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10 MANAGED CARE / SUPPLEMENT
Historically, pharmaceutical prices have varied
significantly across countries. This wide range of
costs provides an incentive for arbitrage, a mech-
anism for sidestepping the secure supply chain and high
prices that characterize some markets. Given that paral-
lel trade in pharmaceuticals circumvents the regulatory
protocols of the U.S. Food and Drug Administration,
reimported drugs carry an increased risk of counterfeit-
ing. This article examines the economic dynamics of
reimportation and the risks posed by counterfeit phar-
maceuticals. The analysis addresses the economic in-
centives, public policy ramifications, quality implica-
tions, and several policy alternatives.
Proposed solution to rising costs
The market for pharmaceuticals is characterized by siz-
able price differences across countries, which reflect dis-
tinct demand patterns, as well as differences in govern-
mental regulations and health care policies. Recent events
have drawn attention to the pharmaceutical price dif-
ferential between the United States and Canada. In 2002,
“Drug prices in the United States were 67 percent higher
than in Canada” (Harris 2003). Reimportation, or par-
allel trade, has been proposed as a solution, allowing
American consumers to purchase drugs at lower Cana-
dian prices.1Under current U.S. law, it is illegal to import
prescription drugs from other countries. Nevertheless,
cross-border prescription drug sales have increased
tremendously. Recent estimates place the value of such
sales from Canada at $650 million a year (Harris 2003).
A similar trend has emerged along the U.S.-Mexican
border.
To understand parallel trade, it is necessary to under-
stand pharmaceutical price discrimination. The phar-
maceutical industry is characterized by a high research
and development cost that must be shared by all markets.
Economic theory holds that the most efficient mecha-
nism2for recovering this shared cost is to charge differ-
ent consumers different prices, based on price sensitiv-
ity, to obtain the set of prices that generates revenue
sufficient to cover the shared R&D cost as well as the
highest level of consumer welfare.
Parallel trade results in unregulated distribution
pipelines and weakened regulatory control of the supply
chain, both of which are characteristics that facilitate
counterfeiting. According to the World Health Organi-
zation, counterfeiting is facilitated when “there is weak
drug regulatory control and enforcement; there is a
scarcity and/or erratic supply of basic medicines; there
are extended, relatively unregulated markets and distri-
bution chains, both in developing and developed coun-
try systems; price differentials create an incentive for
drug diversion within and between established chan-
nels; there is a lack of effective intellectual property pro-
tection; and due regard is not paid to quality assurance”
(WHO 1992). Notably, many characteristics described by
the WHO are exacerbated in markets in which reimpor-
tation occurs.
Magnitude of the problem
According to the WHO, “A counterfeit medicine is
one [that] is deliberately and fraudulently mislabeled
with respect to identity and/or source. Counterfeiting can
apply to both branded and generic products, and coun-
terfeit products may include products with correct in-
gredients, with wrong ingredients, without active ingre-
dients, with incorrect quantity of the active ingredient,
or with fake packaging” (WHO 1997). It is a pervasive
problem, affecting nations of every size and income level,
and drugs of every description. Nevertheless, the mag-
nitude of the problem is difficult to estimate. The fol-
lowing facts illuminate the problem’s scope:
•Counterfeit aspirin tablets containing little or no
acetylsalicylic acid can be profitable, especially at
open-air markets, such as those in African villages
(McGregor 1997).
•In Nigeria, 80,000 children have been given fraud-
ulent meningitis vaccines. India has been found to
have some fake polio vaccines (Knox 2003).
•India accounts for 35 percent of the counterfeit
drugs that are produced; Nigeria produces about 23
percent; and Pakistan, 13.3 percent (Datta 2003).
•Dora Nkem Akunyili, PhD, head of Nigeria’s insti-
tutional equivalent of the FDA, has stated that the
share of counterfeit drugs in her country may be as
high as 90 percent (Kontnik 2003).
Economics of Reimportation and Risks
Of Counterfeit Pharmaceuticals
KRISTINA M. LYBECKER,PHD
Assistant Professor of Economics, Drexel University
1“Parallel imports are legitimately produced goods imported
legally into a country without the authorization of a trademar k,
copyright, or patent holder.The essential purpose of such trade
is arbitrage between countries with different prices” (Ganslandt
2001).
2This mechanism, known as Ramsey pricing, provides the way in
which markups should vary based on elasticities of demand.
REIMPORTATION OF PHARMACEUTICALS / MANAGED CARE 11
While pharmaceutical counterfeiting is as profitable as
the narcotics trade, it is subject to lesser criminal penal-
ties. It also is a difficult crime to uncover, even with the
availability of sophisticated tools to assist in this process.
Predictably, criminal syndicates in all regions of the
world have established a visible presence in the counter-
feit pharmaceuticals trade.
The WHO estimates that 10 percent of the global mar-
ket for pharmaceuticals comprises counterfeit products.
With an estimated annual turnover of $435 billion, the
financial loss for the industry could reach $43.5 billion
per year.3To put this figure in perspective,it is worth not-
ing that member companies of the Pharmaceutical Re-
search and Manufacturers of America invested $32.1 bil-
lion in R&D in 2002 (PhRMA 2003).
Public policy ramifications
Beyond arbitrage, there are long-term consequences
for pharmaceutical prices due to reimportation. In the
long run, it is more likely that prices will rise in Canada
rather than decrease in the United States.Evidence of this
strategy already is visible in the single market of the Eu-
ropean Union (Danzon 1998).
Alternatively, pharmaceutical manufacturers may de-
cide to limit the supply of drugs to source countries.
Considering that the U.S. market is 10 times larger than
the Canadian market, many manufacturers, including
GlaxoSmithKline, Pfizer, AstraZeneca, and Wyeth, are
electing to limit drug sales to Canada to curb reimpor-
tation. Manufacturers now are selling their products di-
rectly to pharmacies and hospitals instead of going
through wholesalers or distributors, allowing them to en-
force their terms of sale more effectively.
Although prices are the driving force behind reim-
portation, they are only part of the problem. The eco-
nomic welfare effects generated by parallel trade are am-
biguous, further complicating the analysis. As with
patents, parallel imports involve a tradeoff between re-
warding innovation and market power. The ultimate
value of the patent depends, in part, on the geographic
reach of this protection. Parallel imports may reduce the
patent holder’s ability to capture returns to R&D, thus
potentially diminishing the incentive to innovate.4Ulti-
mately, pharmaceutical reimportation may decrease
global welfare.
The incentive to invest in R&D is the third public pol-
icy consideration. While estimating drug development
cost is controversial, it is undeniably an expensive un-
dertaking. According to the Tufts Center for the Study of
Drug Development, the estimated cost is nearly $900
million (Tufts 2003). As such, it is not surprising that
patent protection is disproportionately more important
in the pharmaceutical and chemical industries than in
other sectors. It ensures that the researcher appropriates
the returns to R&D.5Patents and other forms of pro-
tecting intellectual property rights safeguard the indus-
try’s ongoing investment in R&D. This protection is un-
dermined by price controls that prevent innovative firms
from recovering their research investments. The decline
of the European pharmaceutical industry is evidence of
the effects of price controls.
Finally,parallel imports preclude the FDA from guar-
anteeing the safety of drugs that arrive from importing
nations. Without a secure supply chain, the FDA’s ca-
pacity to oversee the situation is compromised and its
responsibilities become unmanageable. Providing safety
assurances for reimported drugs would necessitate mon-
itoring not only the Canadian supply chain, but also the
global pharmaceutical supply chain. Legalizing parallel
trade in pharmaceuticals from Canada permits drugs to
come from any nation or source,as long as they enter the
United States through Canada.
Quality implications
Because many reimported prescription drugs are gen-
uine, reimportation is a necessary but not sufficient con-
dition for quality assurance. Storage and handling con-
ditions are also concerns. Other countries may not adhere
to the same rigorous standards that the FDA mandates.
The strict chain of custody maintained by firms and re-
quired by the FDA may be compromised, resulting in
subpotent drugs. The existing United States regulatory
system safeguards not only the pharmaceutical source,
but the handling conditions as well.
Although precise estimates do not exist, the use of
counterfeit pharmaceuticals has resulted in prolonged ill-
ness, debilitation, and death ⎯a phenomenon not lim-
ited to developing nations. Reimported drugs from Mex-
ico already have been linked to several deaths in the
United States (Turner 2003). Moreover, counterfeit drugs
that contain a substantially reduced dose of the active
constituent contribute to the great increase in global
drug resistance, undermining the fight against infectious
diseases.
If the U.S. market were to be opened to reimported
prescription drugs, the security of the existing system
could not be relied on to protect the consumer. The
3Accounting for industry growth and increasing incidence of
counterfeiting, this is in line with other published estimates.
4Ganslandt (2001) and Danzon (1998) provide more nuanced
treatments of the dynamic efficiency issues surrounding the
tradeoff.
5Echoing earlier findings, the 1994 Carnegie-Mellon Survey found
that while patents are seen as “the least effective of the appro-
priability mechanisms,” the drug industry regards them as more
effective than other mechanisms (Cohen 1996). Several addi-
tional studies report that the protection of intellectual property
is disproportionately more important to the chemical and phar-
maceutical industries. For a comprehensive review of these stud-
ies, refer to Lybecker 2000.
12 MANAGED CARE / SUPPLEMENT
FDA’s regulatory system is based on the incentives of
stakeholders6who have much to lose if they fail to play
by the rules. The current system, therefore,is ineffective
when it comes to rogue traders who have little to lose and
frequently operate at the market fringe (deKieffer 2003).
The threat of rogue traders is only one risk of reimpor-
tation, which has led to widespread opposition among
regulators and health care professionals.7FDA opposition
to pharmaceutical reimportation dates back to 1969 —
10 of the last 11 FDA Commissioners have opposed the
policy.In addition, both former Health and Human Ser-
vices Secretary Donna Shalala and current HHS Secre-
tary Tommy Thompson have expressed their opposi-
tion.
Safety concerns surrounding pharmaceutical reim-
portation also alarm international authorities. Because
the population of the United States is nearly 10 times that
of Canada, Canadian officials refuse to monitor drugs
shipped to the United States or to stop the huge flow of
drugs moving through Canada into the United States
from other nations. Moreover, legislation now under de-
bate in Congress provides that covered products may be
imported from more than 24 nations.8
Finally, parallel trade in pharmaceuticals generates a
number of monitoring difficulties that are less apparent
but significant threats to safety. With drugs entering
through many source-nations,safety warnings and prod-
uct recalls are more difficult to execute. In addition,
product-packaging standards vary across markets, and
prescription recommendations and contraindications
also may differ.Differences in product packages remove
the familiar packaging clues that are so important in the
visual detection of counterfeits.
Policy alternatives
Consumers want access to a variety of affordable, safe,
innovative prescription drugs without prohibitively high
prices, counterfeit drugs, diminished R&D, or burden-
some government regulation. How to ensure this access
and avoid the undesirable elements is much less clear. The
following four possible policy alternatives are proposed
as a starting point:
•Health insurance and prescription drug coverage. The
primary focus of the current debate has been the el-
derly in the population who are without prescrip-
tion drug coverage. The best solution will address
the underlying problem by securing an affordable
health care system.
•Manufacturer’s rebates. This alternative would re-
quire pharmaceutical manufacturers to change their
pricing policies in existing low-price countries.
Prices would increase to a uniform price level, but
manufacturers would offer rebates that would be
paid to the payer or national health system.
•Reimportation exemptions. Considering the eco-
nomic efficiency of Ramsey pricing, reimportation
should be disallowed for products such as pharma-
ceuticals that incur significant global shared costs.
Exemptions to parallel trade laws would allow man-
ufacturers a short period of above-marginal-cost
pricing to recover the R&D investment.
•Free market exports. Drugs consumed domestically
in low-price countries would be subject to govern-
ment price controls, while exported products would
be priced according to market forces. It should be
possible to institute this pricing policy through con-
tractual agreements between manufacturers and
suppliers.
Price differentiation vs. safety concerns
At first glance, parallel trade in pharmaceuticals ap-
pears to be the solution to rising drug prices. Yet the
price differential that characterizes neighboring mar-
kets and safety concerns actually are the most important
elements of the current debate. While capitalizing on
international price differences is tempting, the economic
incentives involved in pharmaceutical reimportation
cannot be considered without the associated risks. Before
embracing reimportation, the public policy ramifica-
tions, quality implications, and potential policy alterna-
tives should be considered. In summary, reimportation
is a complicated issue that has the potential to shape
both health care policy and the state of the pharmaceu-
tical industry.
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REIMPORTATION OF PHARMACEUTICALS / MANAGED CARE 13
