The World Health Organization’s CHOICE program analyzes the cost effectiveness of various health interventions related to the Millennium Development Goals. The program identifies the best strategies for improving health in low-income countries, using a standard set of methodological assumptions. These studies evaluate interventions in many areas, including child health and HIV/AIDS.

For some of these treatments, drug costs are a significant variable: if the drug price doubles, the intervention becomes less cost effective. But if the drug price is reduced by 90%, then more therapies become affordable.

Drug prices are uniquely susceptible to radical price reductions through generic competition. Patented pharmaceuticals may be priced at more than 30 times the marginal cost of production; the excess is the patent rent collected by the drug company while the patent and exclusive marketing periods remain. Patent rents are significant. AIDS drugs which sell for US$10,000 per person per year in the US are sold generically for less than US$200. If patented drugs could be sold at the marginal cost of production, cost effective treatments would become even more attractive, and other interventions would become affordable.

There is a great deal of misinformation surrounding the economics of pharmaceutical importation and price regulation. Among economists, the principles governing the relationships between prices, innovation, and pharmaceutical research and development (R&D) investment are incontrovertible. Unfortunately, faulty, non-economic analyses abound on these fundamental relationships, reinforcing economic illiteracy and leading to unfounded U.S. public policy.

Effective public policy debate requires that all parties to the debate be informed and aware of the potential costs and benefits associated with new policies, or changes in existing policies. This has not yet occurred for pharmaceutical importation and price regulation policy. Therefore, the purpose of this paper is to provide a positive (in contrast to a normative) economic analysis of pharmaceutical importation and price regulation.

U.S. consumers and Canadian pharmacies have rushed to take advantage of the opportunity presented by price differences in patented pharmaceuticals. This rapidly growing parallel trade has brought the Canadian and U.S. systems for determining pharmaceutical pricing under increased scrutiny, and the pressure for change seems to be building. This paper examines why parallel trade in pharmaceuticals has grown and considers some of the policy options confronting both countries.

To do this we begin by identifying similarities and differences in the Canadian and U.S. regulatory frameworks governing trade in pharmaceuticals. While the differences are considerable, we show that they are not the only reason for the emergence of the price disparity that has fuelled the growth in parallel trade. In particular, we argue that the price discrimination strategies of pharmaceutical manufacturers and exchange rate fluctuations have played an underappreciated role. Following this, we examine the claims that this trade represents a threat to American and Canadian interests, and find that there are good reasons for policy makers on both sides of the border to be concerned. Unchecked, this rising trade presents a threat to R&D funding and continued Canadian consumer access to pharmaceutical products.

“This Constitution, and the Laws of the United States … shall be the supreme Law of the Land; and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.”

Under the Supremacy Clause of the United States Constitution, federal law, such as the Federal Food Drug and Cosmetic Act (“FDCA”), is supposed to be the “supreme Law of the Land.” The FDCA establishes a national closed domestic distribution system for approved prescription drugs in an effort to ensure drug integrity and safety. In doing so, it purportedly sets the “gold standard” for prescription drugs regulation around the world. Lately, though, this “gold standard” has been tarnished by personal importation, the practice of buying prescription drugs directly from foreign pharmacies—primarily Canadian—in conflict with the FDCA's restrictions on unapproved drugs and importation.

HORSTMAN: Mr. President, why did you block the reimportation of safer and inexpensive drugs from Canada which would have cut 40 to 60 percent off of the cost?

BUSH: I haven't yet. Just want to make sure they’re safe. When a drug comes in from Canada, I want to make sure it cures you and doesn't kill you.

KERRY: John, you heard the president just say that he thought he might try to be for it. Four years ago, right here in this forum, he was asked the same question: Can't people be able to import drugs from Canada? You know what he said? “I think that makes sense. I think that's a good idea” -- four years ago. Now, the president said, “I’m not blocking that.” Ladies and gentlemen, the president just didn't level with you right now again. He did block it, because we passed it in the United States Senate. We sent it over to the House, that you could import drugs.

Americans rely extensively upon prescription medications to maintain health and quality of life. According to the National Center for Health Statistics, in 2002, at least 1.5 billion drugs were prescribed to patients in physician offices, 196 million in US emergency departments, and 140 million in outpatient settings. Almost two-thirds of visits to physician offices and hospital outpatient departments had at least one drug associated with the visit, and 7% of visits had five or more drugs. In 2004, US pharmacies dispensed over 3.5 billion prescriptions to patients. Estimates indicate that annual expenditures for prescription drugs in the US top $230 billion dollars each year—and there is every indication that these numbers will only increase.

Over the past five years, there have been over 140 reported incidents of counterfeit and mislabeled drugs being sold by legitimate pharmacies in the United States. Thousands of patients have consumed these medications, sometimes with dire consequences. The extent of counterfeits in the legitimate market, however, is unknown. It is certain that the detected incidents of fakes are a fraction of the total number of incidents.

How did these drugs wind up in the bloodstreams of unsuspecting patients? Despite elaborate safety precautions, strict regulations and battalions of enforcement personnel, the stream of phony pharmaceuticals continues unabated. This article will consider the practical and legal dimensions of trade in Trojan drugs.

The world relies largely on private firms for the development of new medicine, and the system is efficient. Driven by the incentive to profit from sales of new pharmaceuticals, drug companies risk millions of dollars and years of work to shepherd basic scientific discoveries through laboratory and human testing in the hope of developing a marketable drug. For example, it is estimated that in 2002 alone, pharmaceutical companies invested $45 billion the development of new medicine worldwide.

While the profit incentive generates such enormous private investment in human drug development, it also encourages firms to pose inappropriate risks to the safety of human subjects when speeding a new drug to the market. The risks posed by financial conflicts of interest associated with human subjects research on new pharmaceutical products are notable examples, both in the U.S. and internationally.

The rise and fall of the pain-killer Vioxx is one of the most remarkable marketing stories in pharmaceutical history. A true riches to rags tale, its events unfolded with lightning speed in an industry defined by lethargy.

On May 20, 1999, the Merck Company secured FDA approval of Vioxx for the management of acute pain in adults and for relief of the signs and symptoms of osteoarthritis. From that date through August 2004, 105 million Vioxx prescriptions were filled in the US and an undetermined number were filled outside the US. In 2003 alone, Merck's worldwide Vioxx sales totaled $2.5 billion.

The fall happened even more quickly than the rise. In March 2000, Merck published a study raising the specter of cardiovascular problems associated with taking Vioxx. In November 2000, The New England Journal of Medicine published a study raising similar concerns. In February 2001, an FDA advisory panel became sufficiently concerned about the association of Vioxx and cardiovascular events that it advised the FDA to require a label warning about the possible link.

Multinational corporations often wield more power than many of the world's nations. Their immense wealth and political capital make them almost hegemonic entities. These domineering enterprises are often able to undertake profit-making endeavors, particularly involving the consumption or extraction of natural resources, in developing nations with little or no regulation, and often without meeting the social and environmental standards adhered to in the United States.

The emergence of multilateral free trade agreements, specifically within the developing world, has further enhanced the ability of multinational corporations to proliferate their business. Concomitant with the rise of free trade, political and legal barriers to multinational entry into the economy of developing nations are rapidly disappearing. In addition, many nations are unwilling and unable to protect their citizens from environmental abuses through domestic law. Therefore, finding a legal mechanism capable of checking the hegemonic power of multinational corporations is extremely important to the vitality of most developing nations.