[Senate Hearing 109-87]
[From the U.S. Government Publishing Office]



                                                         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


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          COMMITTEE ON HEALTH, EDUCATION, LABOR, AND PENSIONS

                   MICHAEL B. ENZI, Wyoming, Chairman
JUDD GREGG, New Hampshire            EDWARD M. KENNEDY, Massachusetts
BILL FRIST, Tennessee                CHRISTOPHER J. DODD, Connecticut
LAMAR ALEXANDER, Tennessee           TOM HARKIN, Iowa
RICHARD BURR, North Carolina         BARBARA A. MIKULSKI, Maryland
JOHNNY ISAKSON, Georgia              JAMES M. JEFFORDS (I), Vermont
MIKE DeWINE, Ohio                    JEFF BINGAMAN, New Mexico
JOHN ENSIGN, Nevada                  PATTY MURRAY, Washington
ORRIN G. HATCH, Utah                 JACK REED, Rhode Island
JEFF SESSIONS, Alabama               HILLARY RODHAM CLINTON, New York
PAT ROBERTS, Kansas
               Katherine Brunett McGuire, Staff Director
      J. Michael Myers, Minority Staff Director and Chief Counsel


                            C O N T E N T S

                              ----------                              

                               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


                   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.
    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.
    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 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 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 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 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\
---------------------------------------------------------------------------
    \1\ Section 1123 of the Medicare Prescription Drug, Improvement, 
and Modernization Act of 2003, P.L. 108-173.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \2\ See H.R. No. 108-391.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \3\ The overview of drug price regulatory systems corresponds to 
Australia, Canada, France, Germany, Greece, Japan, South Korea, Mexico, 
Poland, Switzerland, and the United Kingdom.
    \4\ The prices effects analysis corresponds to Australia, Canada, 
France, Germany, Greece, Japan, Poland, Switzerland, and the United 
Kingdom.
---------------------------------------------------------------------------
    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, inter-agency 
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 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.
---------------------------------------------------------------------------
    \5\ Submissions 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.; 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.
    \6\ PhRMA, AEI (Hassett), and Dr. Donald W. Light.
---------------------------------------------------------------------------
    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 market-
based 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.

      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 
set\7\ to serve as the basis for price comparisons and to clarify the 
implications for revenue and R&D spending.
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    \7\ IMS Health is a leading provider of business intelligence 
services, strategic consulting services, and data for the 
pharmaceutical and health care industry.
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    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.
    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 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 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.

  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 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.
    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--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 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, 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 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.
    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 property 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 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 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.]
    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.
    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 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 break-through 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 trying 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 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.
    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.
---------------------------------------------------------------------------
    \1\ Pricing and Reimbursement Review 2003, Cambridge Pharma 
Consultancy, London, England 2004.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \2\ PARAXEL's Pharmaceutical R&D Statistical Sourcebook 2004/2005.
    \3\ The EU Industrial R&D Scorecard, 2004, European Commission 
2004, http://eu-iriscoreboard.jrc.es/docs/2004--Scoreboard--
%20VOL%20II.pdf.
---------------------------------------------------------------------------
    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,
---------------------------------------------------------------------------
    \4\ Novartis to Move Global Lab to U.S. The Wall Street Journal, 
A3- 17. May 2002--Vanessa Fuhrmans and Rachel Zimmerman.

          ``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\
---------------------------------------------------------------------------
    \5\ Novartis Reaps Benefits From CEO's Changes By GAUTAM NAIK. 
Staff Reporter of THE WALL STREET JOURNAL, October 13, 2003.

    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 cost-
saving 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 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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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 follow-on 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\
---------------------------------------------------------------------------
    \7\ DiMasi, 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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \10\ Pharma 2010: The threshold of innovation IBM Institute for 
Business Value study by: Steve Arlington, Sam Barnett, Simon Hughes and 
Joe Palo, 29 Apr 2004.
---------------------------------------------------------------------------
    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 now work best for which patients. Contrary 
to the popular belief that there are me-too 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.
---------------------------------------------------------------------------
    \11\ Ibid.
---------------------------------------------------------------------------
    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 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.
---------------------------------------------------------------------------
    * 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 [email protected]. A 
short biographical summary is appended to this testimony.
---------------------------------------------------------------------------
    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 
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\
---------------------------------------------------------------------------
    \1\ See, e.g., U.S. Department of Health and Human Services, Report 
on Prescription Drug Importation, December 2004, pp. 65-67.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \2\ See 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.
    \3\ See, 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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \4\ See 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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \6\ This 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.
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \7\ See S. 334, the ``Pharmaceutical Market Access and Drug Safety 
Act of 2005''; and S. 109, the ``Pharmaceutical Market Access Act of 
2005.''
    \8\ See fn. 1, supra.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \9\ An exception is marginal production cost for biologics, a topic 
outside the scope of this testimony.
    \10\ See, 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.
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \11\ See Professor Kevin Outterson, op.cit., at p. 2.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \12\ Whether 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.
    \13\ The latter assumption would be highly questionable and 
inconsistent with the evidence, but that is an issue outside the scope 
of this testimony.
---------------------------------------------------------------------------
    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 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\
---------------------------------------------------------------------------
    \14\ This essentially is monopoly power on the part of a buyer to 
force prices down.
    \15\ See, 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.
    \16\ See 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.
---------------------------------------------------------------------------
                             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 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 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 
research-based 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:]

                 Prepared Statement of Stephen Pollard



    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 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 report 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 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:]

                 Prepared Statement of Kevin Outterson





    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 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 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 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 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 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 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 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.
    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.]

                          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 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 off-patent unbranded generic drugs at lower 
prices.\2\ This resulted in an estimate of potential savings from 
shifting within the off-patent drug market.
---------------------------------------------------------------------------
    \1\ Off-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.

    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 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 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, 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 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. 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?
---------------------------------------------------------------------------
    \1\ Pharmaceutical 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).
---------------------------------------------------------------------------
    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 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 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 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\
---------------------------------------------------------------------------
    \2\ For 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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \3\ See. 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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \4\ Kevin 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).
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \5\ See 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 . . .'').
---------------------------------------------------------------------------
    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 of 
Health Policy, Law & Ethics \9\ and in September 2004 in Pharma Pricing 
& Reimbursement, published by IMS Health.\10\
---------------------------------------------------------------------------
    \6\ Michael 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).
    \8\ F.M. Scherer, A Note on Global Welfare in Pharmaceutical 
Patenting, 27 World Econ. 1127, 1141 (2004).
    \9\ Kevin 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).
    \10\ Kevin Outterson, Free Trade Against Free Riders?, 9 Pharma 
Pricing & Reimbursement 254 (IMS Health, Sept. 2004).
---------------------------------------------------------------------------
    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\
---------------------------------------------------------------------------
    \11\ Kevin 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).
---------------------------------------------------------------------------
    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 improved 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.
---------------------------------------------------------------------------
    \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.

    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\
---------------------------------------------------------------------------
    \2\ The issue of the efficient structure and length of patent 
rights in the pharmaceutical context is not addressed here.
    \3\ The 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.

    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 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 peer-
reviewed 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.
---------------------------------------------------------------------------
    \5\ See, 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 controlled 
prices and market value might be captured in whole or in part by 
various transaction agents (``middlemen'') under a broad range of 
market conditions.
    \7\ See 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.

    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 and possibly the short 
run, by inducing profit-seeking producers to reduce their U.S. prices.
---------------------------------------------------------------------------
    \8\ For 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.

    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\
---------------------------------------------------------------------------
    \9\ See 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.

    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 name-brand 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.
                               __________
              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.
                               __________
   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 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:


------------------------------------------------------------------------
                                                         Number  Percent
                       Category                          of New   of New
                                                         Drugs    Drugs
------------------------------------------------------------------------
Major therapeutic innovation in an area where                 7      0.3
 previously no treatment was available................
Important therapeutic innovation but has limitations..       73      2.7
Some value but does not fundamentally change the            212      7.9
 present therapeutic practice.........................
Minimal additional value and should not change              432     16.0
 prescribing habits except in rare circumstances......
May be new molecule but is superfluous because does        1780     66.1
 not add to clinical possibilities offered by
 previously available products........................
Without evident benefit but with potential or real           73      2.7
 disadvantages........................................
Decision postponed until better data and more thorough      116      4.3
 evaluation...........................................
                                                       -----------------
  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.
    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:


----------------------------------------------------------------------------------------------------------------
                                                                   Life expectancy at       Life expectancy at
               Country                 Infant mortality (2002)    birth (males) (2002)   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.
    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:


------------------------------------------------------------------------
                                                                 Gross
                                                                domestic
                                                       Drug     product
                                                       price      per
                        Year                           ratio     capita
                                                     (Canada/    ratio
                                                      United    (Canada/
                                                      States)    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.


----------------------------------------------------------------------------------------------------------------
                                                                   Life expectancy at       Life expectancy at
               Country                 Infant mortality (2002)    birth (males) (2002)   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 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?
    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.

                              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 industry 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.
    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.

[GRAPHIC] [TIFF OMITTED] T0046.001

    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;
    (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\ \12\Huge 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 substantially 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.
 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 AARP \29\ 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 riding,'' though the term is both 
inaccurate and moralistic. If, however, the fixed costs are only 
$300,000-$600,000 or \1/10\th to \1/5\th'' 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.

                               References

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is anything but free. AARP Global Report on Aging, 2004: 8-9.
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Imbalance Innovation. Boston: Bain & Company, 2004.
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    [Whereupon, at 11:50 a.m., the committee was adjourned.]
      

                                    
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