Coercive Monopsony

Two posts ago, I didn't mean to suggest that other countries "owe" Americans for the R&D our companies fund. Our companies gladly pay those costs because that is in their own interest. My point about drugs is that drug R&D is fundamentally different because American consumers pay for cost of development and manufacture, but foreign consumers pay only for manufacture, of drugs developed in the US. That in turn is caused by legal distortions intentionally introduced into the marketplace by foreign governments.

How? Coercive monopsony. Monopsony is the situation when there is only one consumer to a product, sort of the mirror opposite of monopoly. A "coercive monoposony" is the situation when there is only one consumer because they are able to force other consumers to remain out of the market. They are then able to dictate terms to the supplier, probably by forcing them to overproduce at artificially low prices.

Foreign governments create a coercive monopsony by threatening to withdraw their entire market unless manufacturer plays along with their pricing scheme. Why would the producer go along? One possible answer is that this is similar to "bundling" of anti-trust lore. The consumer (foreign National Health Service (NHS)) will agree to buy other, high margin drugs, but only if new, popular drugs are sold at marginal manufacturing cost. In fact, that seems to be the case, since most foreigners pay more for their generic drugs than Americans, but less for their name-brand drugs. From a Malcolm Gladwell article in The New Yorker:

As the economists Patricia Danzon and Michael Furukawa recently pointed out in the journal Health Affairs, drugs still under patent protection are anywhere from twenty-five to forty per cent more expensive in the United States than in places like England, France, and Canada. Generic drugs are another story. Because there are so many companies in the United States that step in to make drugs once their patents expire, and because the price competition among those firms is so fierce, generic drugs here are among the cheapest in the world. And, according to Danzon and Furukawa’s analysis, when prescription drugs are converted to over-the-counter status no other country even comes close to having prices as low as the United States.

It is not accurate to say, then, that the United States has higher prescription-drug prices than other countries. It is accurate to say only that the United States has a different pricing system from that of other countries. Americans pay more for drugs when they first come out and less as the drugs get older, while the rest of the world pays less in the beginning and more later. Whose pricing system is cheaper? It depends. If you are taking Mevacor for your cholesterol, the 20-mg. pill is two-twenty-five in America and less than two dollars if you buy it in Canada. But generic Mevacor (lovastatin) is about a dollar a pill in Canada and as low as sixty-five cents a pill in the United States. Of course, not every drug comes in a generic version. But so many important drugs have gone off-patent recently that the rate of increase in drug spending in the United States has fallen sharply for the past four years. And so many other drugs are going to go off-patent in the next few years—including the top-selling drug in this country, the anti-cholesterol medication Lipitor—that many Americans who now pay more for their drugs than their counterparts in other Western countries could soon be paying less.

As a counterpoint to this, a recent British Medical Journal article claims to have found that Americans do not subsidize others' costs for medicine. It requires a subscription, so I haven't read it, but the synopsis via Excellence Through Mediocrity is

The United States government is engaged in a campaign to characterise other industrialised countries as free riding on high US pharmaceutical prices and innovation in new drugs. This campaign is based on the argument that lower prices imposed by price controls in other affluent countries do not pay for research and development costs, so that Americans have to pay the research costs through higher prices in order to keep supplying the world with new drugs.
[...]
We can find no convincing evidence to support the view that the lower prices in affluent countries outside the United States do not pay for research and development costs. The latest report from the UK Pharmaceutical Price Regulation Scheme documents that drug companies in the United Kingdom invest proportionately more of their revenues from domestic sales in research and development than do companies in the US. Prices in the UK are much lower than those in the US yet profits remain robust.
[...]
...in Canada the 35 companies that are members of the brand name industry association report that income from domestic sales is, on average, about 10 times greater than research and development costs. They have profits higher than makers of computer equipment and telecommunications carriers despite prices being about 40% lower than in the US.
[...]
Contrary to claims of American dominance, pharmaceutical research and development in the US has not produced more than its proportionate share of new molecular entities. The US accounts for just under 48% of world sales and spent 49% of the global total on research and development to discover 45% of the new molecular entities that were launched on the world market in 2003, less than its proportionate share. European countries account for 28% of world sales, 36% of total research and development spending, and 32% of new molecular entities, more than its proportionate share.

My first comment is that they say that this "disinformation" campaign is being driven by the US federal government; if true, they are right to question it, and because it may be the FDA's attempt to justify its own existence, they may be right. My second comment is to note that they looked only at brand name medicines, not all medicines; in light of the Gladwell article above, there's no wonder about that. Basically their evidence is that since Brits pay less than Americans, and Brit companies spend proportionately more on R&D, and since American companies only spend in proportion to their share of the world market (48%), then Europeans aren't free riding. That's bizarre - the American R&D is less substantial because it's only in proportion to their 50% higher market share? There are 50% more people in Europe, so the proportional contribution is that much larger by the US companies, rather in opposition to their claim. It's quite likely that much of the foreign R&D is funded by foreign taxpayers, and there is no discussion of the efficacy of spending on either side (note that my own discussion of this is marred by the same error, but at least I'm not claiming to be a researcher or publishing in a peer-reviewed journal).

The bundling mechanism described above is the mirror image of what Microsoft was accused of: by bundling Internet Explorer and other programs (like Wordpad and Calculate), they were "forcing" consumers to accept those undesirable goods along with the desirable Operating System. That was and remains nonsense since consumers had and have choices for OS and for browsers (whereas Apple was not accused of such things even though they forced consumers to take their hardware along with their OS and browser). The example of coercive monopsony, however, is different, since the producer (in that country's market) has no other choice for consumers by law. They basically have to concede the market to competitors or go along with the pricing demands of the NHS.

Or perhaps I have defined "the market" too tightly?

A Google for "coercive monopsony" yields only one hit, a review of a research paper about Fair Trade. Well, only one until I post this.