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Drugs and the State

Mises Daily: Tuesday, April 25, 2000 by

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Americans are concerned about the rising cost of pharmaceutical drugs. This has drawn the attention of writers, politicians, and others who have attempted to deal with the issue in typical fashion by advocating the use of government force to implement their plan.

No exception to the general rule, Kathleen Day, a media fellow at the Kaiser Family Foundation, aired the usual concerns and wrote the representative prescription in an editorial that appeared in the Washington Post titled "The Driving Force."

Day writes that the "extremely profitable" drug industry lobbies to prevent the government from limiting drug prices. Among the solutions mentioned—price controls. This solution reminds one of Pufendorf’s advice that "it is foolish to prescribe a medicine far more troublesome and dangerous than the disease."

Ms. Day has shown that she has little understanding of how a market economy works. Mises wrote that the concept of "excess" profits arises from the "popular superstition that profit is an addendum to the costs of production, the height of which depends uniquely on the discretion of the seller." In this view, prices reflect the cost of production plus some margin (profit) determined by the sellers.

However, cost is not the driving force of prices. Rather, consumer preferences drive the prices of goods and services. The marginal buyer and the marginal seller determine prices. As Mises noted, prices are social phenomena brought about by the interplay of all the subjective valuations of the individuals participating in the market.

Prices are the result of countless interactions between buyers and sellers, between non-buyers and non-sellers. Prices are a necessary consequence of living in a world of scarcity. It is self-evidently true that goods are scarce; not everyone can have them. Prices are the means by which goods are selectively provided, how goods are "allocated" in a market economy. This allocation reflects the preferences of the consumers as manifest by their actions. In the absence of prices these goods would have to be distributed according to some arbitrary will. More importantly, without prices these goods would not likely have come into existence at all.

Prices also allow entrepreneurs to calculate; to make rational appraisals of current market data against their own judgment of future prices. Those who make more correct judgments, or who forecast the future state of the market better than their competitors and shape their actions against this picture, will earn profits for their efforts. Those who act on forecasts that later prove to be in error suffer losses.

Mises fully appreciated the social function that profits serve. Profits are rewards for those who served the buying public better than others. "High" prices and profits are signals that a product is in demand. These profits attract the entrepreneurs and mobilize capital serving less desired ends to shift to meet the demands of the consumer.

Mises wrote: "In branding profits as excessive and penalizing the efficient entrepreneurs by discriminatory taxation, people are injuring themselves. Taxing profits is tantamount to taxing success in best serving the public."

In the same way, penalizing the pharmaceutical companies by taxing, confiscating, or limiting their profits in any way inhibits the market process in its drive toward efficiency and the satisfaction of consumer wants.

In the real world for pharmaceutical drugs, however, a free market does not exist. The industry benefits heavily from the granting of patents and the heavy government regulation of the drug industry.

A patent, as Murray Rothbard defined it in his book Power and Market, "is a grant of monopoly privilege by the government to first discoverers of certain types of innovations." Like any monopoly grant, patents confer a legally enforceable privilege to the patentee and restrict new entrants from coming to the market, thereby distorting prices and forcibly altering the competitive pattern of the industry.

Patents are not compatible with the free market to the extent that they go beyond the copyright (which is a claim to tradeable property). For patents punish independent discoverers and violate their right to use their property as they see fit.

Rothbard notes that "mechanical inventions are discoveries of natural law rather than individual creations, and hence similar independent inventions occur all the time. The simultaneity of inventions is a familiar historical fact."

With patents, the first discoverer who registers his patent with some government is given free license to soak the public for his monopoly privilege. The independent discoverer is denied the use of his invention by virtue of the simple fact that he was not first, or not registered with government.

Government regulation also hampers the ability of firms to bring new drugs to market. It takes years, for example, for a drug to go through the FDA’s approval process. To the extent that the supply of drugs is kept below what the market might otherwise produce if left unhindered, the price of drugs for consumers will be kept artificially high.

Also, this process prevents an individual from trying a drug, even after accepting the risks. Perhaps this individual has but a short time to live without the new experimental drug. This person cannot wait for the FDA, but under the present system he must. Or he enters the black market. In this case, society brands him, and the people who helped him, as criminals. How many have died because the FDA prohibited them from using certain drugs?

This is not to say that a free market in drugs will not have quality assurances. There will likely be a demand for some sort of quality assurances and these needs would be met, as all other needs can be met, by private enterprise. There is no logical reason why government should have a sole compulsory monopoly on this useful function.

In the past, statists have argued that government is needed to provide a host of services such as police services, the printing of money, and education. And yet, we have abundant historical and theoretical evidence that these services and more can be provided more efficiently by free enterprise.

Private regulation of drugs is no different. Private regulatory companies could emerge to serve the public. They would vary in the price and level of their assurances reflecting the diverse preferences of their customers.

Moreover, these companies would be more responsive to their customers than government regulators for the simple reason that they would lose their customers and go out of business if they didn’t. Government regulators have no threat of bankruptcy for lack of customers. Their customers are forced to pay for their services by coercive levy whether they want these services or not.

As for price controls, we know by economic theory and historical illustration, that any attempt to set a price for a good or service below the market price will result in shortages of that good or service. It will be no different with drugs. Perhaps the capital that would have flowed to the drug making industry now will find other havens, like microprocessors or software, where prices are not (yet) regulated. Moreover, price controls violate one’s fundamental right of freedom of contract.

Beyond these considerations there are other moral questions. Who should decide how much to pay for drugs? Apparently lacking any systematic rational ethic, Day is baffled by the question. However, underlying her essay is the assumption that this decision is to be made collectively.

Her piece is littered with questions like these: "How much are we willing to pay for the medical technology that we Americans are so adept at developing?…Do we want to decide how much we are willing to spend to keep an 83-year-old man alive?"

These are all difficult questions. The answer in each case is clear for the natural-rights-based libertarian equipped with the proprietary theory of justice, which is rooted primarily in the self-ownership axiom. This axiom, simply stated, asserts the absolute right of each individual to control over his or her own body, free from coercive interference.

Viewed through the libertarian lens, Day’s questions don’t seem as difficult and we can formulate a general reply: these questions should be decided by the individuals involved, and, if they wish, their families and any others they want to involve in these decisions. Morally, what authority does the collective whole have over its non-invasive members? Why should government make the decision whether an 83-year old man lives or dies? Similarly, how can it be morally right to force others to bear the medical costs of strangers?

Similarly, the injustice of price controls becomes apparent. If you are going to impose price controls, how are drugs to be distributed? How is this moral or just? Let us say a man wants to pay a certain sum for a certain drug and he finds a willing seller. The transaction takes place. What is "society" to do now? Is the man now a criminal? Is the seller? Are these men to be imprisoned or fined?

The fact is that any attempt to regulate the drug market is an infringement on the liberties of the buyers and sellers so regulated. Additionally, this infringement will have to be enforced to be at all meaningful. Government will have to prevent consumers from doing something that they want to do and have the means to do. Government will have to force sellers to do something they would rather not do. Worst of all, those who break these arbitrary rules will have to be treated as criminals. Something seems amiss in a country that pays lip service to freedom and yet must treat peaceful citizens as criminals.

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Christopher Mayer is an MBA student at the University of Maryland. A version of this article appears in the May 2000 issue of The Free Market. Send him MAIL.