The High Cost of Cheap Drugs. Jacob Arfwedson. December 2004.

When the socialist Front Populaire came into power in France in 1936, Leon Blum asked distinguished economist Alfred Sauvy to be part of his cabinet. The latter expressed doubts about the future prime minister's grasp of economics, and received this irascible reply: "If I knew anything about economics, would I be a socialist?"

Many decades later, the consequences of socialists' lack of knowledge of economics are all too real. A case in point: the European pharmaceutical industry. It is a shell of its former self. Far fewer life-saving drugs get developed than would otherwise be the case.

The biggest culprits? Price controls and drug reimportation. If the price of something is below the cost of producing it, manufacturers cannot make a profit. Without profits, they go out of business.

Now, in an effort to get cheap drugs, a lot of people in the United States want to institute reimportation -- where U.S.-manufactured drugs are exported and sold abroad at price-controlled rates, and then reimported at the cheaper rate. Internet pharmacies in Canada and elsewhere offer 30%-50% discounts off the price of the drugs in the U.S. Illinois Governor Rod Blagojevic is preparing to make his state a pioneer in large-scale reimportation, despite a federal government ban on prescription drug imports. Several other states are expected to follow suit in early 2005.

Reimportation is one of the most effective ways to slow or even halt the production of new drugs. It is no coincidence that the European Union has lost significant market share to the U.S. in terms of drug research and development during the past decade, with its share of the world market declining to 22% from 32% in that time.

New drugs cost, on average, $400-$800 million to develop. Their prices need to reflect that huge investment. Otherwise, there would be little incentive to develop them. And only a tiny fraction of new drugs actually make it to the market because of clinical trials and regulatory policies. To improve access to new medicines, policy makers and activists should concentrate on facilitating the approval of new drugs, not the siren song of reimportation.

Having crippled their own pharmaceutical industries through price controls and reimportation, the rest of the world (including the EU and Canada) is free-riding on the efforts of U.S. drug makers. As a European, I can only hope that American politicians resist the temptation to destroy the world's last relatively free market for drugs.

But consider this: reimportation likely will not even result in significant savings for U.S. consumers. Most of the "benefits" of controlled prices go to the retailer in the form of profits, not to the consumer in the form of savings. To start an online pharmacy, all you need is a Web site and an MD to oversee the prescriptions. In 2003 the number of Canadian online pharmacies rose to 140 from 30, and Internet pharmacists are sometimes paid twice as much as their brick-and-mortar colleagues. This is business, not philanthropy. As our experience in Europe has shown, reimportation provides at best a mere 1%-2% saving to the consumer on average.

And keep in mind that drugs, which may seem expensive to some U.S. consumers, constitute just a tiny part of overall health-care spending. Recent studies have shown that new drugs significantly reduce the number and length of hospital stays, thus capping overall health-care expenditures.

Reimportation, as the Food and Drug Administration has repeatedly declared, also raises important safety concerns. Online pharmacies and other reimporters are not subject to FDA regulations. Consumers hunting for bargains abroad lack guarantees in terms of product safety (storage, expiration of products, labeling etc), legal protection and redress.

Before the election, the Bush administration hinted that reimportation might address the public's demand for cheaper drugs. But the perceived short-term benefits are likely to be outweighed by the negative longer-term effects of importing price controls. Reimportation may be good for politicians' re-election chances, but not for the health of their constituents.

Mr. Arfwedson is author of "Parallel Trade in Pharmaceuticals" published by the Institute for Policy Innovation and an IPI visiting scholar.

This article appeared in The Wall Street Journal -- Europe on December 13, 2004.