And then there is a series of things that sort of fall into the category of approval delays. I referred to the complexity and the lack

of transparency in the process of marketing and price approval systems that result in major launch delays of new drugs coming on

the market that would provide greater competition to other innovative medicines and potentially have a price effect.

Certainly from the point of view of our industry, one of the

things you are always concerned about in dealing with governments as a trade matter is the extent to which they want to leave

all regulation in the form of a black box so that our companies really don’t know the basis on which they could compete. They are

asked a series of questions. They provide data. A decision is made.

It comes out, which may or may not be consistent with the underlying economics.

And then ultimately, approval policies employed by OECD countries delay the number of new drugs that come on the market because of the length of time it takes. That essentially gives consumers less choice, reduces the competition in the marketplace, and

ironically, has a negative effect in terms of the price competition

that would go on even under a national health system like the U.K.

So you have a system where, as I said earlier, they not only are

jeopardizing intellectual property protection and reducing the competition that would flow from new and innovative medicines, but

perversely are denying themselves the benefits of greater competition from a wider range of generic drugs, as well.

The CHAIRMAN. My experience with price controls comes from

when I first went into the shoe business just after I was married

and started a store in the early 1970s. When it was rumored there

were going to be price controls, the price of our shoes went up

about 30 percent. And then just before they went into effect, they

went up another 20 percent. And then each year, they went up the

maximum of 10 percent. But essentially, consumers were paying 50

percent more than they should have been because of price controls,

so I am always a little bit concerned about that.

Mr. ALDONAS. I think your skepticism is well earned.

[Laughter.]

The CHAIRMAN. In the trade promotion authority that Congress

gave the President, the elimination of government measures such

as price controls and reference pricing, I believe are a principal negotiating objective. Is it the policy of the administration that pharmaceutical price controls are a legitimate trade issue that should

be addressed through bilateral and multilateral agreements?

Mr. ALDONAS. It is, and, of course, we are working on that. Obviously, you are working in a sensitive area with health care systems

that are largely beyond the scope of trade agreements. We don’t

use trade agreement to try and force countries to rewrite their entire health policies. But where you do have practices that undercut

commitments that otherwise have already been made, for example,

in the context of the TRIPS agreement or other intellectual propVerDate 11-MAY-2000 12:56 Sep 02, 2005 Jkt 000000 PO 00000 Frm 00024 Fmt 6633 Sfmt 6601 S:\DOCS\20046.TXT SLABOR3 PsN: SLABOR3
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erty arrangements, and rules that we normally ask for when we

come to the table and talk to an FTA, we do want to address the

economic effects of these practices on your pharmaceutical companies.

So the answer is yes. Now, the problem, of course, is that it is

rare that we are negotiating a free trade agreement with an OECD

country. Australia is the only example. Most of the OECD governments are either in the European Union or are already part of a

free trade agreement with us, Canada and Mexico being members

of both the OECD and the NAFTA. And so the availability of future free trade agreements as a tool is something which I would

be surprised if we can use it effectively if we are not going to engage in a serious negotiation on a free trade agreement with

Japan, Korea, or Europe. At this point, of course, the focus is largely on the WTO rather than trying to do free trade agreements with

that set of countries.

What that leads us to do, Mr. Chairman, is—and it is a point I

always like to emphasize, is that trade policy doesn’t fall solely

within the limits of negotiating in a WTO or an FTA that qualifies

under the Article 24 of the GATT or something like that. Trade policy goes on every working day, and when we sit down with our

friends in Europe in particular, what we try to engage them on is

to understand the implications for their economies of these sorts of

practices. They face the same demographic challenges we face, with

fewer workers per retiree. They face the same sorts of challenges

we have in terms of reducing the cost by increasing the flexibility

on the macroeconomic side of the economy.

And what we point out to them is they have to compete on the

basis of innovation, as well. If their economies aren’t flexible

enough to be able to compete with rising China and rising India,

they won’t succeed in the long run. We will lose export markets

and we will lose the strength that that economy can provide our

European allies. So we make the arguments more on the lines of

saying, you have a Lisbon agenda. You are trying to reform the

economy. Doing something solidly about health care that brings

market forces to bear would actually be beneficial in that longer

run of what they are trying to achieve economically in Europe right

now.

The CHAIRMAN. I know my time has expired, but I want to do

just one more question along this line. What kind of difficulties will

you have in your negotiations if we have a piece of legislation that

specifies that American companies have to provide to Canada so it

can be reimported back into the United States all of the drugs that

the United States would like to have? I am trying to fit this into

a free trade thing where we are telling a company that regardless

of what their margins are, their price controls are, they still have

to bring it back into the country.

Mr. ALDONAS. Well, the more that we engage in that sort of direct control, issuing an edict to companies in the U.S. market about

what they will do in the context of trade, the more that we provide

cover for what other governments would do to intervene in the

market themselves and reduce the interplay of market forces that

benefit our companies and that we bargain for whenever we sit

down at the negotiating table. So ultimately, it undercuts what we

22

would otherwise prefer to achieve, which is the full play of market

forces between these economies rather than introducing further

distortions.

The CHAIRMAN. Thank you.

Mr. ALDONAS. Surely.

The CHAIRMAN. Senator Burr, did you want to do some more

questions?

Senator BURR. Just one additional question, if I can, stimulated

by something that Grant said.

You talked about the U.K.’s policy, or when they wanted it to be

a policy of limiting profit of a drug company. Is that de facto a nationalization of the pharmaceutical industry?

Mr. ALDONAS. Well, you know, they don’t have a written constitution, so it is a little more difficult than when you have something written into American law under the Fifth Amendment that

prevents expropriation directly and gives individuals rights against

their government to protect their property rights.

But what you have to understand is when these rights are conveyed, they do become property rights. And when you are taking

those property rights away or undercutting the utilization of it,

that is, in fact, an expropriation. And ultimately, whether it is in

economic or strictly legal terms, the thing to focus on is you are

taking away the ability of them to exercise the rights that you otherwise have granted. You are diminishing their ability to take the

full exercise of those rights.

If we thought about it in the U.S. context, it goes back to law

cases I learned over 25 years ago like Schecter Poultry, where we

flew Air Force planes over a poultry farm and we expropriated the

chicken farm because we killed all the chickens. That is the level

of what you are doing. You are having an impact on the ability of

that individual to use their property in a way that generates a

property and a return for their family.

Senator BURR. I can’t remember all the specifics that led to our

effort to try to harmonize our drug approval standards with the

European Union, and I know you weren’t involved in that process,

it was an FDA function, but needless to say, we still sit here today

with the inability to reach those harmonization agreements because we won’t accept the approvals of some of the E.U. members

and allow their approved products to come into our stream.

What effect would it have on the United States were we to just

go out and say, ‘‘Okay, we agree to your harmonization and we will

accept all E.U. members’ approvals?’’

Mr. ALDONAS. It is a delicate response, but the truth of the matter is one of the reasons I don’t think we could reach an agreement

on mutual recognition agreements on food and drug approvals is

that I don’t think there is sufficient confidence in an E.U.-wide

Food and Drug Administration, the equivalent of our FDA, to actually provide the kind of intense scrutiny that our FDA provides.

Now, they are coming on-stream with something that may work

eventually, but at this stage, I think if you talk to the experts at

FDA, I think there are still concerns.

At some point, you have got to listen to the market. The constituents in Europe are saying that it is not strong enough, and so I

would be worried about us sort of buying into a system that their

23

own constituents feel isn’t actually adequate to the task in Europe

itself.

Senator BURR. Is it safe to say——

Mr. ALDONAS. That will come, but it is not there now.

Senator BURR. Is it safe to say that, potentially, were we to do

that, this same hearing would turn into a drug safety hearing

based upon the absolute truth that we lower the gold standard that

we have at the FDA to accept theirs?

Senator BURR. You certainly would be looking at the risk associated with the approval process in individual countries. Again, I

know it is sensitive diplomatically, but the fact of the matter is the

E.U. combines a lot of different countries at a lot of different levels

of economic development and a lot of different levels of resources

they can dedicate to government functions that we take for granted

in the United States.

We have a tendency—I think it is the classic thing where you

need to open markets. There is no doubt about that. You also have

to be realistic about what other governments can spend on enforcement that, like I say, we take for granted as a carrying cost in this

country. That is not there. That level of investment hasn’t been

there, for example, in the 10 new entrants in the E.U.

So if you are going to sit down and talk with the E.U. about that

sort of mutual recognition agreement, frankly, the addition of the

10 new countries raises the concerns that I would have and we

would have to ensure that you really had a consistent and uniform

approach that would achieve the same results we would and that

it would be applied E.U.-wide before I would suggest that that is

something you would want to buy into.

Senator BURR. Thank you, Mr. Chairman.

The CHAIRMAN. Senator Isakson.

OPENING STATEMENT OF SENATOR ISAKSON

Senator ISAKSON. Thank you, Mr. Chairman. At the risk of being

very redundant, because I apologize, sir, for being late, I will really

only ask one question, which hopefully won’t be redundant because

it is somewhat personal.

As a member of the House, when given the occasion in the end,

I did not support reimportation legislation, and that is a tough

vote. In the end, the reasons that compelled me were, first, what

you have been discussing with Senator Burr, which is the safety

factor, which is a real issue, and there are plenty of anecdotal stories to bear that out.

Secondly was I do believe the market works and I am a believer

in the free market and don’t think we should directly or indirectly

certify price controls because it begins to mess everything up.

So the question I want to ask is on that second statement. I believe that our system encourages the development and the research

that brings about the breakthroughs in health care that everybody

my age is enjoying. I took two pills when I left this morning, Zocor

and Nexium. They have been wonderful for me.

Mr. ALDONAS. I took five. I just want you to know I am right

with you.

[Laughter.]

24

Senator ISAKSON. Can you elaborate on that point for a second

in terms of the benefits of our system in terms of its encouragement of the development of new and meaningful breakthroughs,

understanding that price is important, but it is important in the

context of what you are able to buy and what you are able to buy

can actually do for you?

Mr. ALDONAS. Senator Isakson, I am glad you asked that question. Let me answer it two ways, one that is with respect to the

pharmaceutical industry and one that really flows from our analysis of the manufacturing sector in the United States generally.

First and most importantly, the market should tell us, because

companies are moving to the United States to do their R&D, and

because we innovate from that innovation and those innovative

medicines make it to the market in the United States much earlier

than they do anywhere else as a consequence, that consumers are

benefitting from both the investment that our companies make as

well as attracting investment which, I hate to say it, means disinvestment from our friends in Europe and Canada and elsewhere,

but investment here, because we get the leading edge in terms of

new and efficacious medicines much sooner than they do. We also

get the benefit of other products becoming generics much sooner

than they do. And so the system works in a way that should both

drive innovation as well as set the limits on substitutability with

more powerful generic competition.

So with respect to pharmaceuticals alone, you are really encouraging new products to get to the market quicker and new generics

to get to the market quicker so that you are having an impact both

with respect to the competition you get from new innovations and

the competition you get on price from generics or from off-patent

branded products.

The more powerful point, to be honest with you, is that you can’t

take pharmaceuticals, as far as I am concerned, out of the broader

context of what we are trying to achieve in our economy. We looked

at the manufacturing sector over the last couple of years because

while there was a one-half a percent reduction in the last recession

economy-wide, there was a 6 percent reduction in manufacturing

and a lot of people wanted to know, well, why are you paying so

much attention to manufacturing? You know, the old line that Michael Boskin had said that we don’t care whether it is potato chips

or whether it is micro chips.

Well, the fact of the matter is the reason you look at manufacturing and pharmaceuticals within that is because manufacturing produces 90 percent of the innovations that raise productivity in this

country, that increases the productivity of the workforce that is on

the job, and that ultimately makes our economy more flexible and

able to adjust to this new competition we are going to face from a

global economy.

And so the reason you want to work very, very hard at preserving the ability to provide that return to innovation is because that

is what drives the economy and will continue to make us competitive, continue to give people jobs, and when you are thinking about

more retirees per worker, it means that the only way we can raise

our standard of living is by raising our productivity, and the key

to that at the end of the day is innovation.

25

So pharmaceuticals, you can see the impact alone. There is a

much broader impact of every time, whether it is pharmaceuticals

or one of our other industries. You start to dent the incentive for

innovation in this economy, because it is where we live and it is

where we are going to compete.

Senator ISAKSON. Would you amplify, because I want to make

sure I understood what you are talking about, you talked about

bringing generics to the market faster in America. Would you amplify on that?

Mr. ALDONAS. Yes, sure. Actually, it is the result of some very

valuable legislation that Congress passed that encourages the introduction of generics as soon as products go off-patent, and that

is something that has led to the current statistics we see where 50

percent of the drugs in the United States that are sold are

generics, whereas that percentage is far lower in every other OECD

country where there is not only less of an incentive to use generic

medicine because of the price controls, but there are actual barriers

to the generic firms providing information about efficacy and price

to doctors and consumers.

Senator ISAKSON. Is there a difference in patent protection times?

Mr. ALDONAS. No. With respect to our European counterparts, I

think there is certainly comfort that the rules as written and as enforced on intellectual property live up to the WTO standards. The

concern more is that when you impose something like price controls

that deny a patent holder the effective use of the rights that came

with the patent, that you are diminishing the incentive to investment and the power that can provide to the market.

Senator ISAKSON. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you very much.

I have some other questions, but I will submit those and we will

leave the record open for 10 days so that others can submit more

questions.

You are a wealth of information and I appreciate the conversation we had before we ever even started, where you were outlining

some of the needs for some further work in this area of the report.

Mr. ALDONAS. And we look forward to working with the committee in terms of developing that.

The CHAIRMAN. Thank you.

Mr. ALDONAS. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you very much.

The CHAIRMAN. While the panel is taking its place, I will go

ahead with introductions.

The next panel, we have Dr. Robert Goldberg, who is a Senior

Fellow with Manhattan Institute. He is the Director for the Center

for Medical Progress for that Institute in New York City, and he

will comment on the impact of price controls on U.S. competitiveness in biotechnology and on investment in genomics and personalized medicine.

We have Dr. Benjamin Zycher, who is a Senior Fellow with Pacific Research Institute for Public Policy. He studies the economic

and political effects of regulation. His testimony will focus on the

true nature of free trade and the costs of price controls.

We have Mr. Stephen Pollard, who is a Senior Fellow with the

Centre for the New Europe. It is a nonprofit, nonpartisan research

26

foundation headquartered in Brussels. The center is the leading

forum for discussing the practical implications of European Union

policies. Mr. Pollard’s testimony will focus on the impacts of price

controls and parallel trade on patients and on innovation.

Mr. Kevin Outterson, an Associate Professor at West Virginia

University College of Law, is a member of the West Virginia Pharmaceutical Cost Management Council, which examines ways to

lower drug costs for West Virginians by establishing a pricing

scheduling using the Federal Supply Schedule, Canadian drug

prices, and other standards. He will comment on the pharmaceutical provisions in the Free Trade Agreement with Australia

and how he believes it will have a negative impact on both U.S.

and Australian consumers.

I hope my summary is correct. You can correct me as you speak

if not.

Dr. Goldberg.

STATEMENT OF ROBERT M. GOLDBERG, PH.D., DIRECTOR,

CENTER FOR MEDICAL PROGRESS, MANHATTAN INSTITUTE

FOR POLICY RESEARCH, NEW YORK, NY

Mr. GOLDBERG. Thank you very much, Mr. Chairman and members of the committee, for giving me this opportunity to testify.

The CHAIRMAN. I will mention that everybody’s full statement

will be a part of the record. If you can summarize, it will drive the

points home more and give us more time for questions. Thank you.

Mr. GOLDBERG. I should just also add that I am also Chairman—

we have a 21st Century Task Force on FDA Reform that is focused

on finding better ways to usher in the next generation of medicines.

Let me start off by saying that importation is the importation of

price controls and it is the appropriation of intellectual property.

Many people believe that importation will give Americans access to

cheaper drugs, but price controls or importation of price controlled

medicines will not make medicines more affordable. It will make

them unavailable and undiscoverable. It will deny millions of

Americans who are dying and suffering from diseases ranging from

Alzheimer’s to eating disorders the targeted medicines that will

save lives and our health system billions in the years to come, and

they will drive up what Americans pay for health care.

Importing price controls would be the wrong policy for the following reasons. First, they delay access to the best life-saving medicines through prolonged price negotiation. Five years after its first

European launch in Europe—well, obviously—the first targeted

drug for breast cancer, Herceptin, is only available in 70 percent

of the continent. New drugs like Avastin for cancer, Humira for

rheumatoid arthritis, and Xolair for asthma, have yet to be

launched in most European countries.

Second, when new drugs are finally available, they are rationed.

In Australia, patients with leukemia and Alzheimer’s have to sign

contracts giving the government the right to take away breakthrough medicines, such as Gleevec and Aerocept, when bureaucrats think they don’t need them. And contrary to what people may

say on this panel, that was part of what we were trying to break

in the Free Trade Act. It had nothing to do with prices. It was tryVerDate 11-MAY-2000 12:56 Sep 02, 2005 Jkt 000000 PO 00000 Frm 00030 Fmt 6633 Sfmt 6601 S:\DOCS\20046.TXT SLABOR3 PsN: SLABOR3
27

ing to get the Australian government to explain why they would

force people to sign those kind of contracts. In Great Britain and

the Netherlands, drugs for cancer and asthma that are standard

therapy in America are unavailable.

Referencing pricing, which is being used in West Virginia and

around Europe, pegs all drugs for the same disease to the cheapest

government price for medicines and assumes that all products and

medicines are alike, with devastating consequences.

Now, the chairman talked about cholesterol drugs in Germany.

Let me tell you, in New Zealand, Australia, and Germany, the

switch to a cheaper cholesterol drug has led not only to a rise in

cholesterol levels in most patients, but a significant increase in

heart attacks compared to the previous 6 months of more expensive

therapy. The result? Higher total treatment costs and more deaths.

Formularies that assume that one or two drugs for all patients

will do, have been shown in studies to make seniors sicker and to

lead to more doctor office visits, more ER visits, and more hospitalizations. In West Virginia, the formulary for managing the

mental health drug budget in their Medicaid program limited the

access of a drug that my daughter has used to save her life. Why?

It is considered to be a ‘‘me too’’ drug and too expensive.

Now, reference pricing also encourages marginal or little innovation because there are few incentives to invest in different medicines for different patient populations. That is why price controls

will ultimately reduce the number of new medicines for treating

Alzheimer’s, cancer, blindness, and other illnesses.

By contrast, as Mr. Aldonas indicated, free market policies have

allowed America’s biotech and drug industry to thrive compared to

Europe. Last year, and this isn’t a Commerce Department number,

this is a scorecard that Europe itself, the European Commission

keeps, American and biotech pharmaceutical firms increased their

R&D investment by 16 percent compared to a 2 percent decline in

Europe. America has 75 percent of all biotech revenues; worldwide,

75 percent of all R&D expenditures; and 80 percent of all key

biotech patents.

We at the Manhattan Institute did a study of what would happen if we imposed either European or VA-type price controls on the

future of R&D and we found that R&D spending would drop by

nearly 40 percent over the next 2 decades, resulting in the loss of

nearly $300 billion in R&D expenditures and 277 million life years,

which means more pain and less gain.

And price controls would be particularly devastating to biotech

companies who have no revenues and who will be producing most

of the new breakthrough and targeted medicines in the years to

come.

I would suggest to Senator Burr that he take a trip down to a

company called Metabalon, which is developing that new platform

for targeted medicines. I think it is down in the Research Triangle

Park. They have discovered for example, that there are four different pathways for treating Lou Gehrig’s disease, not the one that

people assumed would be the case. So now we need four different

types of drugs to treat Lou Gehrig’s disease and not one.

Interestingly—I see that my time has almost expired and I will

get right to the point—Dan Vasella, who is the chairman of

28

Novartis Pharmaceuticals, opened up a research institute with

Senator Kennedy in Cambridge, and he said after the opening,

‘‘As a result of price controls, we were shifting our investment here. European

consumers are headed toward second-class citizenship when it comes to medicine.’’

Now, a lot of people believe that the NIH develops a lot of new

medicines. The GAO found that only six of the medicines that are

saving Medicare $8 for every new dollar spent on new drugs had

a patentable claim by the U.S. Government.

And I ask, if it is so easy and cheap to develop new medicines,

why are generic companies generic? Why don’t they just jump into

the game, take the government technology, slap a label on it like

bottled water, and make more money? The fact is, drugs are very

difficult to discover and they are becoming even more challenging

to discover in the future as medicines become more personalized.

This is the exciting part, and this is where I am going to close.

We already have a test to determine which people should get what

medicines at what doses. More are on the way. All of this is being

done in the United States. There is and will be no such thing as

‘‘me too’’ medicines in the future, and the great thing about it is

that targeted medicines will save billions in wasted and ineffective

care, adverse drug effects, and billions more by replacing more expensive health care services. IBM had a health care consultant who

did an estimate and said that we could probably save up to $100

billion a year in health care costs with this new platform of personalized drugs.

In closing, the best way to make newer medicines less expensive

is to reduce the cost of developing them. Using this platform of

pharmacogenomics, I believe, and our task force working on FDA

reform believes, we will be able to reduce the time it takes to find

a new drug, reduce it from 10 years to about 3 to 5, and slash R&D

costs by 75 percent.

We should spend, Mr. Chairman, more on new medicines, not

less. It is a good thing. Every time we spend a dollar on new drugs,

we save $8 on other health care costs. It is a way of making health

care better and making it more affordable. We won’t be able to continue on that path if we embrace price controls or import them.

Thank you very much.

The CHAIRMAN. Thank you very much.

[The prepared statement of Mr. Goldberg follows:]

PREPARED STATEMENT OF ROBERT M. GOLDBERG

Mr. Chairman, members of the committee, my name is Robert Goldberg. I am director of the Center for Medical Progress for the Manhattan Institute for Policy Research in New York City. Thank you for the opportunity to testify. I will focus my

comments on the impact of price controls on our competitiveness in biotechnology

and our ability to invest in the genomic revolution that will allow Americans to receive cost-effective and personalized medicine for a wide range of diseases.

Drug importation is the importation of price-controlled medicines. It is therefore

a form of price controls. I assume we are setting aside the reality that price controls

create shortages. As Americans demand more drugs and lower prices it will cause

a run on Canada and our northern neighbor will not be America’s drug store for

long. And because Europe’s inventory of medicines is tightly regulated as well, it

too will not be a large and safe source of price controlled medicines. By the time

any importation bill is passed, there won’t be a lot of medicines to import.

Congress should oppose drug importation for several reasons.

29

1Pricing and Reimbursement Review 2003, Cambridge Pharma Consultancy, London, England

2004. 2PARAXEL’s Pharmaceutical R&D Statistical Sourcebook 2004/2005.

3The EU Industrial R&D Scorecard, 2004, European Commission 2004, http://euiriscoreboard.jrc.es/docs/2004—Scoreboard—%20VOL%20II.pdf. 4 Novartis to Move Global Lab to U.S. The Wall Street Journal, A3¥ 17. May 2002—Vanessa

Fuhrmans and Rachel Zimmerman. 5 Novartis Reaps Benefits From CEO’s Changes By GAUTAM NAIK. Staff Reporter of THE

WALL STREET JOURNAL, October 13, 2003.

First, it simply supports the protectionist policies of Europe. The regulation of

prescription drugs in Europe and Canada are barriers that keep our innovative

drugs down and out and protect less innovative companies that are not globally

competitive. Europe and Canada consistently under price American medicines.

Price controls involves setting a reimbursement policy that first, delays to the

market through prolonged price negotiation. For example 5 years after it’s first European launch in Europe, the first targeted drug for breast cancer, Herceptin is only

available in 70 percent of the continent. New drugs like Avastin for cancer, Humira

for rheumatoid arthritis and Xolair for asthma have yet to be launched in most European countries.

Second, even when new drugs are made available they are priced beneath American prices and patient access is restricted.1 In Australia, patients with leukemia

and Alzeheimer’s have to sign contracts giving the government the right to take

away breakthrough medicines when bureaucrats think they don’t need them. In

Great Britain and the Netherlands, drugs for cancer and asthma that are standard

therapy in America are strictly rationed. And in all cases, the reimbursement rates

for the drugs are far below what the biotech companies get in America.

At the same time, these governments pay premium prices for their countries own

branded generic medicines. In Germany for example, they spend more on brand

name generic medicines as a percentage of drug expenditures to the exclusion of

newer medicines developed by American firms for the same diseases. Instead that

money is used to prop up less efficient German firms that are less innovative and

unable to compete globally. The German price control system protects domestic

firms at the expense of more cost-effective and globally competitive American products. Australia similarly devotes more of their pharmaceutical dollar to generic

drugs that are 90 percent of the price of brand drugs through their protectionist

schemes.

Thanks to America’s free market pricing, U.S. biotech and pharmaceutical firms

invest more relative to Europe. In 2003, American biotech and pharmaceutical firms

increased their R&D investment by 16 percent compared to a 2 percent decline in

Europe.2 Today, Europe pharma companies spend less than half of their R&D in Europe, down from 73 percent in 1990. While Europe has more biotech companies than

America, we have 75 percent of all biotech revenues worldwide, 75 percent of all

R&D expenditures and 80 percent of all key biotech patents.3

Indeed, a day after Dr. Daniel Vasella the CEO of the Swiss-based Norvartis

Pharmaceuticals and Senator Kennedy opened the Novartis Institute of Biomedical

Research, in Cambridge, MA. Dr. Vasella said, ‘‘There’s no doubt that growth and

profitability in a market-place help determine where research investment goes,’’ 4 In

a separate interview Dr. Vasella went on to say,

‘‘Any government under pressure could do things that are shortsighted. We’ve

seen the effect in Europe—less investment in R&D and less progress in treating

diseases like cancer. Many Europe-based companies are focusing increasingly on

the U.S. market. As a result of price controls, European consumers are heading

toward second-class citizenship when it comes to access to medicine.’’ 5

While Europe’s price controlled pain may be our gain, ultimately I believe the continent and the entire world can benefit from our commitment to medical innovation

and should embrace our market-based approach to improve their economic and

physical well-being. Indeed, it is part and parcel of our entrepreneurial and innovative character as a Nation that Americans have avoided price controls as a costsaving measure. Instead, we have shown that we can save money by investing

health care dollars by improving quality, and investing more money on the most valuable and cost-effective medical technologies available. Time and again, that has

meant spending more on prescription drugs, which at 11 percent is still the smallest

part of our health care budget.

Since the advent of penicillin, new medicines have produced the biggest gains in

well-being and life expectancy compared to most other medical goods and services.

The more we spend on new medicines, the more we save in money and in lives. As

Columbia University economist Frank Lichtenberg has shown, over the past 30

30

6 ‘‘Pharmaceutical Innovation, Mortality Reduction, and Economic Growth,’’ in Measuring the

Gains from Medical Research: An Economic Approach, ed. by Kevin M. Murphy and Robert H.

Topel (Chicago: University of Chicago Press, 2003), pp. 74–109. 7DiMasi, J. The economics of follow-on drug research and development: trends in entry rates

and the timing of development, Pharmacoeconomics, Feb. 2004. 8 Horn SD, Sharkey PD, Tracy DM, Horn CE, James B, Goodwin F. Intended and Unintended

Consequences of HMO Cost-Containment Strategies: Results from the Managed Care Outcomes

Project, The American Journal of Managed Care 2:3 (March 1996): 253–264. 9 Are Drug Price Controls Good For Your Health? Authors: John A. Vernon, Rexford E.

Santerre, and Carmelo Giaccotto Source: Center for Medical Progress at the Manhattan Institute, December 2004. 10Pharma 2010: The threshold of innovation IBM Institute for Business Value study by: Steve

Arlington, Sam Barnett, Simon Hughes and Joe Palo, 29 Apr 2004.

years, each generation of new medicines reduces what it costs to treat disease, increases productivity and lengthens our lives. For every dollar Medicare will spend

on new medicines in the future, it will save $8 on hospitals, physicians and home

health care.6

Let me digress for a second to discuss the claim that me-too medicines exist and

that we can save research and health care dollars by eliminating what we spend

on them. The majority of follow-on drugs were in clinical development before the

breakthrough drug for that disease was approved. In addition, one-third of followon drugs for a disease receive FDA’s priority rating.7 Most follow-on drugs have different mechanisms of actions, side effect profiles. Finally, as a number of studies

have shown, formulary limitations on the elderly, based on the assumption that all

medicines are alike make seniors sicker and to lead more doctor office visits, more

emergency room visits and more hospitalizations per year. In Australia and Germany, patients are routinely denied access to the newest medicines, even those such

as Gleevec or Herceptin that have known disease targets and genetic tests that can

identify for whom the medicines work. Hence, common cost-containment strategies

based on the me-too medicine myth are associated with higher health care costs and

poorer health.8

This me-too medicine myth flows from the belief that most drug development is

imitative or merely the easy part of bringing medicines to market. As a result, price

control supporters claim—without evidence—that it is cheap to develop new medicines or that government does all the research and that drug companies simply market what government labs invent. That begs the question that if drug development

is more like opening up a Dunkin Donuts franchise, why aren’t more generic firms

jumping into the game? Why do biotech venture capital firms demand such a high

rate of return?

Indeed, critics claim that companies don’t need high profits to be innovative.

That’s ironic since under price controls in Europe, innovative drug development has

been on the decline.

Using Dr. Lichtenberg’s analysis as a starting point, the Manhattan Institute

commissioned economists from the University of Connecticut to do a study to uncover the impact of European and VA type price controls on medical innovation and

access to new medicines in the United States over the next 25 years. A copy of the

full report is available here today and on the Manhattan Institute Web site. The

researchers found that R&D spending will drop by nearly 40 percent over the next

2 decades, resulting in a loss of nearly $300 billion in R&D and 277 million life

years.9

Given the negative impact on future investment, the decision to impose or import

price controls comes at a critical time in the course of medical progress. I believe

that the impact of price controls on our well being would be greater than can be

imagined because the scientific opportunities that await are so exciting and so significant. Further, they often originate in small companies with no revenues. Taking

medicine to the next level of targeted drug development will require a complete

transformation of the discovery and development platform and billions in new investment each year.

Smaller biotechnology firms—many of which have pharmaceutical firms as venture partners—will lead the way in developing the next generation of targeted medicines. Thirty of the 34 drugs approved by the FDA last year came from such companies and fit the targeted medicine profile. Indeed, the era of the blockbuster drug

is over. All companies are investing in the development of medicines targeted to specific molecules that control how we respond to drugs and to the different ways diseases are triggered.10 In this fundamental respect, all companies large and small

are starting from scratch.

This will lead to more cost-effective medicine and better health in two ways. First,

gene-based diagnostics will be able to determine what drugs that are on the market

31

11 Ibid.

now work best for which patients. Contrary to the popular belief that there are metoo medicines, most people respond differently to the same medicine or need different drugs to obtain the same outcomes. My daughter, whose life was saved by

the last of five drugs given to her for an eating disorder is a case in point. We will

have an array of genetic tests to guide such decisions.

Second, new drugs will be tailored to smaller groups of patients—or even a single

person—based on their genetic response or adverse reaction to drugs as well as to

differences in how diseases unfold. We have seen that with cancer drugs but the

same will apply to drugs for diabetes, arthritis and heart disease.

Here too, American companies have been leading the world in this next medical revolution investing nearly $4 billion in gene-based tools for researching and developing treatments. Price controls and importing price controls will only discourage

the personalized medicine revolution. This revolution will save more money and

lives than any across the board price cut might generate. That’s because the cost

of poorly caring for patients with Alzheimer’s, cancer, Parkinson’s, blindness, stroke

and others is much more expensive than the personalized and targeted medicines

that will treat. Put another way, treating or curing a disease with a new medicine

is always cheaper than the disease itself.

In the final analysis, the best way to make new medicines less expensive is to

reduce the cost of developing them. As more companies move toward targeted medicines and as the FDA embraces scientific reforms that encourage their development,

companies will be able to reduce the time it takes from target identification to

launch from more than 10 years to between 3 and 5 and slash research and development costs by 75 percent.11 That will save companies and consumers billions of dollars a year in drug costs without undermining incentives for investment or access

to new medicines. The Manhattan Institute has established a 21st Century FDA

Task Force that seeks to create a path toward personalized medicine. We welcome

the opportunity to assist the committee in reducing the cost of drug development.

Price controls will not make medicines more affordable, they will make them unavailable and undiscoverable. We can pay for new medicines as we always have, by

taking the money we used to spend on intensive care units, polio wards, on TB hospitals, on HIV hospice, on body bruising chemotherapy, on nursing homes and

spending it to cover more people with miracle cures. And we can pay for them by

transforming the way we discover and develop new medicines by sustaining our investment in genetic science. Let’s embrace the future and avoid the mistakes of the

past.

The CHAIRMAN. Dr. Zycher.

STATEMENT OF BENJAMIN ZYCHER, SENIOR FELLOW IN

ECONOMICS, PACIFIC RESEARCH INSTITUTE FOR PUBLIC

POLICY, SAN FRANCISCO, CA

Mr. ZYCHER. Thank you, Mr. Chairman and distinguished members of this committee. I will summarize briefly the four central

points covered in my written testimony, which has been submitted.

First, pharmaceuticals subject to price controls overseas are not

cheap and I urge this committee to reject efforts to impose price

controls on U.S. medicines, whether directly or indirectly. Any such

policies incontrovertibly would mortgage the future in favor of the

present by reducing the market research and development incentives yielding more improved medicines, alleviating future human

suffering.

Second, foreign price controls enable overseas consumers to obtain a free ride on the prices the American consumers pay for research and development. U.S. trade and other policies that raise

foreign prices toward competitive levels unambiguously would benefit U.S. consumers regardless of the assumption one makes about

the competitiveness of the U.S. pharmaceutical sector.

Third, the recent free market argument favoring the importation

of price controlled medicines from overseas is fundamentally flawed

32

* The views expressed are those of Benjamin Zycher, and do not purport to represent the

views of the Pacific Research Institute for Public Policy or of any of its officers or contributors.

Benjamin Zycher can be reached at 818-706-1028 or at benzycher@bzecon.com. A short biographical summary is appended to this testimony.

because compulsory licensing processes combined with ambiguities

and the failure to work the patent framework mean that negotiations would be highly vulnerable to implicit or explicit threats of

patent theft. At a more general level, free markets domestically,

even in principle, cannot be reconciled with the enforcement of

price controls overseas.

Fourth, Federal price negotiations over the long term would

harm consumers. The Federal Government is not like a very large

pharmacy chain. It is instead so big that it has monopoly pricing

power as a buyer that large private sector buyers engaged in competitive negotiations do not have. At a more subtle level, private

sector buyers must compete for customers and so must balance the

conflicting objectives of low prices and broad formulary availabilities. The Federal Government, on the other hand, does not have

customers as such so that short-term budget pressures inexorably

will tend to crowd out consumer choice over time. That is the deeper implication of the evidence-based medicine approaches now

being considered and adopted by some States. The non-interference

provisions of the 2003 Medicare Act truly were far-sighted and I

urge this committee to continue that approach.

In conclusion, we want our medicines to be affordable and we

want them also to be available over the long term. That is why

price controls must be rejected. Thank you very much.

The CHAIRMAN. Thank you very much, and thanks for the conciseness of your statement. I will repeat that the full statement will

be in the record and we appreciate that.

[The prepared statement of Mr. Zycher follows:]

PREPARED STATEMENT OF DR. BENJAMIN ZYCHER*

Thank you, Mr. Chairman and distinguished members of this committee, for this

opportunity to offer my perspective on the now-prominent issues of pharmaceutical

importation, domestic/foreign pricing differentials, and the long-term economic effects of pharmaceutical price controls and Federal price negotiations, particularly in

the context of consumer well-being.

Well-known principles of economic analysis and existing bodies of data not subject

to serious challenge yield several conclusions on the prospective adverse effects of

the importation of price-controlled pharmaceuticals into the U.S. Moreover, the recent ‘‘free-market’’ argument favoring the importation of price-controlled pharmaceuticals is deeply flawed, as discussed below. Similarly, the perverse market effects

of a possible imposition of Federal negotiating power—Federal ‘‘interference’’—in the

context of the Medicare program are not difficult to predict. Alternatively, U.S. consumers would benefit from efforts to end the free ride that foreign consumers are

able to obtain on U.S. research and development investments, financed largely by

U.S. consumers. These central observations and some other ancillary arguments

form the basis of my testimony today.

I. PHARMACEUTICALS SUBJECT TO PRICE CONTROLS OVERSEAS ARE NOT ‘‘CHEAP’’

The true economic cost of pharmaceuticals—that is, the real resource cost to the

economy of developing and producing them—cannot be reduced without improvements in the economic and regulatory environment, a broad set of issues outside the

scope of today’s hearing. The importation of drugs subject to foreign price controls,

far from reducing real economic costs, by necessity would import those price controls

into the U.S. in terms of prices received by manufacturers. To the extent that lower

prices for consumers result, that would not represent a true reduction in ‘‘costs’’; instead it would be a wealth transfer from pharmaceutical producers and possibly

33

1See, e.g., U.S. Department of Health and Human Services, Report on Prescription Drug Importation, December 2004, pp. 65–67. 2See Ibid., chapters 7 and 8. See also U.S. Department of Commerce, International Trade Administration, Pharmaceutical Price Controls in OECD Countries: Implications for U.S. Consumers, Pricing, Research and Development and Innovation, December 2004, chapters 2–4. 3See, e.g., Frank R. Lichtenberg, ‘‘Are the Benefits of Newer Drugs Worth Their Cost? Evidence From the 1996 MEPS,’’ Health Affairs 20(5), September/October 2001, pp. 241–51. 4See U.S. Department of Commerce, op.cit., chapter 8. 5 In order to see this, suppose that market conditions shifted for some reason, yielding a reduction in future pharmaceutical demand and prices. That would shift the entire distribution

of investment returns, but would not bias future returns in favor of losses. 6This seems to be the argument of Professor Kevin Outterson in his ‘‘Statement’’ to the Committee on Ways and Means, U.S. House of Representatives (undated), on the U.S.-Australia Free

Trade Agreement.

from foreign consumers to U.S. consumers in the short run, with adverse consequences for U.S. consumers in the long run, as discussed below. The more likely

short run outcome for U.S. consumers, depending on market conditions, would be

little or no price reductions but instead price increases for various market participants (intermediaries) in the supply chain, since the importation of price-controlled

pharmaceuticals would not affect either market demand conditions or market supply

conditions on the margin.1

In the long run—which is not necessarily a long period of time—it is incontrovertible that lower prices will reduce the marginal efficiency of investment, that is, the

incentive to invest in the research and development of new pharmaceuticals.2 Since

ultimately it is anticipated consumer demands—for cures, for disease alleviation, for

better health, and for reduced suffering—that drive the research and development

choices of profit-seeking firms, lower anticipated prices will reduce research and development investment and thus the future flow of new drugs. The adverse future

effects in terms of fewer cures and greater suffering will be real economic costs attendant upon the importation of foreign price controls; but such costs will not appear directly in government budgets or private balance sheets, except to the (significant) extent that more-costly hospitalizations and other substitute medical procedures will be used in place of the drugs that will have failed to have been developed

due to the long term effects of price controls.3 Thus will the adoption of price controls through the vehicle of the importation of price-controlled drugs mortgage the

future in favor of the present by weakening incentives for research and development

investment and other activities yielding streams of new and improved medicines.

Based upon the recent experience in the non-U.S. OECD and upon simulation exercises and other analyses, the magnitude of this projected adverse research and development effect varies somewhat, although it is never predicted to be small.4 My

view is that all of these estimates are biased downward because they fail to take

into account the fact that the imposition of price controls, whether direct or indirect,

introduces an asymmetry into the statistical distribution of future returns to research and development, in that the price controls have the effect of limiting (truncating) upside potential while leaving downside risk unaffected. This is an effect

separate from the price reduction itself, the implication of which is that the long

term effects of price controls in terms of a reduced flow of new and improved drugs

is likely to prove larger rather than smaller.5

Some observers have argued that there can be an inefficiently large amount of

pharmaceutical research and development investment, so that a reduced amount

still may be efficient. High purported ‘‘profits’’ (either undefined or defined poorly)

then are used to infer that current investment is too high.6 But if ‘‘profits’’ are

(uncompetitively) high—adjusting for investment risk—we would expect to see significant entry into the market by new firms. We do not.

More generally, the current emphasis by some commentators on total revenues or

total profits as predictors of research and development incentives is incorrect. It is

the marginal efficiency of investment for a particular research and development effort that is relevant. Consider, for example, a firm earning enormous profits, however defined; would it sink dollars into a project that it knows will not yield adequate returns (however broadly defined)? Regardless of overall revenues or profitability, firms have powerful incentives to make only efficient investments, that is,

investments expected to yield at least normal rates of return with some allowance

for risk. Price controls cannot further that outcome; and competitive capital markets

will enforce such discipline.

Finally, an accounting of the true cost of imported drugs subject to price controls

must include some consideration of the safety problem, important socially in particular in the context of contagious diseases. That solutions to the safety problem

are likely to prove highly elusive is evidenced by the fact that current legislation

34

7See S. 334, the ‘‘Pharmaceutical Market Access and Drug Safety Act of 2005’’; and S. 109,

the ‘‘Pharmaceutical Market Access Act of 2005.’’ 8See fn. 1, supra. 9 An exception is marginal production cost for biologics, a topic outside the scope of this testimony. 10See, e.g., J. Dimasi, R. Hansen, and H. Grabowski, ‘‘The Price on Innovation: New Estimates of Drug Development Costs,’’ Journal of Health Economics, 22 (2003), pp. 151–185. See

also Christopher P. Adams and Van V. Branner, ‘‘Estimating the Costs of New Drug Development: Is It Really $802M?’’ December 2004. 11See Professor Kevin Outterson, op.cit., at p. 2. 12Whether U.S. producers face competitive or monopolistic market conditions, the increased

prices from overseas would increase long run incentives to produce new drugs. Because demand

is an inverse function of price—it is ‘‘downward sloping’’—the greater flow of drugs would put

downward pressure on prices. 13The latter assumption would be highly questionable and inconsistent with the evidence, but

that is an issue outside the scope of this testimony.

under discussion either shunts the issue aside completely, or apparently bestows an

‘‘FDA-approved’’ imprimatur upon foreign plants not actually approved by the FDA.7

The safety problem is discussed in detail in the Department of Health and Human

Services study noted above; I will not repeat its findings here.8

In short: As much as we want our medicines to be affordable, we also want them

to be available when needed.

II. U.S. CONSUMERS WOULD BENEFIT FROM POLICIES REDUCING THE FOREIGN

FREE RIDE

The basic cost economics of pharmaceuticals are somewhat unique, in that large

fixed costs (for research, development, and production facilities) are accompanied by

small marginal production costs.9 The large fixed costs—over $800 million per

drug 10—yield a body of knowledge, which itself is a classic collective (or ‘‘public’’)

good in that those who can find ways to avoid paying their ‘‘fair’’ share thus obtain

a free ride on the efforts of others to finance the research and development investment. Foreign price controls on drugs have the effect of yielding for foreign consumers just such a free ride at the expense of U.S. consumers.

Some have argued that policies designed to increase foreign prices would not yield

benefits for U.S. consumers because ‘‘drug companies are under no obligation to

lower U.S. prices as [foreign] prices increase.’’ 11

That argument is incorrect, regardless of the assumption one makes about the

competitiveness of the U.S. pharmaceutical market. From the viewpoint of U.S.

pharmaceutical producers, an increase in foreign prices analytically is equivalent to

an increase in foreign demand; total perceived worldwide demand would increase,

yielding an increase in the marginal efficiency of research and development investment, and so a long run increase in that investment and in the flow of new drugs.

But, ceteris paribus, U.S. demand would not change, so that the increased long run

supply of drugs would induce profit-seeking U.S. firms to reduce their U.S. prices,

that is, would put downward pressure on U.S. prices.12 Again: This is true whether

the U.S. market is viewed as perfectly competitive or as a perfectly discriminating

monopoly.13 In the short run, it is unclear whether U.S. prices would fall; demand

and cost conditions would not change, but producers might have incentives to cut

prices in the expectation of increased competition over the longer term.

III. THE ‘‘FREE-MARKET ARGUMENT’’ FAVORING DRUG IMPORTATION IS

FUNDAMENTALLY FLAWED

Some prominent supporters of free markets have argued recently in favor of the

importation of price-controlled drugs. The argument in summary is that an end to

the import ban would force pharmaceutical producers to negotiate more stringently

with foreign governments over the prices for drugs, because the prospect of ‘‘cheap’’

foreign drugs flooding the U.S. market would make it difficult to preserve U.S.

prices sufficient to cover high R&D costs. The producers also could insist upon ‘‘no

foreign resale’’ provisions in contracts, which could be enforced by limiting sales to

the foreign governments.

This argument is fundamentally flawed. Most foreign governments under their

patent laws reserve the right to engage in compulsory licensing under various conditions, one of which is a ‘‘failure to work the patent.’’ The precise meaning of that

phrase is unclear, but to foreign officials it might mean a failure to sell all that is

demanded at the controlled price. What is clear is that foreigners will not be happy

to pay more for medicine. And so it is unlikely that foreigners faced with substantial

increases in their drug costs would be fastidious in their adherence to the rule of

patent or international trade law, as interpreted by U.S. drug producers and some

35

14This essentially is monopoly power on the part of a buyer to force prices down. 15See, e.g., Sally C. Pipes, Miracle Cure: How To Solve America’s Health Care Crisis and Why

Canada Isn’t the Answer, San Francisco: Pacific Research Institute, 2004, pp. 171–179. See also,

Cambridge Pharma Consultancy, ‘‘Delays In Market Access,’’ December 2002. 16See Institute of Medicine, Financing Vaccines in the 21st Century, Washington, DC.: National Academies Press, 2004, ch. 5. See also, The Global Vaccine Shortage: The Threat To Children And What To Do About It, Proceedings of the Albert B. Sabin Vaccine Institute Ninth Annual Vaccine Colloquium, 2003, pp. 25–33.

U.S. officials. Indeed, compulsory licensing already has been used, so that price negotiations and trade environments are highly vulnerable even to implicit threats of

patent theft.

Moreover, under some prominent interpretations of patent law, producers control

their patents but not the resale of their patented products. Would contracts to limit

resale of price-controlled drugs, even if they could be negotiated and enforced, survive challenge under this interpretation? Such uncertainties inevitably will force the

producers to sign agreements eroding their ability to recover R&D costs or to protect

their intellectual property.

The basic problem with the ‘‘free market’’ position in support of drug importation

is that it tries to reconcile free markets domestically with price controls overseas.

That is a circle that cannot be squared as long as foreign governments can steal

patents; and in the final analysis, it is likely to be difficult and time-consuming to

stop a government intent on doing so. What is needed instead are U.S. Government

efforts, perhaps in the context of trade policy, designed to end the free ride that

many foreigners now obtain at the expense of U.S. consumers. That many U.S. officials now attack drug producers—whose investments have saved millions of lives—

rather than the foreign theft of U.S. intellectual property is unlikely to prove salutary.

IV. FEDERAL PRICE NEGOTIATION WOULD NOT SERVE THE INTERESTS OF CONSUMERS

Consider a large pharmacy chain or other sizable intermediary between pharmaceutical producers and consumers. That intermediary must balance two competing

objectives, which actually are the objectives of its customers. It seeks to reduce

costs, and thus prices for its customers; and it seeks to preserve a formulary broader

rather than narrower, so that it can serve as broad a market as possible, that is,

preserve more rather than less consumer choice. Both objectives are driven by competition among pharmacies and other intermediaries; that these objectives conflict

is obvious, so that private sector intermediaries, reflecting the preferences of their

customers, must find ways to balance them.

The more obvious difference between such private sector intermediaries and the

Federal Government is the sheer size of the latter as a purchaser; it is almost axiomatic that the Federal Government has more monopsony power 14 than private sector intermediaries. At a more subtle level, the Federal Government has incentives

in terms of the cost/formulary tradeoff incentives that differ substantially from those

constraining private sector intermediaries. Budget pressures are strong at all times,

so that incentives to negotiate substantial price reductions are powerful. But the

Federal Government is not a profit-seeking firm, so that its incentives to satisfy its

‘‘customers’’ in terms of broad formularies must be attenuated through political

processes; voting is simply a weaker constraint than the ability of customers to take

their business elsewhere. This is a common problem with public sector services: The

tradeoff incentives between cost (budget) reduction and preservation of service quality systematically are different from those constraining private sector choices. This

bias in favor of price reductions as opposed to formulary availability is obvious overseas,15 and arguably has affected U.S. consumers in the vaccine market.16

V. CONCLUSIONS

The interests of consumers are served by a pharmaceutical sector offering medicines both affordable and available. More generally, consumers are served by economic efficiency, that is, policies yielding an aggregate output basket as valuable

as possible. Policies that bestow benefits upon one set of consumers at the expense

of others, perhaps in the future, are inconsistent with that goal; in particular, price

controls are fundamentally incompatible with the operation of free or competitive

markets, with the institutions of free trade, and with the interests of consumers.

It is incontrovertible that the importation of pharmaceuticals subject to foreign price

controls will have the effect of importing the price controls themselves, with clear

and substantial adverse effects over the long term in terms of research and development incentives and the flow of new and improved medicines. Other analyses suggest that such policies will not save much even in the narrow dimension of budget

36

dollars and drug spending; and the longer term costs in terms of substitution of

costly substitute medical procedures and reduced human health outcomes are obvious. This committee would be wise to reject efforts to allow the importation of pharmaceuticals subject to foreign price controls.

Instead, the pursuit of consumer well-being would be served by policies—perhaps

in the context of trade negotiations—ending the free ride that foreign governments

have garnered for themselves, through the imposition of price controls, at the expense of the U.S. market. Noninterference—a farsighted policy incorporated into the

2003 Medicare legislation—with competitive private sector negotiations will further

those consumer interests as well.

The CHAIRMAN. Mr. Pollard.

STEPHEN POLLARD, SENIOR FELLOW AND DIRECTOR,

HEALTH POLICY, CENTRE FOR THE NEW EUROPE, BRUSSELS, BELGIUM

Mr. POLLARD. Mr. Chairman, members of the committee, it is a

great honor for me to be here as a foreigner to testify before you

this morning and give you a European perspective on this, the

most critical of health care issues.

For your information, my background is in policy making for the

Labor Party in Great Britain. My time as Research Director of the

Fabian Society, the oldest think tank in the world, and the Labor

Party’s in-house policy proposing vehicle, coincided with Tony

Blair’s election as party leader and I remain proud today to describe myself as a Blairite.

In my current role as Director of the Health Unit at the Centre

for the New Europe, a free market think tank in Brussels, I study

health care systems across the European Union and beyond. In my

view, there is only one thing which really matters when examining

health policy: The patient.

In that context, it is clear to me, the evidence is unarguable, that

European patients suffer directly and avoidably as a result of two

interrelated problems, price controls and parallel trade. There may

well be ideas which the U.S. could consider importing from Europe.

What puzzles me is why, despite the experience of European patients, the U.S. should be considering importing one of the most

damaging and dangerous aspects of our health arrangements.

Importation will weaken, if not destroy, the United States’s global dominance in developing new drugs. It will do that because, as

well as importing foreign drugs, importation will also import the

consequences of foreign price controls, which falsely lower prices

and in so doing deny patients access both to new medicines and

drive away research. This is not theory. It is the current experience

of European patients.

In every member state of the European Union, the state imposes,

as we have heard, price controls on pharmaceuticals. Prices are

lower in countries such as Spain and Greece than in Britain, not

because costs are lower or competition is greater, but simply because the government has decreed them to be lower. And so what

happens is arbitrageurs import drugs from Greece and Spain, making easy profits which contribute nothing to research and development and nothing to the broader health care economy.

By the end of 2001, the parallel trade in pharmaceutical products in Europe reached $3.3 billion and is set to reach $7.4 billion by

2006. In Germany, for instance, from an almost standing start, the

largest pharmaceutical company is now Kohlpharma, which does

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no research of any kind and exists purely to import drugs from foreign countries. Indeed, it is now the fourth-largest company in Germany as a whole.

Price controls and parallel trade have crippled the development

of new products in Europe. In 1990, major European researchbased companies spent 73 percent of their global research expenditure within the E.U. By 1999, that had fallen to 59 percent. Between 1993 and 1997, 81 unique new drugs were launched in Europe, compared to 48 in the United States. But from 1998 to 2002,

the European number had declined to 44, while the U.S. number

had risen to 85. During 1990, Europe’s share of the world pharmaceutical research has fallen from 32 percent to 22 percent.

This is not supposition, it is not academic economic theory, it is

fact. This is what happens to research when importation is allowed.

Those who favor importation into the U.S. are arguing quite

straightforwardly for the importation of all these problems.

An array of cost-containment measures are limiting pharmaceutical spending within E.U. member States. As a result, for example, in cardiovascular medicine, so high are the hurdles for reimbursement that the most innovative and effective lipid-lowering

therapy is only available usually to heart attack sufferers. And

with cardiovascular disease, 83 percent of Italians, 77 percent of

Brits, and 74 percent of Germans receive what is medically described as suboptimal treatment, compared to only 44 percent of

Americans. This is, again, not by accident. It is the inevitable consequence of the price controls which come alongside parallel trade.

American concern with European free riding on investment and

research is understandable and wholly justified. European governments are, in effect, shifting the cost burden of research from Europe to the United States, but the correct response is for Europe

to get its act together, not for the U.S. to adopt the same mistaken

policies which have caused the problem in the first place. Importation might look like a panacea, but it is no such thing. It involves

the importation of the price controls which have wreaked havoc

with European patients’ health care and the European pharmaceutical industry.

The argument is made that this is an issue of free trade. It is

not. Allowing such imports will not, as one proponent put it, allow

American consumers, particularly seniors, to benefit from worldwide price competition. Far from inserting competition and the free

market into the price of medication, as another advocate has put

it, there is no competition. There is simply pricing by governmental

dictate with all the deleterious consequences I have outlined.

It is precisely because the patient should come first that the sophistic and superficially appealing arguments in favor of importation should be resisted. Thank you.

The CHAIRMAN. Thank you.

[The prepared statement of Mr. Pollard follows:]

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PREPARED STATEMENT OF STEPHEN POLLARD

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The CHAIRMAN. Mr. Outterson.

KEVIN OUTTERSON, ASSOCIATE PROFESSOR, WEST VIRGINIA

UNIVERSITY COLLEGE OF LAW, MORGANTOWN, WV

Mr. OUTTERSON. Good morning, chairman and distinguished

members of the committee. My name is Kevin Outterson. I am a

Professor of Law at West Virginia University, a purple State. I am

here today to talk about the Commerce Department study.

I would have to say that about 80 percent of what Mr. Aldonas

said, I agree with. I am not a fan of price controls, but given the

5 minutes, I am going to focus on the things we disagree on on the

report. But if you understand it broadly, much of what he says, I

agree with.

I offer three conclusions to the report. First of all, the strategy

to raise foreign drug prices through free trade agreements is not

only unnecessary, but it is dangerous, and I think he supported the

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fact that he doesn’t think free trade agreements are the way to do

that.

Secondly, the report grossly overestimates the likely impact of

free riding by rich countries and ignores the tremendous human

cost of higher prices.

Third, the drug industry suffers from too little transparency. We

need independent research on these questions, not PhRMA-funded

studies cloaked as an academic exercise.

So, first of all, let us look at free riding. The USTR strategy depends upon raising patented drug prices abroad, but it will only

succeed in doing that in the poorer countries of the world and it

will fail to do that in the richer countries, like Europe, Japan, and

the other OECD nations in the report. What PhRMA calls price

controls, if you listen carefully, are actually governments deciding

what they will pay, what they will reimburse for a drug. The mechanisms that they use are very similar to American managed care

mechanisms, but the goal is to control government reimbursement.

The United States employs very similar mechanisms. The Veterans’ Administration’s Federal Supply Schedule, the 340(b) Public

Health Service program, the Medicaid Federal mandatory rebate

and supplemental rebates, all of these things are very similar

mechanisms, and through the studies we have done in West Virginia, the prices out of these programs are, in many cases, lower

than Canadian and European prices.

For us to say that this is a bad idea, we are being hypocrites.

We are throwing stones. We are living in a glass house. We should

not be attacking European core domestic policies when we use the

exact same techniques both in our commercial sector in managed

care as well as in our government.

These powerful OECD countries will resist an American attempt

to increase their drug prices. The Australian FTA was hailed as a

model, but the actual text of the Australian FTA is exceedingly

modest on this particular issue and it has failed. It is counterproductive. John Howard, his government has announced in the

past few weeks that they are going to cut drug prices by 12.5 percent across the board in Australia in response, partially, to the

Free Trade Agreement. It is counterproductive.

Is it going to increase drug prices in Australia? No. They are actually going to go down. It is far more likely that the U.S. will succeed in raising drug prices only in smaller and more vulnerable

countries who need a free trade agreement with the United States

for other reasons, places like the CAFTA agreement. The terrible

human cost of these price increases will be many times greater

than the R&D benefit, according to PhRMA-supported studies

which link how prices affect utilization of necessary drugs.

Now, my second topic, is the relationship between drug company

revenues, R&D, and innovation. To the extent that the HHS,

Health and Human Services report touches on this topic, my comments apply there, as well.

Now, the Commerce Department report relies on a series of highly contestable estimates, primarily the work of Vernon, Grabowski,

and DiMasi, to conclude that free riding by rich OECD countries

will destroy three to four innovative new drugs per year. The reVerDate 11-MAY-2000 12:56 Sep 02, 2005 Jkt 000000 PO 00000 Frm 00055 Fmt 6633 Sfmt 6601 S:\DOCS\20046.TXT SLABOR3 PsN: SLABOR3
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port grossly overestimates the benefits and ignores the cost of this

free rider strategy.

First of all, given what I have said about Australia, a more realistic revenue target for the USTR strategy is many times smaller.

Mr. Aldonas said, $15 to $27 billion needs to be increased in the

rich OECD countries. How will they achieve that? In Australia, we

tried—the report says $400 million is needed out of Australia. In

fact, their prices are going to decline over the next 4 years by 850

million Australian dollars.

How will we achieve it? It is more likely, and this is laid out in

more detail in my written report, that we will achieve increases

only in the low- and middle-income countries of the world. We are

talking about a very small amount of money, which reduces the impact of the report. We are taking the widow’s mite and we are

using that to fund PhRMA innovation, which I suggest we may

want to think about.

Secondly, why assume that the drug companies will use incremental revenues for U.S. R&D? It is an assumption here that if

U.S. prices are high, they will do the research here. They do their

research here because we have the NIH here and they want to be

close to our scientists. We have the great human capital of our research engine and they want to be close to those people. It makes

no difference what our price system is. These are global companies.

In a recent Tax Court filing, GlaxoSmithKline told the Tax Court

that the vast majority of their profits on research and development

are in Ireland, not the United States. So I would like some consideration of that issue.

If we use more realistic estimates on pharmaceutical research

and development, such as the estimates by the National Science

Foundation, then this report is inflated by an additional factor of

four to five times. He assumed this morning that one-third of the

incremental revenue would go into R&D. PhRMA’s data on their

Web site says 17 percent, if you believe that. The National Science

Foundation says it is more like 8 percent. You change that number

from 33 to 8, you have just cut by 400 percent the impact of innovation of this report.

The final conjectural step in this report assumes that these funds

will be turned into drugs. The report promises three to four new

drugs per year. The evidence is based on DiMasi’s analysis of confidential data provided by the pharmaceutical companies themselves, knowing what it would be used for. This data cannot be

verified for accuracy. This isn’t a scientific study in the normal

sense of the word and it is the source for all the estimates of what

drug spending actually costs, research and development.

Now, seeing the time, I just want to conclude by saying the analysis suggests that—my analysis suggests that the USTR’s strategy

might buy one innovative new drug every 12 to 13 years, which is

hardly a price worth paying in order to offend our best trading

partners and to damage the health of millions, not only abroad but

also in the United States. A 1 percent change in the NIH budget

has a much more significant impact than everything this report

talks about.

In conclusion, I also think we should approach these topics with

some humility. I am not suggesting that my estimates are anything

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near the last word on these topics. What we need here is transparency on the data. Grant Aldonas said they had to buy the IMS

data, and that is pricing data. We don’t have access to the R&D

data. Congress is making major public policy decisions without the

necessary facts. Every time someone proposes something about

PhRMA, the response is innovation, but we do not have the data.

They don’t give transparency on these relationships. It is shocking

that we don’t have the access to this data on a transparency basis

in order to make good public policy.

Mr. Chairman, I want to thank you for allowing me to speak

today. If I can, you left out one Wyoming site. I spent 3 weeks in

the Wind River Mountains, which is a wonderful place to visit and

would encourage tourists to head that direction, as well.

The CHAIRMAN. I thank you for that comment. We usually don’t

tell people about that until they have been to Yellowstone and

Jackson. We leave out some of the really beautiful places that are

kind of saved for those who have been to some of the other spots.

Mr. OUTTERSON. I am willing to remove those comments from the

record.

[Laughter.]

[The prepared statement of Mr. Outterson follows:]

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PREPARED STATEMENT OF KEVIN OUTTERSON

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The CHAIRMAN. I appreciate the testimony of everyone this morning. This is an educational process that we are going through. I am

a firm believer that we need to find out as much about a problem

from as many sources as we possibly can before we do the legislation. It is a trend I am trying to reverse, but hopefully, we can get

there.

We have had some good testimony here and need to follow up on

that a little bit. I will start with Dr. Zycher.

While many economists believe as you do that importing medicines from abroad is nothing more than importing foreign government price controls, there are others who disagree, such as Mr.

Outterson. They argue that importation is the epitome of the free

market at work. How do you answer your critics who believe that

legalizing importation is about opening markets? Do you believe

that opening U.S. borders to prescription medicines from all over

the world advances the cause of free trade?

Mr. ZYCHER. Well, no. I don’t think the importation of price controlled products from overseas is any more free trade than the purchase of stolen merchandise from a fence is free enterprise.

At the same time, I think it is important to avoid quibbles over

terminology, what is and what is not free trade, and focus on the

issues that you, Mr. Chairman, have raised, the analytic issues.

What would be the effect on patients, on the pharmaceutical sector,

on the U.S. economy generally of a regime in which price controlled

drugs from overseas are imported?

There are safety issues, which I think the Health and Human

Services Department report explores in good detail. I did not discuss them in my testimony.

More generally, I think it is incontrovertible that the long-term

effect on patients in the U.S. would be negative and large, and so

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that is the context in which I think we ought to focus attention in

this area.

The CHAIRMAN. Thank you. Mr. Pollard, I share your appreciation of Tony Blair. I have gotten to visit with him a few times and

listened to him speak and even appeared before the House of Commons. He is a very knowledgeable person. You share an accent

with him, too.

[Laughter.]

It is a little different than Wyoming, but I think that adds to

your credibility.

Mr. POLLARD. It is spurious British credibility. We play on it a

lot.

[Laughter.]

The CHAIRMAN. I want to ask, why is it that European countries

tend to devalue the new innovative medicines by restricting access

and attaching price controls to those products while overpaying for

the generic versions of the medicines? Doesn’t this policy seem out

of line with what you want in a functioning marketplace, to reward

innovation?

Mr. POLLARD. Absolutely. Europe is caught in a sort of a dilemma as a result of the single market. On the one hand, there is

free trade within that single market. Anything that is allowable—

that is bought and sold has to be moved about without restriction.

What that means, though, is that because of the obsession with

price controls, which is a result of the fact that the state in Europe

plays so much of a role in the purchase of pharmaceuticals, what

that means is that the market is, right from the very beginning,

distorted and is not a free market.

You see with generics the role of the state, again, is not about—

let me rephrase that. In Britain, we have the perfect example of

this. We have a body called the National Institute for Clinical Excellence, which is known by its acronym of NICE. It was introduced

in 1999, ostensibly to assess all kinds of different medicines, innovative new medicines, generics, whatever, basically to decide

whether a particular treatment could be made available throughout

the NHS for a particular illness and so on.

Like all these things, what it was sold as is almost always the

exact opposite of what its actual effect has been. Its actual effect

is one of pure rationing. I prefer to think of it not as NICE but as

NASTY, ‘‘Not Available So Treat Yourself.’’

[Laughter.]

And what it does is it includes all the different medicines and it

examines them purely on the basis, supposedly, of what they call

economic efficiency and so on. But what that means, we heard from

Dr. Goldberg about Herceptin. It is not available in the U.K.

Relenza for flu, not available in the U.K. Beta interferon for multiple sclerosis, not available in the U.K. as a result of the state determining what should and shouldn’t be available rather than allowing it to the market, leaving it to the market.

The CHAIRMAN. Thank you. I will try and quickly cover one more.

Mr. Outterson, again, I am just relying on my shoe business

background, which is not very good on economics—profitable, but

not very good on economics. We made investment decisions all the

time about building our business, and your conclusion that drug

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importation is safe, saves billions of dollars with no net effect on

pharmaceutical innovation strikes me as a little counterintuitive.

Could you explain to me how R&D expenditures can be delinked

from innovation and the return on investment?

Mr. OUTTERSON. My written testimony goes into this in more detail and that, in turn, is based on a much longer study which is

being studied this week, in fact, at Yale.

But to put it briefly, I believe in intellectual property and in the

story about innovation, but the question that is never asked, really,

is when do we have too much innovation and when are we getting

the wrong types of innovation?

So we have 20 years of patent term. Maybe 20 years is the right

amount. Maybe it should be 25. Maybe it should be 15. It is an

open question. When society is developing and giving funds to research and development, what is the socially optimal amount

through the marketplace?

That question, we can’t answer, ultimately, because we do not

have access in the pharmaceutical industry to the data, the transparent data on pricing and research and development to know

whether we are wasting money and it should be going to something

else or whether we are not investing enough money. So that is really my core conclusion of the study, is that we don’t know the answer.

Now, for importation, I do come out on the free trade side and

say that within the rich countries of the world, we probably should

have pricing that is roughly equivalent between the rich countries

of the world and that we should forbid the type of arbitrage or importation that would take a cheap drug from Africa that is being

provided really on a charitable basis and bring that into the United

States. That should be absolutely illegal and a criminal act. But

within the rich countries of the world, all the other goods that we

deal with, we want to see free trade and price equalization to some

degree.

So the question is, why don’t we have that in PhRMA, and, of

course, it is because governments try to set the prices on which

they are going to buy these drugs and that is at the nub, the problem.

Mr. Aldonas and the Commerce Department are trying to address that through free trade agreements, forcing these other countries to increase their prices, and he acknowledged that that is not

going to happen with Europe and with Japan and even with Canada and Mexico because we don’t have new agreements coming up

and it is going to be difficult to convince them. So how do we get

that equilibrium?

Another way to get that equilibrium is for the United States to

upset the apple cart, in a sense. If the United States allowed safe

importation from countries with equivalent drug regulatory systems, it will force the pharmaceutical companies, in a sense, to go

back to Europe and to make the case, this time with transparent

data, publicly available data, of, look, innovation is really being

hurt, and not just stuff on their Web site that is not verifiable, but

actual data that independent researchers can look at.

At that point, all of these arguments that are being made are essentially saying Europe is being foolish, and I think the Europeans

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are a little more sophisticated than that. They are resisting because they don’t have the data to make that judgment. If we allowed importation on a safe basis, I think we would, in a sense,

create a revolution for markets in the European Union on drug

pricing.

Mr. GOLDBERG. Mr. Chairman, may I respond?

The CHAIRMAN. I have run out of time. I have been a bit too liberal there, but perhaps someone else. I will be submitting some follow-up on that because I am not sure what over-innovative is, so

I want to follow up on some of that.

Senator Burr.

Senator BURR. Thank you, Mr. Chairman, and I thank this

panel. Your testimonies really have been enlightening.

Mr. Pollard, we can’t thank you enough for being here. There are

Blairites here, and those are great looking cufflinks, I will tell you.

Mr. POLLARD. Thank you.

[Laughter.]

Senator BURR. Mr. Outterson, you are a law professor.

Mr. OUTTERSON. Yes, sir.

Senator BURR. Let me say one thing about patents. A patent in

the pharmaceutical world is triggered when an application to the

FDA is submitted. There is no manufacturer outside of those that

participate in the Orphan Drug Act that can, with some predictability, tell you how long their patent is going to be because it is

dictated by how long the approval process is. So one drug may have

7 years left by the time it is approved, another one may have 11

years, another one may have three. That patent life is what dictates the price that they set for the recovery of their research and

development.

As a law professor, I know that you have got a basis in U.S.

Code, and U.S. Code specifically protects patents and intellectual

property. And as it relates to drugs specifically, the TRIPS agreement, the Trade Related Aspects of Intellectual Property Rights, is

in effect. U.S. patent law is in effect. The Food, Drug, and Cosmetic

Act is very specific as it relates to intellectual property protection.

The Prescription Drug Marketing Act of 1987 is very specific.

If we pass reimportation, we basically step on four pieces of legislation—five, excuse me—that clearly state U.S. law, and I think as

Grant Aldonas alluded to and I agree with, it inherently comes out

of the U.S. Constitution.

Are you willing, as a law professor, just to step all over that to

achieve reimportation of drugs?

Mr. OUTTERSON. One word, no.

Senator BURR. Well, that is a relief to me from the standpoint

of the law students that are coming out.

Mr. OUTTERSON. I could give a slightly longer answer if you

want.

[Laughter.]

Senator BURR. Let me go to Canada, because you made a statement and I just want to try to clarify the truth. When Canada negotiates drug pricing, it is my understanding that Canadians say,

‘‘Here is the price we will pay. Your option is to sell to us at this

price or we will take your patent and we will have a company

somewhere else in the world make this compound and we will buy

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it from them and, in fact, bypass your patent.’’ I am not sure that

that is how you portrayed it, that there is a negotiation that takes

place.

In the United States, when you go into the VA, the VA does have

a price target. But a company has another option. They can choose

not to sell to them. They can choose not to sell them and know that

their patents are still protected in this country because we do it

across the board.

If you understand Canada to be different, please share that with

me.

Mr. OUTTERSON. Canada formerly had a broad compulsory licensure statute which was really done away with in the process of

them joining NAFTA. Canada, to my knowledge, is not exercising

compulsory licensure with the exception that they have passed the

Jean Chretien bill to permit it under the WTO Doha process only

for utilization in the poorest countries of the world, which is something the U.S. agreed to.

You are right to say that when a government says, here is the

price, take it or leave it, that it really is kind of the immovable

force—the unstoppable force hitting the immovable object. You

have a monopsonistic buyer, the government, and a monopolistic

seller, the person with the patent, and what do you do in that situation?

I am not a fan within developed nations of rampant compulsory

licensure. I think it is a mistake and I think you are right, that

it does endanger unnecessarily patent rights. If we did it in the

United States, it has to be done under the Fifth Amendment and

14th Amendment. Just compensation has to be given.

Senator BURR. I think if you ask Germans today whether, in fact,

the German price policies on drugs have cost in innovation, they

would tell you, yes, and it has also cost them jobs, because most

of them have moved those research facilities here. I think Mr. Pollard is very wise at recommending to us that we not look at what

they have done and make similar mistakes.

Mr. Chairman, I will ask one additional question to anybody on

the panel. If we approve reimportation, what effect would that have

on the products that are currently developed in this country under

the Orphan Drug Act? Given that the Orphan Drug Act extends,

for a predictable period of time, exclusivity because we ask

innovators to create things for very small populations of Americans

who need that drug, and on the economics of the amount of research and development it would cost, those drugs would not be

created. We provide them with additional exclusivity to get those

drugs made and those Americans to have products. What would

happen if——

Mr. GOLDBERG. I can address that, Senator, because we have

been talking about that on our task force. We talked to venture

capitalists and here is an area where, despite Mr. Outterson’s derision of peer-reviewed economic literature by people of Peter Price’s

economics, there is extreme transparency since you are supposed

to, as he knows, his colleague, James Love, has looked at the orphan drug R&D, venture capitalists would pull out of the orphan

drug market. Why? Because they have actually said so on the

record, that if there was a hint of importation, it was a signal that

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the government would be endorsing price controls and they would

terminate their investment in the orphan drug market, even with

the exclusivity, because the returns on the small market would be

tenuous and insubstantial. That is the long and short of it. It is a

high risk, unpredictable market even with the orphan drug incentives.

Mr. OUTTERSON. Very briefly, because I know we are restricted

on time, many of these other nations have analogs to the Orphan

Drug Act, and if Europe has the same link to protection on an orphan drug as we do, then the importation issue becomes—doesn’t

affect orphan drugs.

Secondly, orphan drugs really deserves its own hearing, I think,

because the number of things that are getting orphan drug designation right now is tremendous. In June of 2004, the FDA gave

orphan drug designation to Vioxx for juvenile rheumatoid arthritis.

Vioxx, a drug, one of the best-selling drugs in the world.

Senator BURR. Well, you are right. That is for another hearing

and I think we all would agree that the attractiveness in the Orphan Drug Act is the exclusivity, and I would only challenge you

that if we say we are not going to protect patents or intellectual

property on everything else and we turned around and said, ‘‘but

we are going to on orphan drugs,’’ why would they believe us? Why

would Microsoft believe us if we ignored it on prescription drugs?

Why would any company out there that looks at the safety and predictability of this country for their intellectual property protection

believe us if every time we are forced to address something that is

expensive, we choose to find a way to make it cheaper just by ignoring our own laws.

Mr. Chairman, I thank you.

The CHAIRMAN. Senator Isakson.

Senator ISAKSON. Thank you, Mr. Chairman. I will yield 1

minute to Dr. Goldberg, who had something to say a minute ago

and got cut off, so Dr. Goldberg.

Mr. GOLDBERG. I just wanted to address this issue of transparency. First of all, the issue of transparency is important, and

one of the principles—the fact of the matter is, there is ample public data on the cost in development of R&D. Our Federal Trade

Commission just released a study saying that the estimate that it

costs, with the opportunity cost built in of $182 million to bring a

new drug to market, not just adding another coat of paint to it, was

wrong. It is probably more. It is probably $865 million.

But there is another element to transparency, Mr. Chairman and

members of the committee, and that is why European governments

restrict access to new medicines. The principal driving element of

our negotiations with Australia and the other European countries

is they won’t tell us, they won’t tell us why they won’t give people

access to breakthrough drugs.

As Mr. Pollard says, with the NICE Commission, it is a black

box. Again, my daughter has an eating disorder. I looked at the

NICE guidelines for treatment of bulimia. They are the dark ages.

It is nasty. If you have an eating disorder, you are given a pamphlet and then you are—the only drugs that they use to treat eating disorders is an SSRI. Now, I know that the standard of care

for eating disorders is three different types of drugs, two of which

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are not on the formularies in West Virginia, which is part and parcel of their way of using the VA pricing and drug pricing and Canada.

Why is that happening? There is an ample amount of literature,

the clinical literature, which is peer reviewed, not paid for by drug

companies, and to suggest that somehow, that the Commerce Department study is a rigged study because it is just paid for by the

drug industry is disrespectful to the fine work of the Commerce

study, the fine work of many clinical researchers, and it denies, ultimately denies patients the best care possible now and in the future.

Senator ISAKSON. Thank you. I will reclaim my time. I wanted

to ask Mr. Outterson to make sure I understood something correctly, because I was listening and writing and I didn’t have a

chance to read.

I thought I heard you say it makes no difference what our price

system is. Ultimately, the Europeans will bring the drug to the

United States because of NIH, or something to that effect. Would

you tell me what you meant by that?

Mr. OUTTERSON. I was probably speaking a little fast at that moment, seeing the clock tick on me. But what I meant to say, if I

did indeed misspeak, was that these companies do the research and

development on a global basis. These are global companies. And

they market in the markets that give them the highest prices first,

and then they market more slowly into places like Greece and

Italy, who have lower prices. So that is why drug introductions are

slower in those countries, because the price isn’t quite as good, so

they don’t get around to introducing them right away. They wait

a couple of years.

But the decision about where the research happens is not based

on how valuable the market is because these pills are made in Ireland and Puerto Rico and shipped globally. The decision on where

the research lab is is based largely on the fact that we have the

NIH and we have a great human capital invested in the United

States and the research institutions, the biotech companies, the

universities, and they want to be near those people.

So if you want to increase more PhRMA research in our country,

boost the NIH budget a little bit and they will put another research

facility right next door. That was my——

Senator BURR. Thank you, but I just have to ask you, though,

isn’t your statement a ratification for a market-based system, because you just got through saying that most innovative drugs are

going to go first to the markets where they can recover and last

to those where they are so repressive. I think you used Greece as

an example. And ultimately—price is a tremendously important

factor for the constituents I represent, but so is life and health.

And so how do you—I just wanted to—in that answer, it made a

pretty good statement for market forces to work.

Mr. OUTTERSON. And I am in favor of market forces. The thing

about slow introductions into Greece and New Zealand and places

like that is that that is a company decision. It is not something

given by chemistry. The company decides to introduce later in

Greece because the process may be slower there, their version of

the FDA, or they may not want those drugs to get on a truck and

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come to England. So that is a company decision. If we had more

rationalized pricing, market pricing, across the rich countries of the

world, you would eliminate that incentive to slow down and introduce drugs more slowly in certain countries of the world. We

should all be introducing these innovative, safe, effective drugs at

the same time throughout the world. That would be best for the patients.

Senator BURR. My time has expired.

The CHAIRMAN. Thank you.

Senator Alexander.

Senator ALEXANDER. No questions, Mr. Chairman. I have been at

the Budget hearing on Medicaid and Medicare and I just came to

listen. I want to thank the witnesses for their appearance.

The CHAIRMAN. Thank you. I didn’t get a chance to let Dr. Goldberg speak earlier, and I noticed you just had some reaction to

what had just been said. Would you care to comment on that?

Mr. GOLDBERG. Maybe I have said enough, Mr. Chairman. I don’t

know.

The CHAIRMAN. Well, I——

Mr. POLLARD. If Dr. Goldberg doesn’t, I would quite like to.

The CHAIRMAN. Okay.

[Laughter.]

Mr. POLLARD. I have to say that sort of flies in the face of the

evidence of what has actually happened in Europe. Professor

Outterson is quite right to say that these are complicated issues

and that these are global drug companies and so on, but what matters is the general economic climate in which a company is operating.

In the European Union, for instance, we have seen a direct brain

drain. I mean, there was a front cover of Newsweek, I think it was,

18 months or so ago on the brain drain in Europe, and it is a direct

flight of some of Europe’s most able scientists from Europe to the

United States, and they are doing that not simply because they

fancy the lifestyle here in the United States. They are doing it because companies, pharmaceutical companies, are leaving Europe

and headquartering themselves in the United States.

Novartis, for instance, recently upped stakes from Europe and

moved to the United States. The clear lesson—I mean, in Germany,

employees who were working on high-level research in the last 11

years, from 1990 to 2001, fell by 36 percent, just at the same time

as in the United States another 400,000 jobs were created, an increase of 52 percent, and that is a direct result of the flight from

Europe to the United States.

If the United States wants to see a flight in reverse, as it were,

from its own research base back to Europe or to elsewhere on the

continent, then really, all it needs to do is copy what we have done

in Europe. That seems to be what the professor is recommending.

The CHAIRMAN. Dr. Zycher.

Mr. ZYCHER. Thank you very much. Just a couple of very brief

comments on my colleague, Professor Outterson’s, presentation.

First, his argument that somehow if the Europeans had better

data, they might be willing to pay more, is an argument that to me

is a little difficult to take seriously, to put it mildly.

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Second, implicit within the professor’s argument is the premise

that there are no complementarities economically between research

and development activities, marketing activities, et cetera. I think

that is wrong simply as a matter of the industrial organization of

the sector.

And third, his argument that we really don’t know whether there

is too much or too little research and development going on similarly is a rather unappealing argument. If, in fact, there is too

much R&D going on, that presumably would be because profits

were so high that it would be attracting all of this capital in the

industry. But we don’t see that kind of massive entry into the sector. So I think, again, Professor Outterson’s argument that there

might be too much research and development going on, therefore,

price controls might actually be efficient, again, is an argument

that really is quite difficult to take seriously.

The CHAIRMAN. I suspect the brevity of a hearing like this,

though, impedes all of you in your explanations, and in particular,

Mr. Outterson, we will hope that you will provide us with a copy

of the paper that you have done so that we can have the additional

detail and benefit of that, as well.

We will leave the record open for another 10 days so that any

of you can expand on your remarks and also so that we can submit

some more questions. I have got at least four or five more questions

for each of you, not counting follow-up that I might have. They are

fairly technical in nature and I would prefer perhaps a more

thoughtful answer to them than you might be able to give in the

few seconds that we can do during a hearing, and I suspect that

other members of the panel might have questions, as well.

I want to thank you all for the time and effort that you went to

to provide us with this additional information and we look forward

to yet more information that we can hopefully base some good decisions on that will help the American people. Thank you.

The hearing is adjourned.

[Additional material follows.]

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ADDITIONAL MATERIAL

RESPONSE TO QUESTIONS OF SENATOR ENZI BY GRANT D. ALDONAS

Question 1. The Commerce Departments study concludes that price restrictions

tend to have the most significant impact on the newest and most innovative medicines. Since the U.S. market does not impose price controls, consumers here pay

higher prices than in the rest of the world. This results in U.S. consumers absorbing

over 80 percent of R&D costs.

What can the Department of Commerce do to convince OECD members to contribute their fair share to R&D costs?

Answer 1. Our objective is to encourage these governments to create a transparent environment where they work with industry, through formal dialogue, to

reach mutual objectives on appropriate levels of care for their citizens at a price

that the government and patients can afford.

Our approach has been to ask host governments to hold meetings with innovative

producers. We urge that meetings include representatives of all ministries whose responsibilities are affected by drug pricing decisions. I have often found that ministries with healthcare expertise, like Health Ministries, are not aware of the impact

their decisions have on trade, the economy, and innovation. As a result, we always

ask that the Ministries of Finance, Economics, Trade, and Health, as well as the

Prime Ministers’ offices, participate.

We have had some positive results using this approach. We successfully addressed

concerns in Austria by calling together such a group. We have also raised pricing,

reimbursement, access, transparency, and intellectual property issues in Germany,

Denmark, Italy, Poland, and Portugal in interagency meetings.

Question 2. Various studies comparing drugs show that Americans appear to pay

higher prices for some drugs than consumers in other parts of the world. The U.S.

International Trade Commission 2001 report highlights many of the reasons U.S.

prices differ from those of other countries. Differences in wealth, purchasing power,

insurance coverage, product liability coverage, exchange rates and drug coverage

policies all can have an impact on pricing in various countries. Price controls prevent the market from reflecting the true value of drugs.

If foreign prices were allowed to reflect the true value of drugs, would a free and

open market adjust accordingly?

Answer 2. If price controls were eliminated, a price adjustment would take place.

This study assumed that relative levels of per capita income determine variances

in prices among developed countries. Further research would be required to determine the likely impact of other factors, such as product liability coverage, insurance

coverage and exchange rates, on prices.

Question 3. The Administration has addressed market access and price control

issues in the pharmaceutical sector, especially in the U.S.-Australia Free Trade

Agreement. Your report demonstrates that price controls in developed countries impede access to state-of-the-art medicines, undermine global research in life-saving

drugs, and unfairly shift the burden of developing new drugs to American citizens.

The Medicare Modernization Act calls for the Administration to develop a strategy

to address these price control practices in OECD countries. What do you see as the

elements of an effective strategy, and what is the Administration doing to implement such a strategy?

Answer 3. With other agencies in the Administration, we are looking at the details of the Commerce study and the follow-up public debate in order to develop a

coordinated strategy. We intend to strike a balance between supporting continued

R&D and innovation in the pharmaceutical sector and ensuring access to innovative

pharmaceuticals. In addition to any new actions we may decide to take, we will continue to encourage governments to consider the benefit to the health of their citizens

and their economies that result from creating and preserving sound economic incentives and a competitive environment in which to develop and market new health

technologies.

RESPONSES TO QUESTIONS OF SENATOR KENNEDY BY GRANT D. ALDONAS

Question 1. Given Professor Outterson’s testimony, did the Free Trade Agreement

with Australia succeed in raising drug prices in Australia?

Answer 1. The Free Trade Agreement (FTA) does not require Australia to increase

pharmaceutical prices. Instead, the pharmaceutical provisions of the FTA set forth

shared principles, like the importance of research and development; of recognizing

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1Off-patent unbranded generic drugs are drugs that are marketed under a molecular name

rather than a brand name. 2 U.S. off-patent unbranded generic drugs were used as a benchmark for the new off-patent

unbranded generic drug prices in comparison to OECD countries.

and appropriately valuing the therapeutic benefit of innovative drugs; and of transparent, expeditious, and accountable procedures. Australia agreed to make improvements in its Pharmaceuticals Benefits Scheme (PBS) to enhance transparency and

accountability in the operation of the PBS. The FTA establishes a Medicines Working Group to further promote the agreement’s public health principles through an

ongoing dialogue between the United States and Australia. No data are yet available on whether the FTA has had an impact on prices in Australia, and evaluating

the potential impact may be difficult because drug prices are affected by factors not

directly related to the FTA.

Question 2. The Commerce Department Report states that price controls in OECD

countries lead to decreased revenues to the pharmaceutical industry, which in turn

leads to a decrease in R&D expenditures and a subsequent loss of new molecular

entities available to the U.S. market. The Report also states that the loss of revenues also decreases competition in the drug market, which could indirectly raise

U.S. prices.

On page 24, the report suggests that OECD countries should adopt policies similar to the U.S. to increase the availability and decrease the cost of generic drugs,

stating, that this study estimates that total savings for these 11 OECD countries

would have ranged between $5.2 billion and $29.6 billion in 2003, depending on the

volume measure. This range of potential savings suggests that if prices of on-patent

drugs were to rise to competitive market levels, then the additional cost to OECD

countries could be significantly or fully offset by a more competitive generic market.

Would the decreased revenues to the drug industry from the switch to generics

lead to the same untoward effects on R&D and competition that the Report attributes to price controls, or would it at least offset the gains in R&D that the report

identifies?

Answer 2. The report studied the impact drug price controls have on the patented

and generic drug markets separately, allowing no interplay between the two markets. It would be reasonable to conclude that increased spending on generic drugs

would reduce revenues from innovator drugs (after such drugs lose their patent protection), and that the increased generic competition could offset some gains in R&D

spending estimated in this report, at least in the short-term. However, the deregulated market would likely result in increased expectations of returns on newly developed drugs, and greater R&D investment based on those expected revenues. In considering whether to research and develop new products, drug company executives

compare the expected present value of net revenues from such investments with

their expected costs. Greater use of generics may adversely affect the expected value

of net revenues but this effect would likely be modest because it appears far in the

future and because those future revenues are much more uncertain than revenue

changes during the patent term.

Overall, it is likely that increased R&D spending associated with the increased

revenues from new drugs while they are patent-protected would be offset somewhat

by the short-run reduction in revenues from generic competition (and any concomitant effect on R&D spending).

The study estimated that the potential savings from greater generic drug utilization was in the range of $5 billion to $30 billion dollars. This estimate is based on

a shift in usage of off-patent branded and unbranded drugs. The study found that

off-patent unbranded 1 drugs in the United States are used more frequently and

have lower prices than in comparison countries. Therefore, using the off-patent

unbranded generic drug market in the United States as a benchmark, the report

estimated a counterfactual situation where comparison OECD countries allow greater generic drug competition that would lead to an increase in the utilization of offpatent unbranded generic drugs at lower prices.2 This resulted in an estimate of potential savings from shifting within the off-patent drug market.

Question 3. The Report uses U.S. prices as the benchmark for deregulated competitive market levels. Can you explain how the U.S. prices were calculated? Is that

the price charged to the uninsured in the U.S. or the average price paid in the

U.S.—taking into account prices paid by people with insurance, drug cards, or coverage through government programs? Is it the policy of the Administration to encourage all people, in America and abroad, to pay the price paid by the uninsured

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person in America who has no one—whether a benefit manager or a government

official—to negotiate a lower price for them?

Answer 3. U.S. drug prices were estimated by dividing total manufacturing sales

for each active ingredient or molecule by total volume sold for that active ingredient

or molecule. The result of this calculation is an estimate of the U.S. manufacturers

selling price to wholesalers. The price paid by the uninsured is the public or retail

price, which would include mark-ups on the manufacturers selling price to wholesalers and mark-ups on the wholesaler selling price to pharmacies. Manufacturers

selling prices rather than wholesalers or pharmacies selling prices were used to

make the price comparisons because they offered a more reliable basis for comparing drug prices internationally. If wholesaler or pharmacy selling prices were used,

the study would have had to adjust them for differences across countries.

RESPONSE TO QUESTIONS OF SENATOR ENZI BY ROBERT M. GOLDBERG

Question 1. Many innovative drugs are not available in Australia because of PBS

pricing policies. Most innovative drugs are not available in Australia for several

years following their launch in the U.S. The process for getting a drug on the PBS

is onerous, time consuming and bureaucratic.

Pricing is only part of the Australian PBS schedule. The schedule also includes

strictly enforced prescribing restrictions that cover most innovative products. For example: • Merck’s osteoporosis drug Fosamax is only available to women who have suffered a fracture. The fracture must be proven to be a result of low bone mineral

density. • The Novartis drug Gleevec, which treats Chronic Myeloid Leukemia, is restricted by an enforced ‘‘stopping rule.’’ The stopping rule requires a patient to sign

a legally binding agreement that allows the Government to discontinue their access

to Gleevec after 6 months if they do not ‘‘respond’’ to the drug. The patient’s response is measured by a technical test. The patient can fail the test even if they

no longer show symptoms, have returned to work or enjoy an overall better quality

of life.

Is this really the sort of system Americans would be satisfied with?

Answer 1. Americans now receive widest access to the newest and best medicines

faster than any other group of people on the planet. They would revolt against such

rationing. Further, rationing of such products overseas translates into limited quantities for importation should it come to pass.

Question 2. As you are aware from Mr. Aldonas’s testimony, price controls reduce

company compensation to levels closer to direct production costs, leaving less revenue for R&D. According to the Department of Commerce report, ‘‘As OECD countries individually seek to reduce spending on drugs through price controls, their collective actions reduce R&D that would provide substantial health benefits.’’

Considering these statements, how do you suppose importation may affect patients’ ‘‘health benefits’’ in the United States?

Answer 2. Given that EU is seeking to eliminate wide price variations among

member states to do away with parallel trade because of the impact it has on

R&D—in an effort to boost over all prices—we can only assume that the importation

of European prices controls will hurt R&D here.

Question 3. The vast majority of biotechnology companies do not have products

on the market; rather, they have patents on what may eventually become a commercially viable product or technology. The capital generated as a result of this intellectual property supports companies as they invest hundreds of millions of dollars over

decades to develop a commercial biotechnology product.

Government instituted price controls essentially remove a fundamental tenet of

patent law, the right of the innovator—not the government—to determine price of

the product.

How might a system of importation be implemented while still protecting the

rights of patent holders?

Answer 3. Importation violates patent rights two ways . . . it tells the owner of

the patent it can’t determine who it can sell it’s products to and it can’t set the

terms of the sale. Rather, it allows the government to hand those rights over to distributors and wholesalers and foreign ministries without due process or compensation.

Question 4. New medicines have produced the biggest gains in well-being and life

expectancy compared to most other medical goods and services. It was for this very

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reason that we passed the MMA last Congress and added prescription drug coverage

to Medicare. You reference in your testimony a report the Manhattan Institute commissioned regarding the impact of European and VA price controls on medical innovation and access to new medicines in the United States over the next 25 years.

The researchers found that R&D spending will drop by nearly 40 percent over the

next 2 decades, resulting in a loss of nearly $300 billion in R&D and 277 million

life years.

Based on the findings of the study you reference in your testimony, what are the

possible long-term impacts of legalizing commercial importation in the United

States?

Answer 4. Legalizing commercial importation is the quickest way to ship our biomedical industry overseas to places like India which just reaffirmed its commitment

to international patent treaties and is increasing investment in pharmaceutical

R&D by 400 percent over the past 4 years. The idea that prices have no effect on

R&D is now being floated as an excuse for removing the non-interference clause and

imposing importation. Why then is Europe stating that it is seeking to do away with

price controls and importation to boost R&D?

RESPONSE TO QUESTIONS OF SENATOR HATCH BY ROBERT M. GOLDBERG

Question 1. Without a doubt, medical innovation thrives because of America’s free

market pricing. As you noted, it is our entrepreneurial character as a Nation that

Americans have avoided price controls as a cost-saving measure.

How might we encourage price-controlled countries to embrace our country’s market-based approach, rather than focusing on short-term fixes?

Answer 1. As noted above, the European Commission is seeking to roll back price

controls and improve access to new medicines in part because of the success of our

free market approach to innovation and the growing competitiveness of countries

like India, Singapore and Korea in attracting and retaining scientific minds in developing their biotechnology industries. Individual countries in Europe need to understand that access to new medicines actually reduce total health care spending

and promote better health. Our USTR, in coordination with Medicare’s Mark

McClellan and the Department of Commerce should produce studies demonstrating

how many countries in Europe, by restricting access to American products are costing European countries money and lives.

RESPONSE TO QUESTIONS OF SENATOR KENNEDY BY ROBERT M. GOLDBERG

Question 1a. The Department of Commerce Report suggests that the increased

prices of name-brand drugs in Europe could be offset by reduced prices (and increased utilization) of generic drugs.

Do you agree with that assessment?

Answer 1a. Yes . . . appropriate generic use, particularly in the treatment of cholesterol, hypertension and depression could reduce total health care costs in Europe

as it has in the United States.

Question 1b. How much could Europe save with increased generic use?

Answer 1b. Currently a country like Germany spends up to 20 percent more on

generic drugs than they would if it introduced generic drug competition. At the

same time, it limits access to newer medicines for similar disease, restricting a

broader range of treatments that are necessary to treat individual differences in illnesses and in recognition of the fact that not every one responds the same way to

the same medicine. Suboptimal therapy and side effects cost every health system

billions.

Question 1c. Would increased generic savings impact innovation?

Answer 1c. Increased generic savings can provide an additional and cost-effective

addition to the range of treatments doctors can offer patients.

Question 2. Would you agree that increased utilization of pharmaceuticals is beneficial to health status?

If so, should the Health and Human Services and Department of Commerce Reports have estimated the positive health impacts of increased consumer access to

drugs due to lower prices? Should comparative effectiveness play a role in approval

or R&D or marketing incentives?

Answer 2. The Commerce Report could have demonstrated, based on a large body

of evidence that increased use of new medicines allows people to live longer,

79

healthier, more productive lives, with reducing the total cost of treating disease.

Comparative effectiveness is not the best way to evaluate medicines post market.

Rather companies should, perhaps as a precondition for remaining for Medicare reimbursement, provide data of its value as part of a total approach to therapy for

a specific patient population. To this end, companies would have a strong incentive

to provide patient level data, including outcomes and pharmacogenomic data that

could be used to determine a drug’s safety and effectiveness in new uses and in future clinical trials.

QUESTION OF SENATOR HATCH TO RICHARD CARMONA

Question 1. You mentioned that there are significant safety concerns regarding

drug importation, but if Congress wants to legislate a system, it should be closed,

well-defined, and capable of ensuring the pedigree of the drugs.

While these seem to be valid principles if there were to be an import regime, I

am concerned about the practicality of designing a system to meet those requirements. Could you elaborate on what you meant by a closed system? For example,

would other countries have to participate? If so, how would the U.S. negotiate the

agreement with those other countries? How would this be enforced? Similarly, what

are the ways in which the U.S. would go about ensuring that pedigree?

The enforcement mechanism is also of great interest to me, especially in reference

to Internet pharmacies. Could you please advise the committee as to how the Internet marketplace could be policed so that American consumers could be assured

about the safety, efficacy and pedigree of the consumers they are receiving? In the

United States, for example, pharmaceutical manufacturing plants are registered and

regularly inspected, pharmacies are licensed, etc. Would those same regulatory safeguards exist with respect to products distributed through Internet pharmacies.

Answer 1. Response unavailable.

QUESTION OF SENATOR HATCH TO TIM PAWLENTY

Question 1. I understand from your testimony that Canadian pharmacies on the

Internet require customers to sign a waiver absolving the pharmacies of any liability. These waiver forms routinely make U.S. customers waive many other rights,

such as the right to privacy, the right to consult a qualified pharmacist, the right

to child-proof packaging, and any warranties that the drugs are safe and effective.

Many of these requirements are well-established tenets of U.S. practice and law.

For example, the right to privacy of medical information was established by HIPAA,

an act passed overwhelmingly by the Congress. The U.S. standard of safety and efficacy for pharmaceuticals is the hallmark of our country’s drug approval system, and

a requirement that has led many to call our system the ‘‘gold standard’’ of the

world.

My questions are this: Why should Minnesota consumers be required to waive

these important requirements, requirements that largely apply to the purchase of

pharmaceuticals in other states? Have you developed any information, such as public education or surveys, to gauge the measure to which your residents are aware

of these important rights and the fact that they are entering into legal agreements

to waive them, agreements that would in effect make the consumers responsible for

the potentially hazardous results of safety problems?

Answer 1. Response unavailable.

QUESTION OF SENATOR HATCH TO ROBERT GOLDBERG

Question 1. Without a doubt, medical innovation thrives because of America’s free

market pricing. As you noted, it is our entrepreneurial character as a Nation that

Americans have avoided price controls as a cost-saving measure.

How might we encourage price-controlled countries to embrace our country’s market-based approach, rather than focusing on short-term fixes?

Answer. Response unavailable.

QUESTION OF SENATOR HATCH TO STEPHEN POLLARD

I appreciated your insights on European healthcare issues as they relate to prescription price controls and parallel trade. I agree that every developed Nation has

something unique and important to add in the field of medical research. Your comVerDate 11-MAY-2000 12:56 Sep 02, 2005 Jkt 000000 PO 00000 Frm 00083 Fmt 6633 Sfmt 6621 S:\DOCS\20046.TXT SLABOR3 PsN: SLABOR3
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1Pharmaceutical Price Controls in OECD Countries: Implications for U.S. Consumers, Pricing,

Research and Development, and Innovation (U.S. Department of Commerce, International Trade

Administration, Dec. 2004).

ments about price controls and how the European governments are imposing costs

on the developing world were particularly interesting.

Could you explain how the supply of medicines to lesser-developed countries is affected by price controls on prescription drugs?

Answer. Response unavailable.

RESPONSE TO QUESTIONS OF SENATOR ENZI BY KEVIN OUTTERSON

March 18, 2005.

U.S. Senate,

Committee on Health, Education, Labor, & Pensions.

DEAR CHAIRMAN ENZI: Thank you for the opportunity to testify before the Committee, and for your written questions.

Drug importation should not be opposed on innovation grounds. The OECD Drug

Pricing Report 1 grossly overstates the negative impact that lower prices would have

on innovation, and dramatically misses the main point: that lower prices would help

U.S. consumers by improving access to needed therapies. Where is the estimate of

the number of Americans who would benefit from being able to afford their medications?

I also continue to challenge the USTR strategy to raise drug prices abroad, particularly with regard to developing countries. This is a terrible idea for global

health, and unnecessary on innovation grounds. As for raising prices in the OECD,

perhaps the USTR can articulate its strategy, given my written testimony previously offered to the committee. The experience with the Australian free trade

agreement appears to have been counterproductive on this score.

These are complex issues with important consequences for health and trade. I

would be willing to explore them in more depth, at your convenience.

Please let me know if you require anything further.

Best wishes,

KEVIN OUTTERSON,

Associate Professor of Law,

West Virginia University.

Question 1. Germany employs reference pricing for statins, cholesterol-lowering

drugs taken by millions of Germans. Due to cost pressures on the system, and the

expiration of the patent of one drug in the statin class, reimbursement for Lipitor

is now so low that the manufacturer cannot have the drug participate in the national health system. In theory, patients can pay the full cost of the drug, but in

practice only reimbursed products are prescribed by doctors and sought by patients.

Unless these state-insured patients can pay for the full cost of the drug out of pocket, 1.5 million Germans will lose access to Lipitor.

Do you think we will see more of this, as price controls get tighter and tighter?

Do you believe Americans would accept a system whereby they could lose access to

a drug they have come to depend on?

Answer 1. The statin class includes several drugs with similar modes of action

and FDA approved uses. The fact that we have choices among statins is exactly the

reason Pfizer faces competition and must negotiate for price.

Germany’s position is no different in principle from the U.S. Medicare Part D

plans which will negotiate to include only 2 or 3 statin drugs in their formularies.

U.S. commercial managed care plans and PBMs also routinely exclude some drugs

from formularies, or subject them to prior approval or tiered co-pays. This is a normal part of the price negotiation between the drug companies and the payors. I suspect that Pfizer and Germany will negotiate a mutually agreeable price.

Question 2. The Australian Pharmaceutical Benefits Scheme (PBS) is subject to

significant public criticism because patients are often denied access to modern and

innovative therapies. Many innovative products for the treatment of chronic and debilitating conditions are either not available, or their availability is restricted and

many patients that would benefit are denied access. In addition, prices for generic

medicines in Australia are high—approximately 70–90 percent of the brand price.

You advocate U.S. states adopting the Australian pricing scheme. Will States really

81

want to adopt the Australian pricing schedule, including increased prices for

generics?

Answer 2. I have divided the question up into parts in order to respond fully:

Question 2a. The Australian Pharmaceutical Benefits Scheme (PBS) is subject to

significant public criticism because patients are often denied access to modern and

innovative therapies.

Answer. 2a. The PBS has not been subject to significant public criticism in Australia. The pharmaceutical companies certainly are critical, but the PBS enjoys remarkable public, political and professional support within Australia.

I queried an email list of leading Australian pharmaceutical specialists, and they

were unaware of any evidence of significant criticism by the public. The PBS enjoys

remarkable support from all major political parties in Australia, as was demonstrated in the last election.

Legislation creating the PBS arose from a constitutional referendum in which a

majority of Australian citizens in all States voted for its protection of their access

to affordable, essential medicines. That legislation was eventually ruled constitutionally valid by the High Court, the Australian equivalent of the U.S. Supreme

Court.

Support for the PBS is also very strong within the medical profession. The following is a quote from the Royal Australasian College of Physicians, Response to a Public Consultation Document (25 July 2004) Australia-United States Free Trade Agreement, Implementation of the Obligations to Improve the Transparency of the Pharmaceutical Benefits Scheme (16 August 2004):

It is the concerted view of the College that all Australians should continue

to have affordable and timely access to essential medicines. This reflects the

College’s broader commitment to the principle of equity in the financing and delivery of health care services in Australia . . .

The PBS is a scheme that is much admired worldwide: both for its equitable

delivery of medicines to all Australians, and (despite current concerns) for its

proven record of containing costs relative to the drug expenditures of other

highly developed countries . . .

The College rejects the proposition that the PBS restricts pharmaceutical industry innovation and profit through the undervaluing of research and development and market distortion. (at 2)

It is the College’s view that all information submitted to PBAC by a drug

sponsor be placed in the public domain. This would facilitate clinical decisions

by physicians that are based on the best available evidence. (at 4)

Question 2b. Many innovative products for the treatment of chronic and debilitating conditions are either not available, or their availability is restricted and many

patients that would benefit are denied access.

Answer 2b. I queried leading Australian specialists in pharmacy and public

health, including government officials, and they were unable to provide a list of any

such medications. If PhRMA or Medicines Australia were willing to provide a list,

then I could respond directly.

As one Australian expert put it:

I would feel confident to say that there are no drugs that are more effective

than an alternative AND are cost-effective at the requested price AND have

been submitted to PBAC that are not available to Australians at a subsidized

price. There are drugs that are approved by the TGA for a given condition but

are not subsidized by the PBS because they are not cost effective for that condition (compared to the therapy that would otherwise be used). But again there

are very few of these. And I would like to see the list!!! So in summary—show

me the list . . . and I will eat my proverbial hat.

A second Australian expert offered the following explanation:

In general, if a drug company is unhappy with the price or other terms offered

by Australia for any drug, they are free to renegotiate, particularly if new evidence

of the cost-effectiveness of the drug is available. The AUSFTA also provides an independent review process for these decisions. If drug companies have a specific complaint about a particular drug, they should exhaust their available processes and

remedies under Australian law rather than make general, unsubstantiated complaints to the U.S. Senate.

Also many medications that are very specific and expensive are either available

through public hospitals (such as antiretrovirals) or under a special access S100

scheme and are thus still paid for out of the public pocket (a bit more complicated

as the public hospitals are funded by State level governments and not the Federal

82

Government). An example I used recently was accessing sufentanil for a palliative

care patient at home, this was obtained by the local public hospital pharmacy and

presented to him at no cost even though it is not available on the PBS. An example

of a medication available in Australia but not subsidized by the PBS would be the

Anti-Alzheimer’s medication Ebixa (Memantine), if the doctor is willing to prescribe

it and the patient is willing to pay the $150–180/month then it is freely available

(mostly because Lundbeck has applied in the last 2 rounds for the medication to be

listed on the PBS but been rejected for what I understand to be ‘‘insufficient cost

benefit ratio’’).

A third Australian expert has provided some additional information about access

under the PBS follows, which may further answer the question:

This frequently cited criticism of the PBS from the pharmaceutical industry arises

from a selective analysis of the Australian pharmaceutical market. In fact, applying

the economic definition of access, one can show that access to modern innovative

medicines in Australia is far greater than that in the U.S. For a product to be accessible to consumers it needs to be:

1. Available for sale on the market, AND

2. Available at a price that all consumers who may gain a benefit from it, can

afford.

Criterion 1. All products passing TGA safety and efficacy approval (equivalent to

the FDA process), are available for purchase by consumers in the Australian market, at the price set by producers free of any price controls. This is comparable to

the U.S. Virtually all products available on the U.S. market are also available for

sale in Australia. The 2001 study by Australia’s Productivity Commission also found

that the PBS process does not delay the launch dates of new innovative medicines

in comparison to the U.S. and other OECD countries:

For most countries, there is no significant difference in the delay between the

global launch and the local launch. For example, the delay between the global and

Australian launch dates is an average of 2.6 years for all categories. This is similar

to the results for France, the U.S., Spain, Canada and NZ. (PC 2001, p. 85)

Therefore access to modern innovative medicines in Australia is at least equivalent to that in the U.S.

Criterion 2. Pharmaceutical access in Australia is further expanded by addressing

financial impediments to products deemed essential and cost effective. PBS listing

subsidizes the cost of medicines to ensure universal access to modern innovative

medicines deemed essential and value for money by a panel of experts. All U.S. citizens without access to a drug insurance benefits plan therefore have less access to

modern innovative medicines, than do Australian consumers. If a product is determined to be uneconomical relative to cost, by a panel of experts and fails PBS listing, Australian consumers can still access the product by purchasing it on the private market. Consumers who have private health insurance may have part of the

cost of these medicines refunded by their insurer; other consumers will pay the full

market cost of the product. The lack of PBS listing is not a denial of access but a

restriction on the availability of taxpayer subsidies for medicines deemed by experts

to be uneconomic.

Additionally, the PBS Schedule is extensive with all available modern innovative

and essential drugs listed for subsidy. If a product is not listed it is because a therapeutically equivalent product is listed for subsidy at a cheaper price.

Question 2c. In addition, prices for generic medicines in Australia are high—approximately 70–90 percent of the brand price.

Answer. 2c. The reason that generic medicines are close in price to brand name

medicines is not that the generics are expensive in absolute terms, but that the

brand name medicines are relatively cheap. They are cheap mainly because the

Pharmaceutical Benefit Advisory Committee employs stringent cost-effectiveness criteria to get the best value for their money. Please see http://www1.health.gov.au/

pbs/ for an online list of current medication prices in Australia. Generics may be

priced at 70–90 percent of the cost of brand name drugs, but both prices are really

cheap in absolute terms.

A number of institutional factors influence generic drug prices in Australia. Generic manufacturers in Australia face limited economies of scale due to the small

size of the Australian market and intellectual property law that limits Australia’s

ability to export to developing countries in the region while a patent is in force in

Australia, but not in the destination country. One measure which has been recently

put forward would encourage competitive prices in the open international tendering

for PBS generic medicines.

The narrow gap between PBS brand name and generic prices mainly relates to

me-too drugs rather than truly innovative therapies. Reference pricing in the PBS

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2For my published comments on price controls and the Australian PBS, see Kevin Outterson,

Pharmaceutical Arbitrage: Balancing Access and Innovation in International Prescription Drug

Markets, 5 Yale J. Health Policy, Law & Ethics 193, 238–241 (2005). 3See. e.g., Kevin Outterson, Agony in the Antipodes: The Generic Drug Provisions in the Australia—U.S. Free Trade Agreement, 2 Journal of Generic Medicines (pending, Spring 2005); and

Kevin Outterson, Free Trade in Pharmaceuticals, 181 Medical Journal of Australia (Sept. 6,

2004, pp. 260–261). 4Kevin Outterson, The Transparency Revolution in PhRMA Pricing, 10 PhRMA Pricing and

Reimbursement 4–9 (IMS Health, Cambridge, Jan. 2005); Kevin Outterson, Pharmaceutical Arbitrage: Balancing Access and Innovation in International Prescription Drug Markets, 5 Yale J.

Health Policy, Law & Ethics 193, 217–222 (2005).

narrows the price differential between therapeutically equivalent generics and patented me-too compounds. Rather then being a weakness, this pricing approach

should result in a more efficient outcome in the allocation of R&D resources by rewarding product innovation above product differentiation.

For example, the Productivity Commission’s study in 2001 found price differentials between Australia and the U.S. were large for me-too drugs, and smaller for

innovative medicines (PC 2001).

Question 2d. You advocate U.S. States adopting the Australian pricing scheme.

Will States really want to adopt the Australian pricing schedule, including increased

prices for generics?

Answer. 2d. I do not advocate the wholesale adoption of the Australian PBS by

the United States, or by particular U.S. States.2

I have argued on several occasions, however, that the Australian PBS is an excellent model, because it pays for value.3 If a drug company demonstrates that the

drug is highly cost-effective over existing therapies, the PBS pays more for it. If the

drug is a relatively modest addition to an existing class of medications, the PBS will

reimburse at the same level of other drugs in the class. The PBS pricing system

rewards product innovation above product differentiation. If the U.S. adopted a

similar system we would have more innovative drugs and fewer me-too drugs.

PBS pricing also reduces the rewards for strategic patent games designed to

evergreening existing blockbusters beyond 20 year patent terms. If a generic in a

therapeutically equivalent class exists all products within that class are priced at

comparable levels regardless of patent status.

Paying for value is an excellent idea for U.S. health care markets. The Centers

for Medicare & Medicaid Services (CMS) are experimenting with paying for value

and quality in several areas, as are many private payors.

If U.S. payors adopted an economic evaluation system, it is beyond doubt that significant savings would ensue, even if generic prices rose. An even more favorable

pricing result would be to adopt economic evaluation for patented products, but retain current U.S. pricing for generics.

Question 3. Implementation of price controls will not create a corresponding reduction in drug development costs. It will still cost the same to discover, test, validate through clinical trials, manufacture and ultimately market a new product. The

costs will remain the same, but the potential return will be greatly diminished if

there are price controls.

Do you believe that in the face of price controls, companies will limit their development efforts to those drugs that have the highest potential profitability? And that

this limitation could have the greatest negative impact on drug candidates—such as

orphan drugs—that, while they have the potential to help many patients, are not

market ‘‘blockbusters?’’ Is a free-market pricing system more favorable to smaller

market products?

Answer 3. I will divide this question up into two parts:

Question 3a. Do you believe that in the face of price controls, companies will limit

their development efforts to those drugs that have the highest potential profitability? And that this limitation could have the greatest negative impact on drug

candidates—such as orphan drugs—that, while they have the potential to help

many patients, are not market ‘‘blockbusters?’’

Answer. 3a. We do not have the data to adequately answer this question. All

major studies on pharmaceutical company response to modest changes in revenue

are based ultimately upon data provided by the companies themselves. I have suggested in my testimony before this committee and in other articles 4 that we should

not rely on this data, but should have access to transparent, audited data for this

important public policy.

84

5See Global Forum for Health Research, ‘‘The 10/90 Report on Health Research 2003–2004’’

(‘‘health research has suffered from an overall lack of funding and from a huge discrepancy between the allocation of research funding and the diseases or conditions that account for the

highest global disease burden . . . less than 10 percent is devoted to research into the health

problems that account for 90 percent of the global disease burden . . .’’). 6Michael Kremer & Rachel Glennerster, ‘‘Strong Medicine: Creating Incentives for Pharmaceutical Research on Neglected Diseases (2004); Michael Kremer, Creating Markets for New Vaccines: Part I: Rationale & Part II: Design Issues, in 1 ‘‘Innovation Policy and the Economy’’ 35–

109 (Adam B. Jaffe et al. eds., 2001). 7 Jean O. Lanjouw, ‘‘A Patent Policy Proposal for Global Diseases’’ 4 (The Brookings Institution, Working paper No. 84, 2001); Alan O. Sykes, TRIPS, Pharmaceuticals, Developing Countries, and the Doha ‘‘Solution,’’ 3 Chi. J. Int’l L. 47, 56–62 (2002). 8F.M. Scherer, A Note on Global Welfare in Pharmaceutical Patenting, 27 World Econ. 1127,

1141 (2004).

However, common sense would suggest that drug companies would cut their least

valuable projects first. Innovative, blockbuster drugs would continue to be developed; marginal me-too drugs might get less funding.

As for orphan drugs, the Internal Revenue Code and FDA law provide many direct and indirect incentives for the development of orphan drugs. (Orphan drugs are

an increasingly disparate category. In June 2004, the FDA approved Vioxx as an

orphan drug for certain juvenile conditions). These incentives are expected to continue in any event.

Question 3b. Is a free-market pricing system more favorable to smaller market

products?

Answer 3b. It is a mistake to characterize our present pharmaceutical system in

the U.S. as ‘‘free market.’’ Tens of billions of dollars in government grants flow into

the system to stimulate basic research through the NIH and other sources. The patent system itself is a severe distortion of the market, designed to address the appropriation problem with investments in knowledge. Billions of dollars in tax credits

and incentives are offered in the Internal Revenue Code. Additional market

exclusivities are offered under the Orphan Drug Act and for pediatric testing,

among others. Yet more incentives are proposed under BioShield II. FDA marketing

approval rules delay market entry pending review of safety and efficacy.

On the pricing side, mandatory rebates in Medicaid, FSS pricing in the VA, 340B

pricing in the Public Health Service, and many other special programs demand and

receive concessionary pricing. Pricing transparency in PBMs and private insurance

plans is quite limited (free markets typically imply transparent prices). Information

disparities are rampant. Intellectual property rules prohibit parallel trade. FDA

rules block global pharmaceutical competition through pricing arbitrage. Other examples could be given.

I don’t know any responsible economist who would describe the U.S. pharmaceutical system as a ‘‘free market.’’

Question 4. In your written testimony you state some countries should be characterized as ‘‘fair followers’’ and not ‘‘free riders.’’ If it is fair for developing countries

to not pay for the development costs of pharmaceuticals generally, what incentive

would exist to develop pharmaceuticals that are needed to treat diseases that are

endemic in developing countries?

Answer. 4. It is clear that the present patent system offers very little incentive

to research and develop drugs for conditions which are endemic only in developing

countries. (Usually called ‘‘neglected diseases’’).5 The poverty of the potential customers blocks a normal commercial market for these drugs. Almost everyone, including the major drug companies, would agree with this statement. The question is

what we should do about it.

In response to the failure of the commercial patent system for neglected diseases,

many public-private cooperative ventures have been established to focus R&D dollars on neglected diseases. Donors include governments, multilateral agencies, and

private sources such as the Bill and Melinda Gates Foundation. Michael Kremer’s

group at Harvard has suggested offering global prizes and purchase commitments

for successful R&D into neglected diseases.6 Other researchers, such as Jean

Lanjouw at Brookings and Alan Sykes at the University of Chicago suggest modifications to the patent systems of developing countries to encourage neglected disease innovation.7 The eminent economist F.M. Scherer has stated that developing

countries should be allowed to be ‘‘fair followers’’ on pharmaceutical innovation.8 My

own views on these subjects were published in February 2005 in the Yale Journal

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9Kevin Outterson, Pharmaceutical Arbitrage: Balancing Access and Innovation in International Prescription Drug Markets, 5 Yale J. Health Policy, Law & Ethics 193, 244–250 (2005)

(concluding that neglected disease innovation does not require appropriation of pharmaceutical

rents from low income populations via the patent system). 10Kevin Outterson, Free Trade Against Free Riders?, 9 Pharma Pricing & Reimbursement 254

(IMS Health, Sept. 2004). 11Kevin Outterson, Nonrival Access to Pharmaceutical Knowledge, Submitted to the World

Health Organization Commission in Intellectual Property Rights, Innovation & Public Health,

Jan. 3, 2005, available at www.who.int and www.ssrn.com (author = Outterson). 1 Note that profit-seeking firms generally have efficient and powerful incentives to preserve

the economic value of their brand names and thus the safety and effectiveness of their products.

In the context of the pharmaceutical market, the problem of contagion may introduce a distortion, and the cost of policing counterfeit drugs may yield an efficient role for government activity. See, e.g., Benjamin Klein and Keith B. Leffler, ‘‘The Role of Market Forces in Assuring Contractual Performance,’’ Journal of Political Economy 89(4), 1981, pp. 615–641.

of Health Policy, Law & Ethics 9 and in September 2004 in Pharma Pricing & Reimbursement, published by IMS Health.10

In addition to neglected diseases, many ‘‘Western’’ conditions such as heart disease, AIDS, diabetes and cancer are increasingly common in the developing world.

The markets of the OECD members are sufficient to sustain robust innovation in

these conditions. Extending the pharmaceutical patent system to low-income populations for these ‘‘global diseases’’ will be both cruel and unnecessary: cruel because

we know the higher prices under a patent system will discourage medically necessary use and encourage counterfeiting; unnecessary because OECD markets alone

are sufficient to stimulate innovation and very little additional R&D will be stimulated by these low income markets. For a longer description of this particular issue,

please see my submission to the WHO in January 2005.11

The USTR pursues many strategies which limits the sale of drugs at marginal

cost of production for global disease conditions in low income settings worldwide.

These policies damage static human health, but are allegedly supported on innovation grounds. The basic ‘‘fair followers’’ argument is that the USTR strategy is not

important to global pharmaceutical innovation, and so it should yield to the pressing

needs of global human health.

RESPONSE TO QUESTIONS OF SENATOR ENZI BY BENJAMIN ZYCHER

Question 1. As I am sure you are aware, every free trade agreement that the

United States has signed recognizes the importance of allowing legitimate domestic

regulation. Both WTO agreements as well as NAFTA explicitly permit governments

to restrict imports for a number of important purposes, like protecting public health

and safety, and national security. Do you believe that permitting importation of

pharmaceuticals from foreign nations works against such trade agreements?

Answer 1. Throughout the postwar GATT and more recent WTO negotiating

rounds and through the NAFTA process, the central purpose of liberalized trade has

been the improvement of economic productivity and thus the long-term well-being

of consumers. That improvement is achieved through the reduction of artificial barriers to efficient resource allocation, so that individuals, firms, and economies can

exploit both their own comparative advantages and those of others as well. In short:

The central goal of free trade agreements is an expansion in the value of overall

economic output, and so a reduction in the aggregate level of real prices. International trade in pharmaceuticals is fully consistent with that goal, subject to safety

and other public health considerations,1 and subject to the absence of other policies

that might obviate the gains that trade otherwise would yield. In the context of the

international pharmaceutical market, foreign price controls are foremost among

such perverse policies. Because of the basic economic conditions of pharmaceutical

development and production—for the most part fixed costs are high while marginal

production costs are low—foreign governments have strong incentives to obtain a

‘‘free ride’’ on (a substantial part of) the fixed costs financed by U.S. consumers, by

imposing price controls on retail transactions. These foreign price controls impose

several types of inefficiency costs, foremost among them an inefficient reduction in

incentives for the development of new pharmaceuticals. Accordingly, the importation

of pharmaceuticals subject to foreign price controls necessarily would introduce

those controls into the U.S., either at wholesale or at retail depending upon market

conditions; such pricing distortions and the perverse long term effects attendant

upon them are inconsistent with the efficiency goals of free trade agreements, and

so indeed would ‘‘work against such trade agreements.’’ This inconsistency would

take the form of reduced and distorted pharmaceutical investment over the long

term, thus increasing real prices by reducing the future availability of new and imVerDate 11-MAY-2000 12:56 Sep 02, 2005 Jkt 000000 PO 00000 Frm 00089 Fmt 6633 Sfmt 6621 S:\DOCS\20046.TXT SLABOR3 PsN: SLABOR3
86

2The issue of the efficient structure and length of patent rights in the pharmaceutical context

is not addressed here. 3The imposition of price controls is very different from differential pricing. Such ‘‘price discrimination’’ is efficient, fully consistent with competitive market behavior, and makes consumers better off by allocating fixed costs in accordance with differing valuations placed upon the

knowledge capital yielded by pharmaceutical innovation, thus moving the production of pharmaceuticals closer to the efficient level. 4 In order to see this, consider the case of a highly profitable pharmaceutical producer; would

it invest in a drug subject to severe (future) price controls merely because overall profits are

high? It will do that no more readily than bury a $100 bill in the hope that a money tree will

sprout. 5See, e.g., Frank R. Lichtenberg, ‘‘Are the Benefits of Newer Drugs Worth Their Cost? Evidence From the 1996 MEPS,’’ Health Affairs 20(5), September/October 2001, pp. 241–51. See

also Kevin M. Murphy and Robert H. Topel, eds., Measuring the Gains From Medical Research:

An Economic Approach, Chicago: University of Chicago Press, 2003. Even with an adjustment

for the costs of substitute medical procedures, such measured ‘‘costs’’ underestimate the adverse

effects of pharmaceuticals made unavailable by the prior direct or indirect imposition of price

controls because they exclude the real but difficult-to-measure costs of increased mortality, morbidity, and suffering. 6 Note that because pharmaceutical producers have incentives to invest only in drugs the development and production costs of which consumers are willing to bear, the reduced prices in

the short run are likely to be offset at least fully by the longer term higher costs of reduced

drug availability, as a first-order approximation. Moreover, the imposition of price controls

might not yield price reductions at retail even in the short run, as the difference between conproved medicines. That outcome obviously is at odds with the central goal of efficient investment in the context of free trade agreements, thus reducing rather than

expanding the value of aggregate output and consumer well-being.

Question 2. Trade agreements such as the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) and NAFTA require governments to

protect intellectual property rights. These agreements are designed to ensure the

continuing viability of industries involved in the research and development of innovative products, and to prevent unfair competition from companies who would otherwise free-ride on the technology developed by others.

Do you think that unauthorized importation of prescription pharmaceuticals

would undermine the value and purpose of U.S. patent rights?

Answer 2. The central economic purpose of patent rights is the creation of a temporary stream of ‘‘monopoly’’ returns to investment in pursuit of efficient investment

incentives for innovation and research and development.2 These returns are engendered by a (marginal) revenue stream temporarily higher than otherwise would be

the case; accordingly, any policies that reduce such revenue streams artificially indeed ‘‘would undermine the value and purpose of U.S. patent rights.’’ The importation of pharmaceuticals subject to price controls obviously would reduce the (expected) revenue stream for the given drugs (or drug class), and so would have the

effect of undermining the goals of the patent system. Indeed, even without importation of pharmaceuticals, and even without compulsory licensing or other such policies, the imposition of price controls overseas interferes with patent rights by reducing the marginal revenues yielded by introduction of a new or improved medicine.

(Merely consider the extreme case of a drug the price of which is controlled at zero;

the patent value would be zero as well.) 3 Note also that neither overall firm ‘‘revenues’’ nor ‘‘profits’’ is the correct criterion for determining whether investment incentives will be efficient; instead we must ask whether a policy affects the marginal

expected returns attendant upon investment in a given drug.4

Question 3. You indicate that the magnitude of the projected adverse effect of importation on research and development varies somewhat, ‘‘although it is never predicted to be small.’’ You also mention that all of the estimates are biased downward.

What do you see as the realistic potential effect on research and development? Do

you feel that even if importation leads to price reductions, U.S. consumers would

end up sacrificing choice in favor of cost?

Answer 3. The importation of pharmaceuticals subject to price controls would

yield both reduced consumer choice and higher overall health care costs. The reduced consumer choice would be one central adverse effect of the lessened research,

development, and innovation that inexorably will be engendered over the long run

by price controls. The higher overall health care costs will be caused by the substitution of hospital and other types of medical services in place of the pharmaceuticals

that will have failed to have been developed over time.5 In the narrow context of

the pharmaceutical market, any short term reduction in drug costs (prices) will be

offset partially, fully, or more than fully by the higher real costs of reduced drug

availability over the long term.6 The potential effect on research and development

87

trolled prices and market value might be captured in whole or in part by various transaction

agents (‘‘middlemen’’) under a broad range of market conditions. 7See U.S. Department of Commerce, International Trade Administration, Pharmaceutical

Price Controls in OECD Countries: Implications for U.S. Consumers, Pricing, Research and Development and Innovation, December 2004, chapter 8. 8For most drugs marginal production costs are low and short run scale economies seem not

to be particularly important; accordingly, supply conditions as a first approximation suggest that

the increased demand for generics would not increase the prices of generic drugs substantially.

is difficult to measure, although a crude but unbiased approximation can be obtained by estimating the reduction in the present value of the expected future revenue stream for a prospective drug, and then comparing that reduced revenue base

with the cost of developing new drugs, estimated at over $800 million in peerreviewed journals, or perhaps with the present value of the expected costs of developing that prospective drug.7 Such analyses are reasonable as initial starting points

for analysis, but they are likely to underestimate the adverse effect of price controls

on research and development because they are static rather than dynamic; they fail

to take into account the fact that the imposition of price controls, whether direct

or indirect, introduces an asymmetry into the statistical (stochastic) distribution of

future returns to research and development. This is an effect distinct from the price

reduction itself: Ex ante, any given potential investment offers upside potential that

is limited (truncated) by the price controls, while downside risks remain unaffected.

The dynamic effect, therefore, is to shift the entire statistical distribution of possible

returns downward (or to the left); this means that the standard static measurements of the adverse research and development effects attendant upon the imposition of price controls are biased downward.

Question 4. The Department of Commerce study acknowledged that improvements

to health care and life sciences are an important global source of gains in health

and longevity. According to the study, ‘‘The development of innovative pharmaceutical products plays a critical role in ensuring these continued gains.’’ The report

states that ‘‘economic incentives are essential’’ in order to encourage the continued

development of new medicines.

Do you think legalized importation would reduce the ‘‘economic incentives’’ that

are critical to the development of new medicines?

Answer 4. It is incontrovertible that the imposition of price controls on pharmaceuticals, whether directly or indirectly in the form of competition from drugs subjected to price controls overseas, would weaken incentives to invest in pharmaceutical research and development. This is true under any set of assumptions about

the competitiveness of the industry, about its maximand, or other parameters; the

market for investment capital will recognize immediately the attendant reduction in

expected returns to investment in this sector, and will reallocate some capital elsewhere. As discussed in footnote 4 above, such parameters as the overall profitability

of the industry (or given firms) or overall industry (or firm) revenues are not relevant. For any given prospective investment in a new chemical entity or other developmental product, the capital market will ask whether expected returns (on the

margin) justify the expected development costs. Price controls cannot improve the

marginal efficiency of any such investment.

RESPONSE TO QUESTIONS OF SENATOR KENNEDY BY BENJAMIN ZYCHER

Question 1a. The Department of Commerce Report suggests that the increased

prices of name-brand drugs in Europe could be offset by reduced prices (and increased utilization) of generic drugs.

Do you agree with that assessment?

Answer 1a. It certainly is true that name-brand and generic drugs in the short

run are substitutes to some substantial degree. In the long run, they are more complementary, in that generic drugs over time cannot become generic drugs unless

they are developed first as name-brand drugs. In the short run, an increase in the

prices of name-brand drugs would increase the demand for generics; depending on

supply conditions for the latter, increased utilization of generics would be expected

to yield some savings that might be substantial.8 In the long run, increased prices

for name-brand drugs would reduce the prices of generics by increasing competition

among them. The reasons that generic prices seem to be higher in Europe than in

the U.S. (abstracting from exchange rate issues and the like) are unclear; some attribute that condition to anticompetitive policies in Europe, but in my view a careful

analysis of this question is yet to be done. As an aside, the elimination of European

price controls unambiguously would make U.S. consumers better off, in the long run

88

9See Charles-Andre Brouwers, Martin B. Silverstein, and Tory Wolff, Adverse Consequences

of OECD Government Interventions in Pharmaceutical Markets on the U.S. Economy and Consumer, Boston Consulting Group, July 1, 2004, esp. exhibit 14.

and possibly the short run, by inducing profit-seeking producers to reduce their U.S.

prices.

Question 1b. How much could Europe save with increased generic use?

Answer 1b. The best evidence that I have seen on this issue is presented in a 2004

study by the Boston Consulting Group, which concludes in summary that an increase in European generic use to levels proportionate to those in the U.S. would

reduce drug spending by 20 percent.9

Question 1c. Would increased generic savings impact innovation?

Answer 1c. Certainly there would be more innovation investment if competition

from generics were reduced, that is, if name-brand drugs enjoyed more or longer

‘‘monopoly’’ positions. The presence of generics yields competition, as does the presence of name-brand competitors, sometimes called ‘‘me-too’’ drugs quite incorrectly.

But the possible reduction in innovation yielded by competition from generics is not

necessarily inefficient if we assume that patent periods are optimal and that other

government policies are efficient also. In the context of Europe, if increased generic

savings were caused by a loosening or removal of price controls, then such a shift

would enhance innovation because the removal of the price control policies would

improve the investment climate. In short, in the European context, the removal of

price controls might induce a shift toward generics, which might increase the savings yielded by the use of generics, but that would be salutary for long run innovation because the removal of the price controls would improve investment incentives.

Question 2a. Would you agree that increased utilization of pharmaceuticals is beneficial to health status?

Answer 2a. Yes; see footnote 5.

Question 2b. If so, should the Health and Human Services and Department of

Commerce Reports have estimated the positive health impacts of increased consumer access to drugs due to lower prices?

Answer 2b. In the narrowest sense, the issue of what the HHS/DOC studies

should have examined is a question for Congress. More broadly, the purported price

and attendant health effects of ‘‘increased consumer access to drugs due to lower

prices’’ in a real sense answers the question (qualitatively) before it has been asked:

Price controls increase ‘‘access’’ in the short run but not the long run, so that the

improved health outcomes yielded by drug utilization in the short run must be

weighed against the adverse long term health effects of reduced pharmaceutical research and development. Is it worth mortgaging the future in favor of the present?

I believe not; but that is one crux of the debate over the importation of pharmaceuticals subject to foreign price controls. And so any such study must examine not

only the short term effects of prospective policy shifts, but the long term effects as

well.

Question 2c. Should comparative effectiveness play a role in approval or R&D or

marketing incentives?

Answer 2c. If ‘‘R&D or marketing incentives’’ are the products of market forces,

then comparative effectiveness is a crucial parameter that should influence investment choices by producers, and market forces yield precisely that outcome. If, on

the other hand, such incentives are imposed by regulators and other public officials—if ‘‘evidence-based medicine’’ is used to allocate resources in a top-down decision process—then they would be highly inappropriate. Patients respond differently

to given medicines; what is ‘‘effective’’ in the aggregate may not be ‘‘effective’’ for

specific patients, who in consultation with their physicians should choose among alternatives for the best solutions to their respective conditions. Moreover, the differences in ‘‘effectiveness’’ can manifest themselves in ways essentially unobservable

to analysts; consider a generic diuretic equal in ‘‘effectiveness’’ with some namebrand hypertension drug, but which causes the patient to visit the bathroom multiple times during the night, before work the next day. Only patients in consultation

with their physicians can evaluate all the relevant tradeoffs in pursuit of ‘‘effectiveness;’’ government policy is too blunt an instrument to do so without the creation

of important adverse effects in terms of patient well-being.

89

QUESTIONS OF SENATOR ENZI TO STEPHEN POLLARD

Question 1. There are several studies that compare the cost of some of the most

widely prescribed drugs in the U.S. to the cost of those same drugs in Canada, the

UK, Germany, France, and other countries where there are price controls.

What impact have price controls had on drug discovery and development in Europe? It is my understanding that there has been a notable decline in R&D in Europe in particular over the past 10 years. Have price controls contributed to this decline? Do you know how pharmaceutical inventions in Canada, Germany, and the

UK, based on NMEs, compare to those in the U.S.?

Answer 1. Response unavailable.

Question 2. Many compare importation of drugs into the U.S. to parallel trade in

Europe—are there important differences that make these two practices different—

if so, what are they? What impacts will EU expansion have on parallel trade in

pharmaceuticals?

Answer 2. Response unavailable.

Question 3. According to a recent study by the London School of Economics, profits from parallel imports accrue mostly to the benefit of the third party companies

that buy and resell the medicines, not to patients. Specifically, the LSE study found

that savings to insurance organizations ranged from .3 percent to 2 percent, while

parallel trader mark-ups ranged from 12 percent to 54 percent. Does the European

experience truly demonstrate that this practice benefits intermediaries rather than

consumers? If commercial importation were to become legal in the United States,

do you think we would have a similar experience in terms of savings or lack of savings?

Answer 3. Response unavailable.

Question 4. According to the Irish Medicines Board’s 2005 annual report, the unauthorized importation of medicinal products, which it investigates, includes those

originating from outside the EU. The report also states that number of investigations it is carrying out into the illegal mail order/Internet supply of drugs is steadily

increasing. How can parallel trade in Europe be safe for patients if—according to

the report—there are a growing number of unregulated prescription drugs coming

into the EU from foreign nations?

Answer 4. Response unavailable.

QUESTION OF SENATOR HATCH TO STEPHEN POLLARD

Question 1. I appreciated your insights on European healthcare issues as they relate to prescription price controls and parallel trade. I agree that every developed

Nation has something unique and important to add in the field of medical research.

Your comments about price controls and how the European governments are imposing costs on the developing world were particularly interesting.

Could you explain how the supply of medicines to lesser-developed countries is affected by price-controls on prescription drugs?

Answer 1. Response unavailable.

QUESTIONS OF SENATOR KENNEDY TO STEPHEN POLLARD

Question 1. The Department of Commerce Report suggests that the increased

prices of name-brand drugs in Europe could be offset by reduced prices (and increased utilization) of generic drugs. (a) Do you agree with that assessment? (b)

How much could Europe save with increased generic use? (c) Would increased generic savings impact innovation?

Answer 1. Response unavailable.

Question 2. Would you agree that increased utilization of pharmaceuticals is beneficial to health status?

If so, should the Health and Human Services and Department of Commerce Reports have estimated the positive health impacts of increased consumer access to

drugs due to lower prices? Should comparative effectiveness play a role in approval

or R&D or marketing incentives?

Answer 2. Response unavailable.

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PREPARED STATEMENT OF ELLEN R. SHAFFER AND JOSEPH E. BRENNER, CPATH

RAISING OECD DRUG PRICES WOULD NOT SOLVE THE U.S. CRISIS IN AFFORDABILITY

CPATH conducts research, policy analysis and advocacy to bring the voice of public health to the trade debate. We appreciate the work of Chairman Enzi and the

committee to explore the issues raised by the U.S. Department of Commerce report,

Pharmaceutical Price Controls in OECD Countries: Implications for U.S. Consumers,

Pricing, Research and Development and Innovation. An objective review of OECD

country policies could provide guidance as the U.S. seeks policies to assure that prescription drugs are more affordable. However, the present report and much of the

testimony presented at the committee’s hearing on February 17, 2005, are deeply

flawed. We concur with others who have criticized the dearth of substantiated evidence, and the choice of sources and terminology that are known to be biased in

favor of the pharmaceutical industry. It draws upon unfounded assumptions to conclude any association between affordable prices for prescription drugs abroad and

ongoing innovation in research.

Nevertheless, even this flawed report reaches the unassailable conclusion that in

the short term, ‘‘the deregulation of OECD prices is not likely to have any impact

on U.S. drug prices.’’ In the undefined long term, the report speculates that certain

changes in OECD prices might, under particular and questionable circumstances,

lead to ‘‘improved health outcomes’’ there, and eventually ‘‘could have some effect

on U.S. prices.’’ One must question, then, why current U.S. policy seeks aggressively

to achieve higher drug prices abroad through trade negotiations.

A central concern regarding this report is not that supporting statements lack intellectual rigor, or even that the report supports bad trade policy. Rather, the report

is bad health policy: it asks the wrong question. The American public is actively

looking to Congress for relief from the high price of prescription drugs. To their

credit, most Members of Congress have voted more than once for the most viable

short-term solutions available, the drug reimportation proposals. The report, however, dodges Americans’ most critical concerns.

To our elderly traveling to Canada to buy the drugs they depend upon, to our

Governors struggling with Medicaid budgets, to our African-American communities

and others battling the scourge of AIDS, this report suggests: the pharmaceutical

industry doesn’t have enough money yet to take care of you. If we are able to raise

prices in Germany, perhaps we’ll get back to you.

NEGOTIATING HIGHER DRUG PRICES: BAD TRADE POLICY, BAD HEALTH POLICY

Reasonable regimes for assuring access to affordable life-saving medicines

throughout the developed world do not account for unsustainably high prescription

drug prices in the U.S., or for the pharmaceutical industry’s dwindling development

of innovative products. U.S. proposals to our trading partners to dismantle their

own drug pricing and distribution systems are already creating serious diversions

from our ability to successfully negotiate agreements with middle and low-income

countries, and would certainly cause an uproar in wealthy nations. The U.S.-

Australia Free Trade Agreement offers a case in point.

Trade language on drug pricing can have consequences for domestic U.S. programs that provide affordable drugs for vulnerable populations. These include veterans eligible for Veterans Administration benefits, Medicaid and Medicare beneficiaries, and community clinic patients who benefit from 340B programs. There are

three reasons these complications could arise:

• These U.S. programs engage in complex negotiations for drug pricing and listing that are in some cases similar to the OECD country programs erroneously described in the report as ‘‘government fiat.’’

• Trade agreements apply to all signatory nations. Trade agreement language can

be imprecise, and subject to retroactive interpretation by non-U.S. trade tribunals.

• There are no public health representatives engaged in trade negotiations. Such

representatives could advise trade representatives of potential unintended pitfalls.

The pharmaceutical industry is among the most profitable in the world. It is not

necessary, nor is it sufficient, to raise more money from higher prices abroad if the

goal is to increase funding for research and development. The industry’s reliance on

ever-lengthening terms of protection for monopoly pricing and barriers to competition, and production of marginally useful but highly profitable copycat blockbuster

drugs, must be addressed through policy. This includes reinvigorating market competition among pharmaceutical manufacturers.

Much of the testimony at the February 17 hearing suggested that the U.S. would

do poorly to import drugs from OECD countries. Doing so would amount to importing those countries’ pricing systems, and exposing Americans to fewer appropriate

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treatments, according to an example offered by one witness, by oncologists. These

remarks suggest the actual interest behind the veneer of concern for the health of

our European counterparts. The attempt to discredit pricing systems abroad may

delay reforms needed to achieve affordable drug prices in the U.S. It is unlikely to

convince Americans that the high prices we pay are worth it.

(According to Alan Sager and Deborah Socolar, among others, reducing prices in

the U.S. would not necessarily decrease pharmaceutical revenues, as the resulting

increased volume could hold revenues constant, or increase them.)

Surely international cooperation would be a valuable element of the realignment

that must take place to assure affordable drugs in the U.S. Lower prices in the U.S.

could reduce the already limited funds devoted to truly innovative research and development, and a better framework to assure sufficient investment may be required.

Limited patent protections can help to protect and encourage genuine innovation in

pharmaceuticals as in other endeavors that depend on up-front investments. Different pricing structures for regions of the world at different income levels can be

part of the solution. But pursuing wrongheaded, unpopular and ineffective trade

proposals with our trading partners will not lead to meaningful progress. We encourage Congress to help engender the political will to seriously entertain thoughtful policy solutions to the present crisis in the cost and accessibility of prescription

drugs.

SPECIFIC COMMENTS ON THE DOC REPORT: ADDITIONAL REVENUES WOULD NOT

IMPROVE INNOVATION

The report contends that higher drug prices in OECD countries might increase

drug company revenues abroad, but then again perhaps not, if spending shifts to

less expensive generics.

In the somewhat unlikely event that Europe, Canada and Japan agree to raise

their drug prices, and that more revenues become available to the pharmaceutical

industry, the question then becomes whether additional revenues, if generated,

would in fact lead to the development of any new drugs.

No one knows with certainty what the pharmaceutical industry spends on research, development, or marketing, because they will not reveal the data. Nevertheless, figures favorable to and in some cases directly sponsored by the industry are

roundly questioned by independent researchers. Independent reports contend:

1. The industry has sufficient funds to sponsor research and development, if it

chose to so allocate those funds. While earning profits of about 19 percent on average, it spends less than 15 percent of revenues on research and development (including government subsidies), and 37 percent on marketing and administration.

2. Many newly marketed drugs are of scant if any additional therapeutic value.

Professor Joel Lexchin, Associate Professor at the School of Health Policy and

Management, York University, offers the following estimate:

Category

Number

of New

Drugs

Percent

of New

Drugs

Major therapeutic innovation in an area where previously no treatment was available ............................. 7 0.3

Important therapeutic innovation but has limitations .................................................................................. 73 2.7

Some value but does not fundamentally change the present therapeutic practice ..................................... 212 7.9

Minimal additional value and should not change prescribing habits except in rare circumstances .......... 432 16.0

May be new molecule but is superfluous because does not add to clinical possibilities offered by previously available products ......................................................................................................................... 1780 66.1

Without evident benefit but with potential or real disadvantages ............................................................... 73 2.7

Decision postponed until better data and more thorough evaluation .......................................................... 116 4.3

Total ............................................................................................................................................................ 2693 100.0

(Value of new drugs introduced into France 1981–2002—Prescrire International 2002;11:58–60).

3. The actual cost of bringing a new drug to market, including research and development, is probably around $100 million, rather than the industry’s claim of $800

million. (Light, D. W., and J. Lexchin. 2004. Will Lower Drug Prices Jeopardize

Drug Research? A Policy Fact Sheet. The American Journal of Bioethics 4(1):W1-

W4.)

4. ‘‘The amount that the industry spends on research and development depends

on many factors aside from revenue generated through sales. A more important

stimulus to industry R&D is the level of public funded basic research.

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Dr. Lexchin notes that between 1980 and 2002:

• Every $1 billion increase in NIH spending was associated with $1.316 billion

more in domestic R&D.

• Every $1 billion increase in retail spending was associated with $172 million

more in domestic R&D.

OECD NATIONS ARE HEALTHY

The report acknowledges that U.S. drug prices are higher than in other OECD

countries. Testimony suggested that Europeans receive worse health care and are

in worse health compared with Americans, suggesting that we buy better health

with our drug spending. These assertions are not documented. As with any such

broad topic, the choice of indicators determines the conclusion. Dr. Lexchin has compiled a table on the most significant indicators, based on OECD data, demonstrating

that U.S. residents lag behind Canadians and Europeans:

Country Infant mortality (2002) Life expectancy at birth

(males) (2002)

Life expectancy at birth

(females) (2002)

United States ........................................ 6.8 (2001) ....................... 74.4 (2001) ..................... 79.8 (2001)

Canada .................................................. 5.2 (2001) ....................... 77.1 (2001) ..................... 82.4 (2001)

Australia ................................................ 5.0 ................................... 77.4 ................................. 82.6

France ................................................... 4.2 ................................... 75.4 ................................. 82.9

Germany ................................................ 4.3 ................................... 75.6 (2001) ..................... 81.3 (2001)

Sweden .................................................. 2.8 ................................... 77.7 ................................. 82.1

United Kingdom .................................... 5.3 ................................... 75.7 (2001) ..................... 80.4 (2001)

OECD, 2004.

CONCLUSION

Widespread importation of prescription drugs could improve rather than undermine market competition, lower prices, and increase access and the volume of sales.

It might or might not lower total drug expenditures in the U.S. There is no reason

to project a decline in innovation or health status as a result. Congressional leadership is badly needed to guide the Nation toward sensible policies that assure development and distribution of effective, affordable prescription drugs.

PREPARED STATEMENT OF JOEL LEXCHIN

The following comments respond to the Department of Commerce report, Pharmaceutical Price Controls in OECD Countries: Implications for U.S. Consumers, Pricing, Research and Development and Innovation, published in December, 2004.

1. One of the most serious flaws in the Department of Commerce report is the

data on the division of market share between brand-name and generic drugs. For

instance for Canada the DOC report says that 54.9 percent of market share (dollar

sales) comes from off-patent and 41.1 percent comes from on-patent drugs. The real

figures from the 2003 report of the Patented Medicine Prices Review Board is: total

sales of $15 billion of which $10.1 billion from patented medications (i.e., about 66

percent), $3.2 billion from off-patent brand name and $1.7 billion from generics.

Therefore, 66 percent from on-patent medication (>50 percent higher than figure in

DOC report) and 33 percent from off-patent medications or about 66 percent lower

than DOC report figure. This type of gross mistake completely throws off all of the

calculations about changes in overall expenditures if Canada adopted U.S. prices

and lowered generic prices.

2. The assumption that pharmaceutical prices in U.S. are market-oriented ignores

the effects of intellectual property laws in the U.S., and company actions that create

restrictive monopoly conditions. These include, e.g., evergreening tactics, deals with

generic companies to delay marketing of generic products, and patent extensions for

pediatric studies even when drugs are unlikely to be used in children.

3. The report ignores multiple factors that might lead to differences in drug prices

in other industrialized countries—e.g., production costs, costs of other forms of

health care. Absent consideration of these other factors, the conclusions from this

study are seriously weakened.

4. GDP includes many things that do not improve standard of life, e.g., clean-up

costs from pollution spills, military expenditures, etc.

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5. The report assumes that movements in the ratio of drug prices in the U.S. relative to other countries are linked to movements in the ratio of GDP per capita. No

empirical data is presented to support this contention. Data comparing Canada and

the U.S. seem to indicate that even when the GDP per capita ratio remains the

same, the ratio of drug prices drops as the table below shows:

Year

Drug

price ratio

(Canada/

United

States)

Gross

domestic

product per

capita ratio

(Canada/

United

States)

1999 .......................................................................................................................................................... 0.62 0.63

2000 .......................................................................................................................................................... 0.63 0.63

2001 .......................................................................................................................................................... 0.59 0.64

2002 .......................................................................................................................................................... 0.60 0.65

2003 .......................................................................................................................................................... 0.57 0.64

6. The increased use of generics in OECD countries, as suggested by the report,

might require restrictions imposed by government, e.g., setting maximum reimbursement prices and the DOC Report argues against government interference in

the pharmaceutical marketplace.

7. Other studies, e.g., even the one that the DOC Report cites from Danzon, put

Canadian generic prices below those in the U.S.

8. Generic prices in the U.S. are heavily dependent on competition between generic companies, and one of the most important factors in generating competition

is market size; the larger the market the more the number of companies willing to

enter the market. Market size in the U.S. is much larger than in any other country.

Therefore, other countries may not match the level of competition and therefore the

prices found in the U.S.

9. The report assumes that price levels are the only thing that determine R&D

spending. This ignores multiple other factors, e.g., level of public spending on basic

research (much higher in U.S. relative to other countries), number of trained researchers and sophistication of health care system, and the home country of multinationals. R&D spending by the pharmaceutical industry in the U.S. also tracks

very closely with NIH spending.

10. Many of the sources cited, and particularly Grabowski, J.M. Vernon and

J.A.Vernon, produce work favorable to the brand-name industry.

11. For the U.S., R&D data by PhRMA are much higher than the figure reported

by the National Science Foundation. For example, in 2000, the NSF reported that

the pharmaceutical industry spent $15,451 billion on R&D; that same year,

PhRMA’s figure was $21,364 billion.

12. Launch delays are also due to internal company marketing decisions—which

country to first file for approval in, size of estimated market, cost of getting a drug

approved.

13. Does drug availability correlate with improved health outcomes in U.S. relative to other countries? Data on accepted indicators such as life expectancy and infant mortality would suggest not.

Country Infant mortality (2002) Life expectancy at birth

(males) (2002)

Life expectancy at birth

(females) (2002)

United States ........................................ 6.8 (2001) ....................... 74.4 (2001) ..................... 79.8 (2001)

Australia ................................................ 5.0 ................................... 77.4 ................................. 82.6

Canada .................................................. 5.2 (2001) ....................... 77.1 (2001) ..................... 82.4 (2001)

France ................................................... 4.2 ................................... 75.4 ................................. 82.9

Germany ................................................ 4.3 ................................... 75.6 (2001) ..................... 81.3 (2001)

Sweden .................................................. 2.8 ................................... 77.7 ................................. 82.1

United Kingdom .................................... 6.8 (2001) ....................... 74.4 (2001) ..................... 79.8 (2001)

14. On p. 32, the DOC Report says that there is ‘‘research that suggests that there

are benefits as well from ‘follow-on’ drugs in terms of increasing competition and

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reducing prices.’’ The study that this conclusion comes from is unpublished and

therefore not peer reviewed.

16. The study by Garattini (BMJ 2002;325:269–71) that examined new cancer

medications introduced into the European market from 1995–2000 found that they

offered few or no substantial advantages over existing medications, yet cost several

times more.

PREPARED STATEMENT OF DONALD W. LIGHT

Summary Points:

1. Blocking free trade makes American businesses less competitive, less productive and less profitable. Current proposals should be rejected as bad for U.S. business.

2. Foreign free-riding is a myth, contradicted by industry and government data.

3. Drug companies earn back all R&D expenses each year at European prices,

with profits. Thus, Americans pay super-prices for super-profits.

4. So-called ‘‘price controls’’ are negotiated wholesale contracts between large buyers and large sellers. The ‘‘controls’’ are largely terms found in other serious contracts.

5. So-called ‘‘reference pricing’’ is value pricing, a refusal to pay more for new

drugs that offer little advantage over existing cheaper ones.

6. Pharmaceutical investments in Europe have been rising, not declining. European teams have been discovering proportionately more new molecules than American teams. Europeans are healthier. ‘‘Poor Europe’’ does not need to be rescued

from a made-up crisis.

7. The Department of Commerce report is not based on solid data, is biased, and

is misleading. An independent study should be commissioned.

8. The U.S. pharmaceutical market is far from ‘‘free.’’ Prices are secret. Companies use corporate price controls to set prices very high and then raise them, seemingly at will. Resulting profits are three times the average—all signs of monopolistic

behavior, not open market competition.

9. Corporate investment in research to discover breakthrough drugs is far lower

than the pharmaceutical industry claims. R&D costs are also far lower.

10. Current protections from price competition reward derivative ‘‘me-too’’ research, not basic research, and that’s what we get: 85–90 percent of all new drugs

are little better than existing ones.

DRUG IMPORTATION BENEFITS AMERICAN BUSINESS AND ECONOMIC GROWTH

Congress is being asked, and the Bush Administration is already implementing,

policies to lock in world-high prices for prescription drugs in the U.S. and raise

prices in other affluent countries.

These policies are anti-business. If you believe in free markets, in competition and

in promoting the growth of American business you will oppose these policies.

Locking in high U.S. prices and raising prices abroad reinforces a major driver

of rising health care and labor costs. What employers and employees have in the

United States is corporate price controls. Pharmaceutical companies routinely set

prices in secret at 5,000 percent to 10,000 percent more than ex-factory costs. The

mark-ups are much greater than those documented by Senator Estes Kefauver in

the late 1950’s, and American business knows it.

These corporate price controls make patented drugs unaffordable to many workers

who do not have good insurance for drugs, and when they get sick, a number of

them will not buy the drugs their physician thinks they need. This reduces productivity, increases sick days, increases disability days, and raises production costs. It

makes American businesses less able to compete in world markets.

In sum, when Congress approves an (un)free trade agreement that prohibits the

export of patented drugs and delays generic price competition, it is harming every

American business sector except the pharmaceutical industry. You could call this

The Great Profit Robbery—big pharma taking millions out from the bottom lines of

every other business and putting into theirs. No wonder their profit margins are 3

times greater than the rest of the Fortune 500, year after year.

THE BIG LIE ABOUT FOREIGN COUNTRIES FREE-RIDING

Both industry and government reports show that countries charging European

prices earn back all their R&D investments within each year, just from their sales

in that country, with profits to spare. Why should prices, then, be any higher?

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This is the bottom line nobody tells Congress—there is no hard evidence of the

free-riding myth. Americans are simply paying super-prices to give big pharma

super-profits. These too are well documented, and they harm American businesses

by raising their labor costs.

EXCESSIVE PROTECTIONS FROM PRICE COMPETITION

It does not take big pharma 10 or 20 or 25 years to earn back their R&D costs.

Their own records show they earn them back in the year they are spent, even at

Canadian and European prices, with substantial profits left over. Further, an investigative financial reporter, James Edwards, has finally figured out a way to separate

the marketing from administrative costs that the pharmaceutical companies intentionally blur and document from company records that major firms spend 25 percent

of revenues on marketing alone, far more than any other industry, and twice as

much as independent data show they spend on R&D.

If pharmaceutical companies want to increase R&D, they already have the billions

to do it in-house. All they need to do is spend more on R&D, less on marketing,

and let superior drugs sell themselves, rather than be marketing companies that

also do some research. Big pharma does not need high prices or more money to be

productive. It needs to be more dedicated to research than to marketing.

Competition has been the greatest engine for innovation since capitalism began,

with patents as a temporary stay from the pressures of price competition to spur still

more innovation. If patents are too long, or if they have fuzzy endings that can be

manipulated and extended, then patent-dependent companies turn from focusing on

innovation to focusing on crafty ways to extend their corporate price controls by

keeping normal price competition from happening.

‘‘PRICE CONTROLS’’ ARE NEGOTIATED DISCOUNTS

The ‘‘price controls’’ that advocates like Robert Goldberg and Grant Aldonis talk

about are volume discounts negotiated between giant pharmaceutical companies and

a given nation’s pricing board. No one ever describes in detail the negotiations when

these boards set prices. It’s like Medco or Express Scripts negotiating discount

prices with big pharma. It’s normal, wholesale, free-market horse-trading.

Most of the time, nations are negotiating for fewer patients than are Medco, Express Scripts and other large PBMs. Mr. Aldonis says these countries are

monopsonies, but so are the large PBMs, only larger. What we have here is the bilateral horse-trading of titans on the wholesale market: the company can demand

a higher price or else a whole Nation won’t get its drug, and the price board can

demand a lower price or else the company will not get to sell its drug to a population. Of course, the drug companies spend millions of dollars to get advocates to

give a distorted picture of this process.

I guess I’m one of the people Goldberg calls ‘‘price control supporters.’’ Not at all.

I support free trade and competitive wholesale markets, as the best way to reward

innovation and good value.

‘‘REFERENCE PRICING’’ IS VALUE PRICING

Every American shopper worth her salt compares new products with existing ones

to decide if they offer any advantage. It they don’t, no one will pay more for them.

If they do, they decide how much more they are willing to pay for them. This is

the beauty of the new Consumers Union web service that compares the benefits of

different drugs doing the same job and recommends which is the ‘‘Best Buy.’’ This

revolution in truly free markets can be found at http://www.crbestbuydrugs.org/.

Finally, America has what many other nations have had for years, professional

side-by-side comparisons of new drugs with old and the ability to pay what new

drugs are worth. That’s so-called reference pricing. Drug companies hate it and do

all they can to keep people from being able to compare the value of different drugs.

Just like good American bargain shoppers, countries like Germany compare new

drugs with older ones and conclude (as do therapeutic committees in many places),

that 80–85 percent of them offer little or no advantage over older ones. Drug companies are furious, because in the fixed ‘‘free market’’ in the U.S., they can use millions of free samples and spend billions in inducements to get physicians to prescribe the new drugs over the old ones. Because of corporate price control, the companies charge substantially more for the ‘‘new’’ drug that is no better and thus carry

out another Great Profit Robbery on the bottom lines of American employers. This

shows that drug companies do not believe in classic price competition for value.

They love using their corporate price controls to charge much more than a drug is

worth, and they love the help that Congress has provided to perpetuate this process.

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POOR EUROPE

A striking part of the testimony is how concerned people like Robert Goldberg and

Grant Aldonis are about how much Europeans are suffering from their lower prices.

Big pharma is pulling its research out of Europe and moving it to the U.S. because

of its low (negotiated wholesale) prices. Europeans suffer from substantial delays in

getting new drugs, or don’t get them at all. As a result, their health is worse than

Americans, who benefit from discovering most new molecules and getting them to

market as soon as they are approved.

Before we impose monopoly corporate price controls on Europe as an act of kindness so that they can bask in the sunshine of an American ‘‘free market’’ (which

means free to price where you like without price competition), let’s look at some

facts.

First, in proportion to size, Europe has been more innovative and discovered far

more new molecules than the U.S. going back at least to the 1980’s. The U.S. is

catching up, but the annual reports of the European Federation of Pharmaceutical

Industries show that the U.S. is just now about to finally match the record of European research teams.

Those annual reports also show that pharmaceutical firms have kept investing

more and more R&D funds in Europe, not less. They are not pulling out; they are

not stupid. Investments in the U.S. have increased still faster, but European research is not going down the tubes. Broader reports about scientific research in general document the opposite to Goldberg myth: Europeans pulled ahead of Americans

in basic science about 1995, and gap has been widening. The spoilers, however, are

India and China. The head of global research for Roche recently pointed out that

most U.S. labs are run by Chinese and Indians; so Roche is going to invest in the

source. Second, I asked Mr. Goldberg for evidence on the alleged delays to market in Europe, and he sent me a report containing a table that ‘‘proved’’ this was so. But the

numbers were odd and inconsistent. For example, why would the table show delays

to market for the U.S. after FDA approval, when drug companies can go to market

after approval? Besides oddly suspicious numbers, the measures used were also unclear, and they fused delays due to decisions by the companies with regulatory

delays. I asked Mr. Goldberg to explain how ‘‘delay’’ was actually being measured

and what data was actually being used? He shot back that I was ‘‘nit-picking.’’ In

other words, solid facts and good measures don’t matter. What matters is asserting

the big pharma line, evidence be damned. But one thing is clear: Mr. Goldberg’s alleged facts are not to be believed until solid, independent data are presented to back

them up. There appear to be no good independent studies and measures of ‘‘delay’’,

especially that separate out delays due to corporate decisions from delays due to

regulatory foot-dragging, so I don’t know whether there are unwarranted ‘‘delays’’

and neither does Mr. Goldberg or any other advocate for big pharma.

Third, international data show that if you compare demographically similar Europeans with Americans, it is the Europeans who are healthier and live longer. Poor

Europe is doing rather well. But industry-sponsored reports try to tell Europeans

that they are worse off. For example, the Bain report on poor Germany is based on

the premise that the more drugs you take, the healthier you will be, and the more

nations pay for them, the better off they will be. Does that sound absurd? Not to

leaders of the pharmaceutical industry who finance these campaigns.

THE DEPARTMENT OF COMMERCE REPORT IS BIASED AND MISLEADING

Grant Aldonas devoted considerable time to explaining the supposedly authoritative study recently done by the Department of Commerce, which in the past few

years has become the most powerful lobbyist for the pharmaceutical industry in

slowing down economic growth and making American businesses less competitive by

locking in high U.S. prices and raising prices abroad. No Congressman should be

so naive as to assume that this report is independent or authoritative.

For example, Mr. Aldonas explains that the data set they used ‘‘excluded prices’’!

Imagine! A major report on prices that lacks data on prices! Why? Because the

prices of drugs in our so-called free market are secret. They are ‘‘proprietary.’’ Adam

Smith would roll over in his grave. So, ‘‘it was necessary to estimate prices’’ and

then use econometric models that turn suppositions into ‘‘facts.’’ After that, as

Aldonas explains on page 6 of his testimony, the models and indexes and ‘‘factors’’

get us farther and farther away from reality and toward a made-up story constructed for big pharma. For these reasons alone, no Member of Congress should

give any credibility to the conclusions of this study, but it gets worse.

The models, equations and parameters come from Grabowski and Vernon, two of

the most prominent industry-supported researchers who have been supplying the inVerDate 11-MAY-2000 12:56 Sep 02, 2005 Jkt 000000 PO 00000 Frm 00100 Fmt 6633 Sfmt 6621 S:\DOCS\20046.TXT SLABOR3 PsN: SLABOR3
97

dustry with justifications for more protections from normal capitalist competition for

over 20 years. Using these ‘‘authorities’’ and studies from the Tufts Center, one of

the industry’s leading policy research centers for over 25 years, is another sure sign

that this report is not independent or credible. Why didn’t Aldonas commission any

independent economists or researchers from the U.S. or Europe if the goal was too

authoritative? And why does Aldonas call the PhRMA data they used an ‘‘independent source?’’ No source could be more biased and inflationary.

Then we learn that the study used the old pharma trick that dates back to studies

done in the 1980’s to mislead Congress into extending patents from 17 to 20 years—

the trick of taking the expiration date of the first patent on a drug as ‘‘the beginning

of generic competition,’’ when everyone knows drug companies pay patent lawyers

millions to add one patent after as a way to obstruct or delay generic competition.

This old trick greatly reduces the resulting artificial estimates of how much the

sponsoring company makes per new drug.

Finally, this report on prices not only has no data on prices but then reports ‘‘we

could not complete a rigorous investigation of the short- and long-term effects of

price deregulation on U.S. prices and consumers.’’ But wasn’t that the whole point

of doing the study, the effect on U.S. consumers? The headline in Aldonas’s testimony reads ‘‘U.S. Consumers Would Benefit From The Elimination Of Price Controls Abroad,’’ but the text provides no evidence! And indeed there is no evidence.

This is yet another myth aggressively promoted by the pharmaceutical industry, together with the Department of Commerce, a new story made up about 4 years ago

to add a new twist to the old myth that prices had to be high in order to pay for

their very costly R&D.

Let’s look at some pharma doublespeak:

• ‘‘free market’’: free to set prices where you want, free of price competition;

• ‘‘market price’’: the price a drug company can set in a market protected from

price competition;

• ‘‘price controls’’: negotiated wholesale contracts by national buyers seeking good

value;

• ‘‘reference pricing’’: paying no more for a new drug that is little better, but paying more for ones that are better;

• ‘‘innovative drug’’: any new drug, even though 80–90 percent of them are no better; and

• ‘‘R&D’’: characterized as devoted to discovering breakthrough drugs but largely

devoted to derivative research for new variations.

THE MYTH OF THE U.S. ‘‘FREE MARKET’’

Grant Aldonas and all the other advocates of big pharma refer to the ‘‘free market’’ in the United States and claim that other countries pay less than ‘‘market

price.’’ But what is ‘‘market price’’ in a oligopolistic market, where competitors hold

off from competing on price and practice forms of de facto collusion that are legal,

because true price competition would seriously damage all of them? ‘‘Market prices’’

are essentially monopoly prices that other large firms do not challenge very much.

This leads to a second myth implied by pharma advocates, that patents give one

the right to 20 years of monopoly pricing. Both of these claims are untrue. No expert

in patent law who is not retained by the pharmaceutical industry would agree they

are. Patents give one 20 years to try to find a market application and to see what

buyers will pay for their unique advantages, without competitors copying one’s invention. Most patents never find a market, and when they do, their price varies

from little more than cost to bonanza profits.

Most patents on ‘‘new’’ drugs are for innovations little better than much cheaper

drugs already discovered before: so why should anyone pay more for them? Because

the advocates for big pharma say their clients have a ‘‘right’’ to a monopolistic ‘‘market price’’? That’s a contradiction in terms and just not true. The whole argument

is trumped up.

Further, it is well documented that pharmaceutical companies unilaterally raise

their world-high prices still higher. This is the only industry where prices are raised

on last year’s model, and the model from the year before that costs even more!

Corporate price controls, the ability to raise prices on last year’s model at will,

and consistently much greater profits than other industries are three clear signs

that drug companies are monopolies, created by anti-free trade government laws.

This hearing is on a proposal to eliminate wholesale competitive markets and impose corporate price controls on other nations. What big pharma loves so much here

is a monopoly friendly market and government, not ‘‘market prices’’ or ‘‘free trade.’’

What the drug companies are advocating is imposing corporate price controls on the

rest of the free world.

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Secret prices are a major feature of the so-called free market in drugs in the

United States. Have you ever heard of a ‘‘free market’’ that features secret pricing?

It’s as if you go into a restaurant for a fine meal and the menu has no prices. You

tell the waiter what you’d like and ask how much it will cost? The waiter says,

‘‘Come back to the manager’s office and we’ll set a price for you.’’ The manager

closes the door and assesses how much you want that meal, how much money you

have, and how much money he’d like to make. Then he gives you a secret price.

Next customer. That is roughly how the pharmaceutical firms have arranged for the

‘‘free market’’ to work.

A far more accurate way to think about pharmaceutical markets is that they are

competitive wholesale markets throughout most of the world, where large volume

buyers negotiate with large, powerful sellers who hold patents on unique products.

Then other countries, like Canada, set their prices on these wholesale negotiated

prices.

LITTLE SPENT TO SEEK BREAKTHROUGH DRUGS

The advocates for the industry misled Congress and the public into believing that

they spend 16–18 percent of sales on research for breakthrough drugs. As one company puts it, ‘‘Today’s medicines pay for tomorrow’s miracles.’’

But objective data from the National Science Foundation (NSF) document that all

R&D investments are closer to 11 percent of sales, and that only 18 percent of that

goes to basic research to find the next miracle. Then taxpayers subsidize pharmaceutical R&D to the tune of 40 percent; so the net investment of pharmaceutical companies in research for breakthrough drugs is 1 percent, 1 cent on the dollar, not 18

percent. (.11 x .18 x .60)

Raymond Gilmartin goes around the country presenting Merck as the premier research drug company, old and far more dedicated to discovering breakthrough drugs

than many other, more market-oriented drug companies. But an analysis of Merck’s

10-K financial reports to the Securities and Exchange Commission documents that

Merck has been putting far less of its soaring revenues (before the Vioxx crash) into

research than the industry average. It peaked at 12 percent for R&D in 1985 and

has declined steadily through the 1990’s to only 5.2 percent in 2002. As the graph

below shows, Merck has been pocketing more and more of its profits too, rather than

plowing them back into research. If you assume that 18 percent of total reported

R&D goes to basic research and subtract out 40 percent of subsidies from other taxpayers, that means Merck spent only 0.37 of a penny on every dollar of revenue it

took in 2002.

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The cost of R&D for new drugs is also far lower than $800 million or $1.6 billion.

First, those estimates are based on secret, unverifiable ‘‘costs’’ submitted by drug

companies to research teams they sponsor to produce big estimates. Second, the best

of the estimates is based on the most costly 20 percent of new drugs and then generalized to the average new drug, a large distortion. Third, the estimates leave out

substantial taxpayer contributions. Fourth, half or more of the estimates consist of

building large estimated profits into the econometric model and then calling them

a ‘‘cost.’’ One bottom line is that the actual costs reported in secret, unverified numbers by drug companies were $60 million average for the most costly 20 percent of

new drugs. Then the industry-sponsored team built a model to multiply those real

costs 14-fold, to $802 million. Independent analyses, which Congress and employers

never see, estimate that the R&D for new drugs averages less than $100 million.

Current laws and regulations do not reward true innovation but derivative innovation. They reward both equally, and derivative innovations involve much less risk

and costs; so we get what we pay for. This is an important reason why pharmaceutical companies are becoming less innovative, because current incentives reward

low-level innovation. That’s why pharmaceutical companies hire twice as many lobbyists as Congressmen and spread around hundreds of millions, so that corporate

welfare replaces success in open markets. That’s why they want you to use legal

powers and threats to substitute for true innovation.

In sum, government laws and regulations reward derivative research rather than

research for breakthrough drugs, and blocking free trade will further reward the

signs of monopolies: manipulating governments and politicians rather than producing good value, setting high protected prices and raising them, and raking in monopoly profits far higher than other healthy industries. Congress can choose to help

the industry become more innovative and productive, or condone the increasingly

unsustainable present course.

CONCLUSION

If Congress wants to know how credible its witnesses are, it should require witnesses under oath to state how much money or other benefits they have received

in the past 3 and 6 years, directly and indirectly, from the industry with a stake

in the issues being discussed. The pharmaceutical industry has never provided audited figures showing how long it takes them to recover R&D costs, but now we

know they recover them every year at European prices, with profits to spare, not

counting the huge U.S. market. If Congress wants to get an honest picture of how

European prices affect American prices and whether Europeans are ‘‘free riding’’ on

Americans, why don’t they commission an independent study? Meantime, the limited research by my colleagues and me have documented that these claims are

myths and that current policy is harming American business and economic growth.

DEMYTHOLOGIZING FOREIGN FREE RIDERS AND OTHER POLICY MYTHS

OVERVIEW

An international campaign by the United States Government aims to use the

threat of trade sanctions to persuade other industrialized countries to sign bilateral

Free Trade Agreements that would lock in U.S. high prices by prohibiting the export

of lower-priced patented drugs and raise prices in other countries by making them

agree to postpone generic price competition by extending the exclusive control of

patent-holding companies for 5 more years over the data from clinical trails that generic companies need for approval to market their drugs. Other clauses weaken a

country’s pricing scheme to further increase prices on patented drugs.1 2

This campaign is based on the argument that lower prices in the UK, Canada,

Australia and European countries do not pay for research and development (R&D)

costs. Thus the UK and these other countries are widely characterized as ‘‘free riders’’ on high U.S. prices and innovation, where most of the world’s pharmaceutical

research is now said to be taking place. Lower foreign prices are said to impede innovation, which now occurs predominantly in the United States, and the price gap

between the USA and other affluent countries is widening. Lower foreign prices are

said to be a cause of high prices in the United States.

We have examined each of these widely believed ‘‘facts’’ and found no evidence

to support any of them. In fact, we have found that industry data supports the opposite of these facts, namely:

(1) prices in the UK, Canada and other affluent countries pay for all R&D costs

every year just out of their domestic sales;

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(2) prices in the UK and other affluent countries have nothing to do with high

U.S. prices, which the industry raises frequently after setting them at the highest

levels;

(3) research and research funds for new drugs is growing briskly, not declining,

even in Europe and the UK;

(4) Europe and the UK are more innovative than the U.S. in proportion to their

size;

(5) this whole argument makes no sense in terms of the global nature of pharmaceutical markets or in terms of basic economic theory;

(6) not much research effort goes toward finding new drugs that are superior to

existing drugs because incentives reward derivative and me-too research more than

long-shot breakthrough research; and

(7) drug companies devote only 1.3 percent of gross revenues to breakthrough research, net of taxpayers’ contributions.

The references enable any journalist or policymaker to verify the basis for our

statements, and further detail is available upon request.

The ‘‘free rider’’ argument is a story told tirelessly to policymakers and journalists

with no foundation in fact. The pharmaceutical industry’s own data and reports document that U.S. prices are well above levels needed to pay for R&D, manufacturing,

marketing and administration, with profits to spare. The British approach, despite

its flaws, rewards the discovery of new molecules over variations of existing ones.

It guarantees profits and supports small, young biotech companies. It promotes the

growth of its pharmaceutical industry, while it holds down prices for its own health

service.

In response to a revolt among American patients to the high prices charged for

their drugs, and to widespread pressure from almost every State legislature to lower

the prices of drugs for their employees and for Medicaid,3 the pharmaceutical industry and high government officials have claimed that U.S. prices are so high because

other industrialized nations’ low prices do not pay for research and development.

The price gap, they claim, is widening as foreign countries lower their prices. Thus,

they are ‘‘free-riders’’ on Americans, who have to pay for the bulk of the R&D and

who make most of the important new discoveries.

Americans have taken this argument to heart and are angry about what the nationally syndicated columnist, William Safire, called the ‘‘foreign rip-off.’’ 4 Acting on

these claims, the Bush administration is threatening trade sanctions and using

other forms of economic pressure to get these other countries to raise their prices,

limit price competition and block export of their cheaper drugs to the United

States.5 6 The goal is to make other countries pay as much as Americans do. The

implicit promise is that if other countries pay more, American patients or their payers can get relief and pay less.7

Some Congressmen, however, have been concerned from the start that this global

campaign to erect a new set of legal barriers to free trade and price competition will

harm American payers and patients by locking in high prices.6 8 9 10 These concerns

have merit, because the Free Trade Agreements raise costs for businesses and make

them less competitive in world markets. They are likely to reduce productivity and

increase sick days for workers who get ill but feel they cannot afford prescribed

medicines to get better. The concerns of these Congressmen also have merit because

we can find no evidence for the reasons given for pressuring other countries to raise

their prices and block free trade.

NO EVIDENCE OF FREE RIDING

All the evidence we can find indicates that corporate R&D costs for new drugs

are fully paid for in each country as an annual corporate expense. For example, 70

pharmaceutical companies report that domestic sales in Canada are about 9 times

greater than R&D costs; so they are easily paid for each year. Audited reports in

the UK show that domestic sales just to the National Health Service are about 6

times R&D costs, with substantial profits after all costs each year.11 12Huge export

sales (largely to the U.S. at prices much higher than in the UK) are extra. William

Safire’s claim of a ‘‘foreign rip-off’’ with Americans paying for the world’s R&D is

contradicted by these facts.4

PRICE GAP DUE TO COMPANIES RAISING U.S. PRICES

Studies confirm that the gap between U.S. and foreign drug prices has been widening, but the growing difference is due to pharmaceutical firms raising their U.S.

prices, not to European countries lowering theirs.13 14 15 16 As audited figures from

the UK show, drug prices could be substantially lower and still cover research costs,

with healthy profits as well. Specifically, although prices in the U.K. are substanVerDate 11-MAY-2000 12:56 Sep 02, 2005 Jkt 000000 PO 00000 Frm 00105 Fmt 6633 Sfmt 6621 S:\DOCS\20046.TXT SLABOR3 PsN: SLABOR3
102

tially lower than in the U.S., pharmaceutical firms in that country devote a greater

percentage of domestic National Health Service sales to R&D than do companies in

the U.S. At the same time, these companies still report profits of 15 percent on

those sales before taxes.14

NO EVIDENCE OF RESEARCH DECLINE

There is also no verifiable evidence for the claim that the prices in other affluent

countries are ‘‘slowing the process of drug development worldwide.’’ For example, according to Organization for Economic Cooperation and Development figures, between 1995 and 1999 R&D grew in Germany, the United Kingdom and Canada by

85 percent, 51 percent and 46 percent respectively, compared to 30 percent in the

U.S.17 Investments in R&D have continued to rise steadily since then as well.18

Since 1990, pharmaceutical companies have increased their European research

budgets by more than 160 percent, and in Belgium, Sweden and Spain by much

more than that.19 Nor can we find any evidence that these foreign prices ‘‘discourage the R&D needed to develop new products,’’ as the Commissioner of the FDA put

it.1

U.S. LESS INNOVATIVE THAN THE UK OR EUROPE

Contrary to claims of American dominance, the latest data from the pharmaceutical industry itself show that European research teams have been discovering

more major new drugs (new molecular entities) than their proportional share of

global sales, while U.S. teams have discovered less.19 Specifically, in 2002 the U.S.

accounted for just over 49 percent of world sales, but it took 50 percent of global

R&D expenditures invested in the U.S. to discover 45 percent of the new molecular

entities that were launched on the world market.19 In previous years, Europe was

still further ahead of the United States. The U.S. is gaining ground, but corporate

R&D investment in Europe has continued to grow. In 2000, four other industrialized

countries devoted more of their GDP to R&D for new drugs than the U.S.17

LIMITED BASIC RESEARCH BY INDUSTRY

The long-standing survey of basic and applied research by the National Science

Foundation (NSF) last calculated that 18 percent of the total domestic research and

development (R&D) budget for the pharmaceutical industry went to basic research,

to discover breakthough new molecular entities.20 Industry-sponsored figures based

on proprietary data are much higher but cannot be independently verified.21 Given

that the NSF survey found that pharmaceutical firms spend only 11.8 percent of

revenue on R&D, this means only 2.1 percent of revenue goes to discovering new

drugs. The net percent after taxpayer subsidies is even lower. The after-tax cost of

$1 of R&D expenditures in the U.S. for large companies appears to be in the range

of $0.53 to $0.61.22

The end result is that, net of taxpayers’ contributions, drug companies invest net

about 1.3 cents of every dollar from sales in basic research for ‘‘tomorrow’s miracles.’’ This investment pattern makes good economic sense, as senior financial writer, Merrill Goozner, describes in detail.23 Basic research takes so long and has so

many twists and frustrations that no company can reasonably invest much in it

year after year. Quite sensibly, the industry monitors the hundreds of basic science

teams around the world and waits until one of them comes up with a promising

breakthrough. It would help if industry claims and rhetoric more accurately reflected the facts. ‘‘Today’s medicines pay for tomorrow’s miracles’’ only a little bit.

U.S. taxpayers also paid for the National Institute of Health budget as well as

medically oriented R&D funds in the Department of Defense and other departments.

Most of that money went for basic research, and public money also supports more

than 5000 clinical trials.24 25 These figures do not support the industry’s claim that

they spend huge sums at high risk to discover the next generation of breakthrough

drugs.

Companies are investing most of their money into the less risky task of developing variations on existing drugs, where the mechanism of action, general effectiveness and safety profile are already known. Independent review panels plus a major

industry review have concluded that only 10–15 percent of ‘‘new’’ drugs provide a

significant therapeutic breakthrough over existing drugs.26 27 28

To summarize, basic R&D into drugs that provide significant therapeutic advantages is only a fraction of overall R&D expenditures and does not require the high

prices currently seen in the United States to support it.

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THE BAIN REPORT—PERPETUATING THE MYTH OF LOW PRICES AS A BAD BARGAIN

A recent report supported by the pharmaceutical industry (the Bain Report) and

reported to millions of Americans by AARP29 claims to document the ‘‘high cost of

Europe’s free ride.’’ 30 Yet the report contains almost no verifiable facts. It portrays

Europe as a ‘‘free rider’’ that will suffer from less drug innovation and ‘‘higher morbidity and mortality from diseases that could be treated with innovative drugs—if

they were more readily available in Europe.30 No evidence is provided for this unlikely prediction. Morbidity or mortality are lower in Western Europe than in the

United States. No evidence is provided that therapeutically beneficial drugs are less

available in Europe. The few facts in the report are contradicted by reputable published reports, including a publication from the European Federation of Pharmaceutical Industries and Associations.19

The Bain report does not mention that proportionately more new major drugs are

being discovered in Europe, nor that pharmaceutical companies have continued to

invest more and more research money in Europe, nor that most new drugs have few

additional benefits to patients. The Bain report’s model claims to show a negative

economic and social impact in Germany as a result of ‘‘free riding,’’ but it presents

no data or facts and hides many unlikely assumptions inside its general graphs. The

fact that the countries in which substantial drug research takes place pay for the

cost of that research through domestic sales alone is ignored.12 17 Rather, readers

will find that the ‘‘free rider model’’ and the report are based on a new premise of

industry-sponsored reports: the more drugs people take, the healthier they will be,

and the more they pay for them, the better off a country will be. The increased prices

and profits from the U.S. market are presented as the ideal. What may be

unsustainable are the rising prices in the United States.

ECONOMIC THEORY AND THE PHARMACEUTICAL INDUSTRY

Beyond not being substantiated by the facts, the free-rider story that the pharmaceutical industry promotes in Europe to pressure the UK and the EU to liberalize

market makes no economic sense. First, the entire argument that prices are high

because there are high fixed costs for research contradicts basic economic theory

that price has nothing to do with past fixed costs but is set by the market. The argument for high prices to cover fixed costs only makes sense if companies are asking

governments to make sure that prices cover the high fixed costs as a social good.

This line of reasoning is basis for utilities: high fixed costs and low running costs

for a valued social good like clean water or electricity. Society sets up a system for

accounting and review so that charges are aligned with those costs. But the pharmaceutical industry makes a utilities argument in order to gain the power to charge

what it wants, without having to report cost data or be subject to a utilities board

that would review the relations between charges and costs.

Second, which country discovers more drugs is largely irrelevant to how the global

pharmaceutical markets work. It is effective political rhetoric that arouses nationalistic feelings but has little to do with the economics of the global drug market. The

industry quickly capitalizes on new discoveries from any country, tests them in

countries where it is most advantageous and then markets the resultant products

everywhere where it is profitable. If research and discovery really worked by national markets, the industry would shut down its operations in small countries like

Switzerland, when in fact it is delighted by exploit Swiss innovations worldwide. It

is both remarkable and disturbing when leading health economists promote either

of these arguments that contradict basic economic theory and the economics of the

pharmaceutical industry.1

Third, the claim that prices in most affluent countries do not pay for research can

only be made through unorthodox accounting methods in which all research costs

are written off each year as they occur. Further, R&D is the heart of the industry,

and R&D costs are reduced by tax deductions and credits; so if anything, they are

deducted before marketing and other costs. If revenues were inadequate, it would

make more sense to conclude they do not cover all marketing costs rather than research costs. Global pharmaceutical companies report that they invest 2.5–3.0 times

more in the combination of marketing, advertising and administration than in research costs.31

A fourth common assertion is buried inside the term ‘‘free rider.’’ This term conveys the image of someone jumping on for a free ride; but the formal economic definition is something referred to as the ‘‘proportional allocation of fixed costs.’’ For example, if some buyers (Group A) pay $1 per pill and others (Group B) pay $2 a pill,

and if they each buy a million pills, then a conventional rule in financing allocates

any large fixed cost proportionately, so that Group A is said to be paying half as

much of the fixed cost as Group B. Group A (e.g., Europe) is then said to be ‘‘free

104

riding,’’ though the term is both inaccurate and moralistic. If, however, the fixed

costs are only $300,000–$600,000 or 1⁄10th to 1⁄5th’’ of the $3 million total revenues

for the 2 million pills, then one could just as easily say that Group A is more than

paying for the fixed costs, while Group B is paying much more than it has to. This

is the flat allocation of fixed costs, and it highlights how much more Group B (American patients and payers) are paying than is necessary to cover the fixed costs of

corporate research. So-called free riding can be eliminated by cutting the price of

Group B in half as easily as doubling the price of Group A.

The core argument by the Bush administration and the drug industry is that nations in Group A are ‘‘free riders’’ and should be coerced into paying $2 a pill like

Group B. But there would also not be any ‘‘free riding’’ if Group B’s prices were cut

in half to $1 a pill. Solving the so-called free rider problem this way would make

drugs more affordable and lowers the ceiling of global prices, while still paying for

the fixed costs of research. The U.S. campaign to raise foreign prices to American

levels simply makes them less affordable and raises profits even higher for what is

already one of the world’s most profitable industries.

A final charge is that efforts to lower prices for patented drugs by other countries,

and by major employers, unions and Governors within the United States, are ‘‘no

different than violating the patent directly’’ to make cheap copies.32 This is a remarkable statement by a major health economist, because it means that normal

competition, in which large buyers use their buying power to seek better value, is

a criminal act and morally offensive. In a similar vein, the Under Secretary of Commerce told Congress that lower prices abroad were a ‘‘negative tax’’ on the American

people. Yet most countries pay by value, little or no more for new drugs no better

than existing ones, and considerably more for superior new drugs. The UK, of

course, does not set prices at all but rather uses a system to reward serious research

and support the pharmaceutical industry.

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[Whereupon, at 11:50 a.m., the committee was adjourned.]

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