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May 2000
Volume 18, Number 5

Profits and Drugs
Christopher Mayer

Americans are concerned about the rising cost of pharmaceutical drugs. This has drawn the attention of writers, politicians, and others who have attempted to deal with the issue in typical fashion by advocating the use of government force to implement their plan.

Kathleen Day, a media fellow at the Kaiser Family Foundation, aired the usual concerns and wrote the representative prescription in an editorial that appeared in the Washington Post titled "The Driving Force." Day writes that the "extremely profitable" drug industry does a lot of lobbying to prevent the government from limiting drug prices. She says that the industry earns eighteen cents after taxes for every dollar of revenues and notes that this number is "three times the average rate of a US company." Her conclusion is that "the numbers strongly indicate that the industry could reduce prices considerably and remain comfortably profitable."

Among the solutions mentioned-price controls. This solution reminds one of Pufendorf's advice that "it is foolish to prescribe a medicine far more troublesome and dangerous than the disease."

Ms. Day has shown that she has little understanding of how a market economy works. Far from being alone, the crucial nature of profit and loss is still not understood by the bulk of the mainstream press. They would find much wisdom in Ludwig von Mises's essay titled "Profit and Loss."

Mises wrote that the concept of "excess" profits arises from the "popular superstition that profit is an addendum to the costs of production, the height of which depends uniquely on the discretion of the seller." In this view, prices reflect the cost of production plus some margin (profit) determined by the sellers. However, cost is not the driving force of prices. Rather, consumer preferences drive the prices of goods and services. The marginal buyer and the marginal seller determine prices. As Mises noted, prices are social phenomena brought about by the interplay of all the subjective valuations of the individuals participating in the market.

Prices are the result of countless interactions between buyers and sellers, between non-buyers and non-sellers. Prices are a necessary consequence of living in a world of scarcity. It is self-evidently true that goods are scarce; not everyone can have them. Prices are the means by which goods are selectively provided, how goods are "allocated" in a market economy. This allocation reflects the preferences of the consumers as manifest by their actions. In the absence of prices these goods would have to be distributed according to some arbitrary will. More importantly, without prices these goods would not likely have come into existence at all.

Prices allow entrepreneurs to calculate; to make rational appraisals of current market data against their own judgment of future prices. Those who make more correct judgments, or who forecast the future state of the market better than their competitors and shape their actions against this picture, will earn profits for their efforts. Those who act on forecasts that later prove to be in error suffer losses. Penalizing the pharmaceutical companies by taxing, confiscating, or limiting their profits in any way inhibits the market process in its drive toward efficiency and the satisfaction of consumer wants.

In the real world for pharmaceutical drugs, however, a pure free market does not exist. A number of factors exist that inhibit these market forces from meeting the consumers' demands for more and better drugs. Foremost among these is the granting of patents and the heavy government regulation of the drug industry.

Government regulation also hampers the ability of firms to bring new drugs to market. It takes years, for example, for a drug to go through the FDA's approval process. To the extent that the supply of drugs is kept below what the market might otherwise produce if left unhindered, the price of drugs for consumers will be kept artificially high.

Also, this process prevents an individual from trying a drug, even after accepting the risks. Perhaps this individual has but a short time to live without the new experimental drug. This person cannot wait for the FDA, but under the present system he must. Or he enters the black market. In this case, society brands him, and the people who helped him, as criminals. How many have died because the FDA prohibited them from using certain drugs?

Private regulation of drugs is no different. Private regulatory companies could emerge to serve the public. They would vary in the price and level of their assurances reflecting the diverse preferences of their customers. Moreover, these companies would be more responsive to their customers than government regulators for the simple reason that they would lose their customers and go out of business if they didn't. Government regulators have no threat of bankruptcy for lack of customers. Their customers are forced to pay for their services by coercive levy whether they want these services or not.

As for price controls, we know by economic theory and historical illustration, that any attempt to set a price for a good or service below the market price will result in shortages of that good or service. It will be no different with drugs. Perhaps the capital that would have flowed to the drug making industry now will find other havens, like microprocessors or software, where prices are not (yet) regulated. Moreover, price controls violate one's fundamental right of freedom of contract.

Beyond these considerations there are other moral questions. Who should decide how much to pay for drugs? We can formulate a general reply: these questions should be decided by the individuals involved, and, if they wish, their families and any others they want to involve in these decisions. Morally, what authority does the collective whole have over its non-invasive members?

Any attempt to regulate the drug market is an infringement on the liberties of the buyers and sellers so regulated. Additionally, this infringement will have to be enforced to be at all meaningful. Government will have to prevent consumers from doing something that they want to do and have the means to do. Government will have to force sellers to do something they would rather not do. Worst of all, those who break these arbitrary rules will have to be treated as criminals. Something seems amiss in a country that pays lip service to freedom and yet must treat peaceful citizens as criminals.

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CHRISTOPHER MAYER is a MBA student at the University of Maryland.

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