American Journal of Law & Medicine

How parallel trade affects drug policies and prices in Canada and the United States.(Globalization of Pharmaceuticals: International Regulatory Issues)

I. INTRODUCTION

U.S. consumers and Canadian pharmacies have rushed to take advantage of the opportunity presented by price differences in patented pharmaceuticals. This rapidly growing parallel trade (1) has brought the Canadian and U.S. systems for determining pharmaceutical pricing under increased scrutiny, and the pressure for change seems to be building. This paper examines why parallel trade in pharmaceuticals has grown and considers some of the policy options confronting both countries.

To do this we begin by identifying similarities and differences in the Canadian and U.S. regulatory frameworks governing trade in pharmaceuticals. While the differences are considerable, we show that they are not the only reason for the emergence of the price disparity that has fuelled the growth in parallel trade. In particular, we argue that the price discrimination strategies of pharmaceutical manufacturers and exchange rate fluctuations have played an underappreciated role. Following this, we examine the claims that this trade represents a threat to American and Canadian interests, and find that there are good reasons for policy makers on both sides of the border to be concerned. Unchecked, this rising trade presents a threat to R&D funding and continued Canadian consumer access to pharmaceutical products. (2)

Despite the apparent threat to Canadian interests, little has been done in Canada to confront this perceived problem. We examine a few of the reasons for this political inertia. Specifically we find that federal action requires intervention in an area touching on provincial jurisdiction, while provincial action requires unanimity, which is unlikely to be achieved given that some provinces are reaping short-term benefits from the industry. We show that many American interests keen on facilitating the parallel trade in pharmaceuticals are unlikely to be satisfied by the outcome of policies that rely on making Canada an important source of U.S. supply. We argue that the Canadian federal government should act now to end the internet pharmacy trade and avoid the uncertainty and disruptions that might follow a resurgence in the growth of internet pharmacies. We finally point to a simple change in federal policy as the most direct route to closing down the internet pharmacies that have been most responsible for growing the business of parallel trade.

Before proceeding it is useful to review what is known about the size of the parallel trade in pharmaceuticals. Unfortunately, because this trade occurs outside of authorized channels, not much is known. The U.S. Department of Health and Human Services (HHS) estimated that the volume of walk-in and internet pharmacy sales to be $695 million U.S dollars in 2003. (3) IMS Health Canada's (2005) most recent estimates put the value of sales from Canadian internet pharmacies in 2003 at approximately $417 million U.S. dollars, which is 60% of total volume of the parallel trade. (4) What makes this interesting is that internet pharmacy sales were negligible prior to 2000. Between 1999 and 2003 the number of Canadian internet pharmacies grew from 4 to approximately 120. (5) Growth in internet sales was the main driver in the growth of U.S. imports of pharmaceuticals from Canada in 2004. (6)

The latest figures from IMS Health Canada (2005), presented in Table 1, suggest that growth may be tapering off. In fact, IMS Health Canada reports declines of between 5% and 11% in each of the last three quarters of 2004. (7) In the final column of Table 1, the share of Canadian internet pharmacy sales as a percent of total U.S. prescription drug sales is presented. Clearly, the share of Canadian internet pharmacy sales is small and seems to be declining. (8)

Another way to think about the volume of the parallel trade in pharmaceuticals is to examine the number of U.S. prescriptions filled by Canadian pharmacies. Approximately 12 million U.S. prescriptions were filled by Canadian pharmacies in 2003, which amounts to 0.39% of total U.S. prescriptions filled, (10) While this is small compared to the total U.S. market, it is a large share of prescription drug imports to the United States. Each U.S. order also required filling an average of 2.5 prescriptions, generating a total of 4.8 million packages of prescription drugs entering the U.S. from Canada. (11) To put this into perspective, this represents almost half of the 10 million packages of prescription drugs that enter the U.S. annually. (12)

While the growth in this trade seems to have slowed for the moment, the rapid emergence of this trade has caused policy makers to re-examine the way in which both countries manage their pharmaceutical industries. In particular, Canadian price controls and safety regulation have been a source of some interest and some debate. In what follows, we examine the similarities and differences between the Canadian and U.S. regulatory environments governing the pharmaceutical market.

II. THE REGULATORY FRAMEWORK FOR PHARMACEUTICALS

While trade frictions are not uncommon between Canada and the U.S., the parallel trade in pharmaceuticals presents a new and unusual source of difficulty. In many ways, this newest friction comes as something of a surprise since Canadian interests in the international market for pharmaceuticals are quite similar to U.S. interests. First and foremost, both countries share a concern that pharmaceuticals be both safe and effective. (13) Both countries are concerned that, as much as possible, pharmaceuticals be appropriately priced and that consumers have access to effective medications. (14) Finally, both countries are committed to providing a policy framework that supports the research and development of new, effective, and safe medications. (15) The result is that both countries share a very similar set of dilemmas that require making choices between often competing policy objectives.

Given these similar objectives, it is not surprising that the Canadian regulatory framework governing trade in pharmaceuticals resembles the U.S. model in a number of ways. First, the Canadian federal government promotes drug safety by requiring a Health Canada review of the safety, efficacy and quality of a new drug before it gives marketing approval. (16) For the most part, Health Canada reviews mirror Food and Drug Administration reviews; they focus on the therapeutic effect of the medicine rather than price. (17) Second, the federal government promotes the research and development of new and effective medications, by directly funding research through the Canadian Institutes of Health Research (CIHR) and other funding agencies, (18) and by providing intellectual property rights under the Patent Act. (19) The rules governing what innovations can be patented are similar to U.S. rules, as is the standard twenty-year patent life. (20) Concern over the fairness and efficiency of pricing has led Canada to follow the U.S. in facilitating the approval of generic drugs through regulations which are modeled on the Hatch-Waxman Act. (21) Concern over access to drugs has led to provincial drug insurance programs that cover seniors and the indigent, as well as some other groups; (22) again, these programs are similar, in some ways, to drug insurance programs such as Medicare in the U.S. (23)

Despite these important similarities in objectives and policies, there are differences in priorities that have led to a number of notably different policy choices. One important example is the tendency of Canadian policy to tilt more strongly in favor of the promotion of low prices while U.S. policy has tilted more strongly towards stronger protection of patent rights and other incentives for innovation. (24) One likely reason for this difference is that Canada's comparatively smaller pharmaceutical research industry appears to have been historically less successful in lobbying for policies that benefit them. (25)

These differences in priorities were, at one time, more pronounced. Until the 1980's Canada maintained a policy of compulsory licensing of pharmaceutical patents. (26) The Canadian government was finally convinced to abandon the policy, but only after the pharmaceutical industry promised to increase research investment in Canada (27) and to submit to a system of price controls.

These price controls were implemented through the Patented Medicines Prices Review Board (PMPRB), a branch of the Canadian federal government that regulates the price of prescription and non-prescription patented drugs sold in Canada to wholesalers, hospitals and pharmacies. (28) The objective is to review "factory-gate" prices to ensure they are not "excessive." (29) To meet this objective, the PMPRB performs an initial review of a drug's price at its introduction. (30) This initial review considers two possibilities. If the drug is comparable to other products already sold in Canada, then the price is permitted to be no greater than that of the other products treating the same disease. (31) If, on the other hand, the drug is not comparable--perhaps because it offers a substantial therapeutic advantage over other products--then the PMPRB requires that the price in Canada should be no greater than the median price in seven other industrialized countries (namely France, Germany, Italy, Sweden, Switzerland, U.K. and U.S.). (32) After this initial review, price increases for a drug are limited to increases at the rate of inflation. (33)

This system of price-setting does not usually constrain the pricing decisions of pharmaceutical companies. When the first drug in a class (or "breakthrough" drug) is introduced, the only restriction is that the price in Canada be no higher than the nominal price of the drug in some other country. This constraint on pricing is usually not binding for two reasons. First, in many countries, the nominal list prices used to establish a median price ceiling are often much higher than the actual prices paid after secret rebates and discounts are considered. (34) Second, the comparator countries are similar to Canada in average per capita income. Thus, if actual prices in the other countries--or at least four of them--are set at a level reflecting their underlying demand, then Canadian prices will not be constrained. The constraint that non-breakthrough drug prices be no higher than that of the breakthrough drug is also unlikely to present much of a restriction: since "me-too" or "follow-on" drugs must compete with an established brand, they are not typically priced higher than breakthrough drugs in countries where no such restrictions apply. (35)

The PMPRB does not conduct additional reviews after a product has been introduced, other than to ensure that its price has not risen faster than the rate of inflation. (36) This can be problematic when drugs acquire new indications, or when new evidence shows either greater or lesser benefits than initially believed. As an example of why this may be important, consider the drug Norvir (generically known as ritonavir), an important antiretroviral used in treating HIV/AIDS. In 2003, its manufacturer Abbott decided to increase the U.S. price of Norvir from approximately $50 per month's dose to approximately $250, a five-fold increase. (37) Such a price increase is not possible in Canada regardless of new evidence or new commercial opportunities.

III. PHARMACEUTICAL PRICING

The parallel trade in pharmaceuticals has been driven by price differentials between the Canadian and U.S. markets. While price regulation by the PMPRB may have some effect on Canadian prices, it is only one of several factors. As we will argue, the two most important factors have been the price discrimination strategies of the manufacturers; and the role of exchange rate fluctuations given the upward inflexibility of prices in Canada. We will consider each in turn.

A. PRICE DISCRIMINATION

Drug firms set different prices for different consumers, just as other firms do. (38) Airlines, for example, typically offer seats on the same plane at radically different prices, depending on when the ticket is booked, and the airplane's load factor. Movie theatres typically charge different prices for different classes of consumers: children and seniors get lower prices. The reason for charging different prices to different groups of consumers is that the price elasticity of consumers varies systematically across identifiable groups. (39) The elasticity is a measure of what proportion of sales are lost when price increases. The higher the elasticity, the lower the profit maximizing price will be. Thus low prices for seniors at movie theatres are not explained by generosity so much as a desire to extract the maximum possible profit, given that seniors are much more likely to react to high prices by not attending. The same profit motivation is at work in pharmaceutical pricing: firms will discriminate across consumer groups according to the price elasticity of demand. Consumers with high elasticity of demand receive lower prices.

In many markets, economists often observe that elasticity is higher among low income groups and that this causes manufacturers to offer lower prices to low income groups. If this is true in the pharmaceutical market, this would provide a convenient explanation for why drug prices are lower in Canada than the U.S. (40) Lower incomes in Canada cause firms to choose lower prices for the Canadian market because such a pricing strategy increases profits. …

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