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Prescription Drug Prices in Canada and the United States --
Part 2: Why the Difference?

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Why are Canadian prices lower?

The PMPRB was set up in 1987, when its measurements showed that manufacturers' "gate prices" (prices at which manufacturers sell to wholesalers) for patented drugs in the United States were 36 percent higher than Canadian prices. Canadian manufacturer's gate prices at that time reflected the program of compulsory licensing through which Canadian generic drug producers could copy patented medicines and pay the inventor a licensing fee, set by the federal government, of 4 percent of sales. Since the creation of the PMPRB, the difference in prices between the two countries has widened: in 1998, it was 60 percent (PMPRB 1999:21). What has caused the 24 percent improvement in Canada's favour over the 11 years from 1987 to 1998?

Comparing drug prices and GDP

The PMPRB has compared foreign prices to Canadian prices for patented drugs as of 1987 and 1998 for Italy, France, the United Kingdom, Sweden, Germany, Switzerland, and the United States (1999: 21). As well, the US Congress has studied Mexican drug prices in the same way it has studied Canadian prices (US House of Representatives 1998).3 Danzon has pointed out that it is inappropriate to compare Mexican and American pharmaceutical prices because the standards of living are so different between the two countries (1999: 32).

However, this stipulation is also relevant for countries with smaller disparities in national income. Table 1 compares drug prices and income per capita in Canada and the eight countries. Each entry in the table represents the ratio of the foreign country's patented-drug price index or Gross Domestic Product (GDP) per capita to Canada's (multiplied by 100). Politicians and policy analysts who believe that patented drug prices should be uniform internationally use market exchange rates to compare prices. This is appropriate because these people often propose allowing countries with highly priced pharmaceuticals to import cheaper drugs from their neighbours. Therefore, the ratios in table 1 are based on market-exchange rates rather than purchasing power parity rates (discussed below). The scattergram (figure 1) plots these two data sets, with Canada located at (100, 100). Although the sample is too small to give a statistically significant result, the trendline implies a positive correlation between the two ratios, especially for the developed countries. This indicates that higher income in one country compared to another partially explains that country's relatively higher patented drug prices.

Table 1: Ratio between foreign and Canadian prices of patented drugs

Prices of
Patented Drugs (1998)

GDP per Capita (1997)

United States

160

146

Canada

100

100

Switzerland

118

179

Germany

109

127

Sweden

108

128

United Kingdom

107

109

France

92

118

Italy

85

99

Mexico (1997)

85

21

Source: PMPRB 1998; OECD 1997.

Figure 1: Countries with higher incomes have higher drug prices

figure 1

Sources: PMPRB 1999; US House of Representatives 1998; OECD.

Change over time

It is also informative to look at the change in these relationships over time, especially since the founding of the PMPRB in 1987. The median Canadian price for patented drugs has declined relative to other developed countries during this period. As well, Canada's GDP per capita has also declined relative to these countries. For example, in 1987, GDP per capita in the United States was 20 percent greater than Canada, at nominal market-exchange rates. In 1998, it was 46 percent greater. Thus, the gap widened by 26 percentage points.4

Table 2 reports the changes in GDP per capita and drug prices for seven countries relative to Canada between 1987 to 1998.5 Figure 2 plots the data with Canada at (0, 0). Although the trendline is not as clear as it is in figure 1, it demonstrates that the other six countries enjoyed superior growth relative to Canada over this period, a fact noted by other commentators (Emes 2000). They also experienced greater increases in patented pharmaceutical prices than Canada. Although we cannot make assessments of statistical significance, this observation indicates that the relative decline in Canadians' incomes has been a factor leading to relative restraint in price increases of patented drugs compared to those in other countries.

Table 2: Changes in the ratio between foreign and Canadian drug prices from 1987 to 1998

Prices of
Patented Drugs (1987)

Prices of
Patented Drugs (1998)

Change

(Difference)

GDP per Capita (1987)

GDP per Capita (1997)

Change

(Difference)

United States

136

160

24

120

146

26

Canada

100

100

0

100

100

0

Switzerland

93

118

25

169

179

11

Sweden

73

108

35

123

128

5

United Kingdom

70

107

37

77

109

31

France

53

92

39

102

118

16

Italy

50

85

35

86

99

13

Source: PMPRB 1998; OECD 1997.

Figure 2: Changes in foreign drug prices and incomes as a percent of Canada's from 1987 to 1998

figure 2

Sources: PMPRB 1999; OECD.

The decline in Canada's standard of living compared to that of the United States corresponds with the deviation from purchasing power parity of the exchange rate between Canadian and American currencies. That is, the Canadian dollar has depreciated significantly against the American dollar during the period studied but the prices of goods and services in Canada have not increased to the degree necessary to compensate for the decreasing value of the Canadian currency.6

The real price level of American GDP in 1998 was 25 percent higher than that in Canada. In 1987, the difference was only six percent (Kemp 2000). This widening of the gap between Canadian and American aggregate price levels by 19 percentage points explains all but 5 percentage points of the increased difference between pharmaceutical prices in the two countries. Simply put, Canadians get a 25 percent discount on total purchases, including drugs, compared to their southern neighbours. Indeed, this gap has been widening consistently since 1992.

Comparing sectors
of the economy

Comparing the aggregate level of prices is telling, but even more interesting is the analysis of various sectors of the economy. Of course, not every good and service sells for 25 percent more in the United States than in Canada. When we look at different sectors, we observe that the real price of medical services and health care overall is 87 percent higher in the United States than Canada (Kemp 2000: 125). This indicates that Canadians are getting even less of a bargain for prescription drugs than we are in other health services.

However, although the price of health services in Canada is low, it is difficult to know whether these figures are meaningful. The price system is legally forbidden as a mechanism for allocating most primary health-care resources in Canada, which are allocated, instead, by political decisions. The Canadian system is marked by lengthy waiting lists for surgery and severe shortages of medical technology (Walker and Zelder 1999; Harriman, McArthur, and Zelder 1999). Therefore, it is not clear that the quality of health care produced in Canada can be compared to that in the United States. Some of the difference in price may be explained by the lower quality of health care in Canada, which is not accurately measured.

Notwithstanding that comparing the overall price of health services in Canada and the United States is not very helpful because the Canadian market is so distorted, it is still necessary to explore why the real price of goods and services is significantly higher in the United States.

Many goods and services are based on intellectual property. Much of the total cost of providing these goods and services are incurred before they are packaged and sold: they are incurred during research and development and have been spent long before the manufacturer receives any revenue (i.e. these are "sunk" costs). The costs of research and development are also "joint costs," which cannot be attributed to specific units of output or to specific consumers. Manufacturers, however, must charge prices such that they can recover both the costs of manufacturing and distributing individual units and the sunk costs of research and development, although the latter cannot be rationally allocated to individual customers. Manufacturers will, therefore, charge different prices to different consumers and, when segmenting markets by country, they often use measures of national income to guide them in setting their prices: wealthier countries will pay more (Danzon 1997).

As we have seen, Canadians' incomes are increasingly trailing those of Americans. This poor economic performance is driven by relatively poor productivity in Canada and has had significant consequences for Canadians' standard of living (Law 2000). It has become difficult for businesses to compete when purchasing relatively expensive machinery and equipment from the more productive United States (Kemp 2000: 102). Since these goods have high marginal manufacturing costs, producers have less ability to differentiate prices in order to keep selling into the poorer country: they will lose money on each item they produce and sell here.

Manufacturers of goods with a large sunk investment in research and development were able to respond by increasing the differences between prices in Canada and prices in the United States. We expect to observe such price differences between Canada and the United States for goods and services besides patented, prescription pharmaceuticals. Indeed, products where marginal production costs are negligible tend to show the largest price differences. Table 3 provides a few examples.

Table 3: Comparison between Canadian and American prices (ex-tax)

Product

Canadian Price (in $US)

US Price

Difference

Quicken Basic Windows 2000 CD_ROM (website order)

$20.52

$34.95

70%

AOL unlimited monthly Internet access

$15.72

$21.95

40%

Private label ASA (London Drugs/Walgreen's)

$3.08

$4.99

62%

Bayer Aspirin® 500mg 50 caplets (Shoppers Drug Mart/Walgreen's)

$3.99

$4.99

25%

Sources: AOL (American Online, Inc.), Intuit, London Drugs, Shoppers Drug Mart, Walgreens.

The CD-ROM version of Intuit's Quicken Basic 2000, a popular personal financial planning software package, can be ordered for US$34.95 from the company's web site. However, the Canadian version, purchased from the company's Canadian web-site, costs the equivalent of US$20 (before GST). AOL charges US$21.95 for unlimited monthly Internet access in the United States but AOL Canada charges less than US$16 for the same service. Intuit's and AOL's American customers pay premiums of 70 percent and 40 percent respectively.7 These are products with very low manufacturing and distribution costs. The price differences cannot be caused by supply costs to the two markets because they are not substantially different.8 Nor, do we have a Canadian "Patented Software Prices Review Board" to claim credit for the price differences.

Bayer Aspirin®, the original branded acetasalicylic acid (ASA) and the generic, private-label substitute sold by London Drugs in Canada and Walgreen's in the United States provide an interesting comparison. They are pharmaceutical products but sold over the counter (OTC). The market structure for OTC drugs in Canada is virtually the same as it is in the United States. There are no significant differences in government involvement yet we still observe significant differences in the prices of these goods. Both the branded and the generic OTC drugs are more expensive in the United States than they are in Canada.

Cost from litigation

Even if incomes and real aggregate prices were equal on both sides of the border, there are other differences between the two countries that would lead to price differentiation in favour of Canadian consumers. Pharmaceuticals can be dangerous in the wrong hands and manufacturers are justly concerned about the safety of their products. The United States is a more litigious society than Canada and we would expect that prices for pharmaceuticals in the United States would be higher, reflecting the increased costs of legal liability. Professor Richard L. Manning found evidence that one-third to one-half of any pharmaceutical price differentials in 1990 were due to the higher cost of protection from legal liability in the United States (Manning 1997). In Canadian courts, compensation for personal injury is capped at CDN$250,000 and judges rarely award large liability settlements.9

Proxy for comparison

Given that Canada has not experienced free-market drug prices in decades, it is impossible to say what those drug prices would be. The closest proxy for the price level of patented drugs in Canada is the price level of non-patented, single-source prescription drugs. These are branded drugs that were never patented (or whose patents have expired) that have no competing generic substitutes in the market. Accutane® (Isotretinoin), used in treating severe acne and some cancers, is an example of such a drug. Although these drugs require regulatory approval of their therapeutic benefits, their prices are not regulated by the PMPRB. In 1996, American prices for these drugs were 96 percent higher than Canadian prices (Conference of Federal/Provincial/Territorial Deputy Ministers of Health 1999a: 6). In contrast, the American price premium for patented drugs in 1998 was 60 percent: the "Canadian discount" for branded drugs not regulated by the PMPRB was far greater than it was for those that were regulated. A recent Fraser Institute survey of price differences for prescription drugs in Canada and the United States confirms that the Canadian discount for branded, off-patent drugs is greater than that for patented drugs (Graham and Robson 2000).

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