Economic illiteracy

CBS News has an article about five health care promises that the president won’t keep. For two of them that’s a good thing, including this one:

Allow Drug Importation

During the campaign, Mr. Obama said his plan (PDF) would “Allow consumers to import safe drugs from other countries” because “some companies are exploiting Americans by dramatically overcharging U.S. consumers.”

As noted above, the Obama administration secretly conceded to forgo the importation of cheaper drugs in its deal with the pharmaceutical industry.

(Via Instapundit.)

Indeed, Obama did make that promise (one doesn’t want to trust CBS for this sort of thing):

Allow consumers to import safe drugs from other countries. The second-fastest growing type of health expenses is prescription drugs. Pharmaceutical companies should profit when their research and development results in a groundbreaking new drug. But some companies are exploiting Americans by dramatically overcharging U.S. consumers. These companies are selling the exact same drugs in Europe and Canada but charging Americans a 67 percent premium. Barack Obama and Joe Biden will allow Americans to buy their medicines from other developed countries if the drugs are safe and prices are lower outside the U.S.

This is sheer foolishness, as basic economics will tell you. In fact, one doesn’t need to know any economics; mere common sense should tell you that we cannot realize real savings by shipping a product to Canada and back.

What is happening here is called price discrimination. This happens when the supplier of a product or service sells it at a different price to different customers. This can only arise with an uncompetitive market (typically a monopoly); a competitive market will compete away such price differences. Also, it can only arise when the supplier is able to segment his market into (at least) two parts and prevent arbitrage between the segments.

Price discrimination is not inherently bad. Abstractly, it leads to more efficient resource allocation. (In the limit, called perfect price discrimination, commodities are supplied in the same quantity as they would in a competitive market.) Concretely, it lowers prices for those who are less able to afford a commodity, and raises them for those who are better able to afford it. A classic example is different rates at museums and zoos for children, adults, and seniors. (Progressives ought to be all in favor of this!)

Prescription drug companies have been able to break their market into U.S. and Canadian segments. (Additionally, many drugs are sold at an even lower price in Africa.) They then sell the drugs more cheaply in the less wealthy market segment, Canada. (An additional complication arises from Canada’s monopsonistic drug purchasing, but that doesn’t affect the analysis.)

So what will happen if we permit drug reimportation (i.e., arbitrage)? At a small scale, nothing at all. If the drug companies gain more from price discrimination than they lose from arbitrage, they’ll stick with it. But suppose we allow drug reimportation on a national scale? Then the drug companies’ ability to segment their market is gone, and price discrimination will disappear overnight.

That means that U.S. and Canadian prices will equalize at some price in the middle. We won’t see much benefit though. Since the U.S. market is much larger than the Canadian market, price discrimination has not affected our price significantly. Therefore, the new price will be imperceptibly lower than the U.S. price.

In summary, large-scale drug reimportation would screw Canada over, while obtaining no significant benefit for us. If this proposal were ever to see the light of day (and fortunately it appears it will not), we could expect Canada to fight hard against it. Barack Obama’s campaign call for reimportation was either economic illiteracy, or (more likely) simple demagoguery.

POSTSCRIPT: As I recall, John McCain supported reimportation as well; not that that matters any more.

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