I think it was Monday, that I was listening to The Glenn Beck Program on Rochester's 50,000 watt news radio station, WHAM 1180 AM. And trying to work at the same time, which involves getting in and out of the truck, having the truck's mechanicals interfere with radio reception, and even driving into buildings that serve as effective Faraday cages. At any rate, I don't get to hear everything, by any stretch.
So, I got in the truck, and fill-in host Pat Gray was talking with a truck driver who had phoned in. Turns out that he hauls breakfast cereal, and had a theory (near as I could tell) that consolidation in the food industry had driven up prices since roughly the year 2000. Corn Flakes have become a standard example product, on account of high corn prices. It must be consolidation, though, since rising fuel and corn prices could not fully explain it, he said. Gray wasn't having any of that, since diesel is currently a few times as expensive as it was-- and so is corn. The driver explained that he was getting a fuel surcharge of 70 cents per mile (adding such a surcharge is customary, when fuel prices rise, rather than constantly changing the base rate), and that they can fit as many as 10,000 boxes of cereal in his trailer. Gray continually mis-heard this as fuel being up 70 cents per gallon in the last few years, which doesn't make any sense, and eventually dismissed the whole notion as tragically flawed math.
I, however, can hear-- at least when circumstances allow me to receive clear sound from my radio.
Unless this chap drives like heck, he's going to get at least 5 miles per gallon with his truck. Which means that his freight rate is being adjusted by the equivalent of at least $3.50/gallon, which is about how much fuel is up in the last few years. He no doubt has a 53 foot long 'dry van' trailer, which has a capacity of about 140 cubic yards, and can very plausibly hold 10,000 boxes of cereal. Which means that, even if the load is shipped 1000 miles, Kellog's is only paying, per box, an extra 7 cents.
If it's, say, a 24 ounce box of Corn Flakes, then we can roughly consider that to be a pound and a half of corn. A bushel of corn weighs 56 pounds, give or take. Even at the current "Holy cow, there's huge floods in the mid-west" price of about $8/bushel, the total cost of the corn in that cereal box is about 21 cents. Up from 8 cents, at a $3/bushel rule of thumb.
For a whopping 20 cents increase in the cost of your Corn Flakes, based on the two factors which are generally believed to be the problem. I don't know about the food industry consolidation theory, but I can do math-- and so could that other trucker.
Edited five minutes later, for uncharacteristic multiple errors.
The American Association of Retired Persons (AARP) has always been concerned with the cost of health care. Logical, since AARP members consume a lot of health care goods and services. As it happens, I have access to AARP publications. When I noticed an article in the AARP Bulletin about how the Canadian system of controlling drug prices actually works, I was immediately intrigued. Of course, that was over a month ago-- and it turned out to be the June 2003 issue of the Bulletin-- but hey...
If you're a drug company marketing a new patented medicine in Canada, it seems that there are just three simple rules that the Patented Medicine Prices Review Board makes sure you follow. Well, it isn't really this simple-- but government meddling never is.
Rule #1: The price cannot be higher than that of the highest-priced (in Canada) drug used to treat the same condition.
That's right-- except under unusual circumstances, you are not allowed to price your product higher than your most expensive competitor. Your drug might cost more to make, or be more effective, but if it isn't grossly so, then the Canadian government just won't let its citizens decide whether or not to pay more for your drug.
Rule #2: For "breakthrough" drugs, which are unique and have no competitors, price cannot be higher than the median of the price for that drug charged in seven Western countries, namely Britain, France, Germany, Italy, Sweden, Switzerland, and the United States.
On 'first reading,' you might think that including the US on their list would drag the allowable price upward, but that's not really the case. The rule doesn't specify the mean (average) of the prices, but rather the median, which is the number in the middle. The median of one, two, and fifty, is two-- the actual size of the numbers is irrelevant. As long as the price in the US is above the median (and it usually is), then the price itself makes no difference.
I'll let the Bulletin help me out with this.
Almost all Western governments, except the United States, control drug prices in varying ways. Canada's system is unique. And, contrary to many assumptions, it does not simply set a price for each drug and demand that the manufacturer accept it in order to do business. [big snip]
The review board system "has had a bigger impact on pricing than I ever anticipated," says Tom Brogan, a former Canadian civil servant who helped write the 1987 law. "It's not price control like it is, say, in France, where they come up with prices almost by edict. But it has made companies more careful of what their introductory price is."
So the geniuses in Ottawa are proud that they don't just declare a price by government fiat-- but they mandate a price that's based on other countries, some of which do exactly that. My Geiger counter is detecting idiocy particles in large quantities.
Rule #3: Over time, prices cannot be increased beyond the general rate of inflation, as reflected in Canada's Consumer Price Index.
That sounds fair. Compared to basing your prices on other countries' price controls, this makes perfect sense.
Three simple rules. Yep. We're not done yet, though. It seems that Canada's famous federal health care systems doesn't cover medications. As such, individual provinces have instituted drug coverage for citizens over age 65-- the age group well-known for its consumption of prescription drugs. The provinces decide which drugs to cover based on "value for money," so new drugs are priced lower than competitors, in order to lure the monolithic and cost-conscious government. Imagine your market share if the Ontario government chooses your drug... or doesn't, as the case may be.
Now that we know how the system works, the big question is whether nations with government price controls are getting a free lunch. I'm afraid that the answer is "yes."
So are higher American prices subsidizing the rest of the world? "When I was in government I would have said absolutely not," says Brogan, who now runs a company that advises governments, insurers and drug companies on prices. "But now I think it is. It takes money to bring a new drug to market, and somebody's got to pay for it."
Grammar aside, there's something extrememly revealing in Mr. Brogan's statements. "When I was in government I would have said absolutely not," he says. When you're holding a hammer, everything looks like a nail. When you're in government, every situation looks ripe for regulation.
It's an undeniable fact that it is very expensive to research a new drug, test it, and then get it through the FDA (or other nation's equivalent). The new drug can turn out to be a dud at many points along the way. If it does finally reach the market, you have to convince people to buy it at prices high enough to pay off not just its own costs, but also those of failed drugs.
Certain American politicians are fond of pointing out that drug companies have high profits these days, citing this as evidence that drug prices could be lower. This will frequently be accompanied by stories of senior citizens who cut their expensive pills in half to make them last longer.
Profits may be high-- but if you actually investivated the situation, I bet you'd find that those profits are being made on the so-called "blockbuster" drugs, which have a very wide market and are not life-saving. The Claritins and Nexiums are where the money is made, as squillions of people have allergies and/or heartburn. Life-saving drugs just don't have that kind of sales volume-- so even if they end up more expensive, the drug companies still can't make huge profits on them. It actually makes more economic sense for a company to develop yet another drug for acid reflux disease, than it does to work on a treatment for some obscure and deadly malady.
Now, it's true that drug companies make money on sales that fall under price controls. All that proves, though, is that the price is higher than the cost of manufacture and distribution.
My father once had a surgery while not covered by health insurance. The surgeon knocked something vaguely like 30% off of the price, leading my father to declare, 'If he can do it at that price for me, he can do it for everybody.' The presumption was that insurance companies were being bilked on surgeries covered by insurance, but that presumption was incorrect. The discounted rate was no doubt enough to pay the surgeon's incremental cost of performing the operation, since that amounts to things like paying the hospital for a room, buying a few drugs, and paying labor costs (including some of his own). In this sense, the doctor made money-- but it in no way proves that the discount rate was enough to cover other expenses, such as malpractice insurance, medical school debt, and other surgeries where the bill was never paid.
Since I broached the subject, it's an interesting coincidence that this is my father's birthday. He would have been 59.
As such, this is cancer awareness day for me-- which isn't just a hollow declaration, considering my education in biology. I may not be a research scientist yet, but I will be eventually. And, like so many people before me, I am determined to eradicate disease.
And now, on with the argument.
So, if anyone ever says that drug companies can afford to sell for lower prices in the US just because they do so elsewhere, feel free to call that person a moron. Especially since it's standard leftist-collectivist rhetoric that workers deserve a "living wage." A person obviously makes money from every hour of work, but some will argue that lower-paying jobs just aren't enought to live on. Well, selling things under price controls is exactly like that.
It costs big money to develop drugs, profits or no profits. If other nations artificially lower prices, then someone has to pick up the tab, and those someones are Americans. If we depressed prices here, too, then the cost would be in the new drugs never developed. And, for that matter, lost jobs at the drug companies. And, yes, lower profits-- which is a bad thing for common investors. Not every stockholder is a millionaire, you know.
About now (if you haven't gotten fed up with me), you're thinking, "That's great, but if drugs are too expensive, and government meddling won't solve it, then what do we do?" Glad you asked.
Part of the problem with health care in general is that people are insulated from the costs of it. Sure, they pay crushingly high insurance premiums, but the cost of goods and services is then generally low. Worse, the cost is usually in the form of a "co-pay" (similar to your 'deductible,' if this was car insurance), which is often of fixed size. So you'll pay X dollars for a prescription drug, regardless of how much it costs. Your doctor doesn't care what the drug price is, and neither do you, really. No amount of frugality on your part will change the insurance company's cost enough to make a difference, so why worry? This sounds a lot like [drum roll please] a tragedy of the commons. Funny how collectivism tends to lead to those.
I recently learned of an HMO which has a three-tiered drug coverage plan. There are three different co-pay levels, depending on the actual price of the drug. And just to be compassionate, they sometimes place a drug in a cheaper tier if there is no less expensive alternative.
There is no need to ban expensive drugs from the program, since costs still discourage people from using them. Discourage, but not prevent. The cheaper drug might not work for you, or it might be less effective in general. You are subject to market forces, and yet you still receive payment assistance from the insurance comapny. Such a system sounds like elegance, itself.
And, of course, patients who pay retail price for their prescriptions put considerable pressure on their doctors to ponder a cost/benefit analysis when writing prescriptions. In much the same way that generic drugs are quite popular.
Now, it's certainly possible that the reduction in costs (if everyone obeyed me) would reduce revenue to the drug companies. I explained earlier that they needed that money to develop new drugs. This is not a paradox, though. People voting with their feet (and money) is the stuff of honest and fruitful competition. Neither government price-reduction edicts-- nor 'competition' to be the one true supplier to a government or insurance monolith-- can possibly create such a positive economic environment.
Very early in the life of my blog, I knew that I wanted to talk about overfishing, and how to properly use the government to eliminate it. Time passed, and Steven Den Beste of USS Clueless wrote an article about something called "The Tragedy of the Commons." I thought, yep, that's the concept I was talking about-- except that I hadn't 'talked' about it at all. But when Lynne Kiesling of Knowledge Problem posted on the exact subject of reducing overfishing (hat tip: Insults Unpunished), I was finally spurred to action.
Allow me to explain the situation. The ocean is a big place, with a lot of fish, and it will support a certain amount of fishing without a perennial decrease in the fish population. As the harvest increases, a point will be reached where the population declines, because fish are being caught faster than they can reproduce (faster than they can reproduce in the wild, that is). Thus there is a smaller base population for future growth, and if 'nothing is done,' the decline will become increasingly precipitous.
Assuming that these fish are located in waters where anyone can catch them, the situation will play out like this: With fewer fish to catch, the harvest will become smaller-- putting economic pressure on fisherman to catch as many fish as possible, which only hastens the decline. There are only two options: keep fishing despite the diminishing returns, or cut your losses and do something else for a living. The latter seems reasonable, but bear in mind that commercial fishing involves a large capital investment in a boat. Selling that boat for decent money depends on someone else wanting to buy it, which is highly unlikely with the fishery in decline.
The government will step in at some point, having detected the situation via its AR-7(b) vote-sensing radar. Fishing will be regulated, and a common way to do that is to impose quotas on the catch, aiming to stop the decline in population. Basically, this worsens the economic plight of the fishermen, and really depresses the value of the fishing equipment. Quotas are assigned to individual fisherman by government decree, thus slashing earning potential-- still without benefit if you stop fishing (or if there is, it will be an expensive public bail-out, like the dairy herd buyouts back in the 80's). The incentive to illegally exceed the quota is immense.
What the government should do is assign individual tradable quotas, or ITQs (thanks to the Knowledge Problem article for the term), which entitle the holder to a certain portion of the total allowed catch, which is then scientifically decided upon every year. Being tradable, you can sell your ITQ to someone else on the open market, thus finally giving people a chance to get out of the business with some money to show for it. The fundamental problem is that too many people are trying to make a living catching fish, and ITQs are the obvious and fair way to let fisherman sell out, and simultaneously reduce the fish harvest to a sustainable level. Illegal overfishing would not only reduce future income, but also decrease the future value of the ITQ, and that's aside from the danger of getting 'caught.' With the economic picture no longer neither dire, nor worsening, the incentive to cheat is minimal.
The solution is obvious. So go forth, my loyal readers, and make the government implement such things.
If you read the entry at Insults Unpunished, then you're probably wondering what I think of Robert Prather's solution, which is fish farming. Fish farming is good, but that's a topic for another day...
Robert Prather (of Insults Unpunished, formerly The Mind of Man) has been on my blogroll since the beginning. He actually believes in classical liberalism, and has an economic head on his shoulders. A follower of Thomas Jefferson, with economics that would make Alexander Hamilton proud. Somebody should convince this man to run for political office, so I can vote for him.
Anyway, over three weeks ago, he posted about going to New Orleans, and meeting with David Frey, of Bowl of Gumbo.
Dave showed up and we had a great conversation, when he could get a word in. He and I have reached a similar conclusion about blogging: we're in it for ourselves. I noted that I recently removed the PayPal button from my site and started writing more on economic issues, because that's what interests me. I get very few comments on those posts, not even people calling me an idiot. Either they're not interested enough to comment or the posts themselves are not interesting. Dave has been blogging about his latest obsession: PhotoShop. He doesn't care if anyone wants to read or not either. It's what interests him.
Funny that he should mention it, as on that very day (October 8th), I met with my mother's financial advisor, and I thanked the knowledge I had gained from Robert's site. Any time you can throw the word mercantilism into a conversation, you have something to be thankful for. :-)
So, I just wanted to point that I find the entries on economics interesting, and personally educational. I don't know jack about economics, really, which is why I don't comment more often. But I've learned enough to feel that I didn't sound like an idiot in front of a guy who manages money for a living. If it worked for me... it can work for you, too.