Thoughts, essays, and writings on Liberty. Written by the heirs of Patrick Henry.

“There are more instances of the abridgement of the freedom of the people by the gradual and silent encroachment of those in power, than by violent and sudden usurpation.”     James Madison

September 18, 2009

Hey Ezra, Strawman Much?

by Brad Warbiany

Ahh, the infamous strawman. Take one aspect of an argument, assume it is not part of a cohesive whole, and argue against it as if it negates everything else at hand. I.e. libertarians and conservatives argue that capping drug prices just MIGHT reduce drug innovation, and Ezra Klein acts as if we’d keep everything else equal in the system:

For a long time, I took questions about stifling innovation very seriously. So did a lot of liberals. But then I realized that the people making those arguments wanted to do things like means-test Medicare, or increase cost-sharing across the system, and generally reduce costs in this or that way, which would cut innovation in exactly the same way that single-payer would hypothetically cut innovation: by reducing profits.

I also found that I couldn’t get an answer to a very simple question: What level of spending on health care was optimal for innovation? Should we double spending? Triple it? Cut it by 10 percent? Simply give a larger portion of it to drug and device manufacturers? I’d be interested in a proposal meant to maximize medical innovation. I’ve not yet seen one.

It turned out that concerns about innovation weren’t really about innovation at all. They were just about attacking universal health care ideas of a certain sort. Which is why I stopped taking them seriously.

No libertarian in the world will argue that government spending can’t achieve certain goals. After all, government spending got us to the moon. If you set the goal of American society, as Kennedy did, as getting to the moon within a decade, then you forcibly take the money to pay for the goal [since Americans weren't exactly going there of their own accord], you can probably get there.

Likewise, if government really put its mind to drastically advancing medical innovation, and threw out, say, $50B a year for drug research to stem the growth of most types of cancer, I’ll bet within two decades they might have results. While money doesn’t exactly solve everything, government subsidies can certainly accelerate development. Granted, that cancer research might be at the expense of heart disease research, and AIDS research, and diabetes research, and just about everything else [excepting penis enlargement research, of course, because that's always a growth industry].

But now I’m getting away from the point. Why is this a strawman? Because opponents to gov’t healthcare view the death of medical innovation as one bad side effect of a wider bad policy, not the most important argument against gov’t healthcare.

Look at it this way. We don’t argue that there is no innovation in the digital music player industry because gov’t doesn’t spend enough. After all, we’ve got all different flavors of iPods, the new Zune, all manner of knockoff players and tiny upstarts, not to mention the fact that just about every new cellphone or car stereo can play MP3′s. Ten years ago, when I was in college, MP3′s were limited to those of us savvy enough to navigate Napster, hook our computers up to our stereos, and had a fast enough internet connection to make the whole deal worthwhile. Today MP3 players are ubiquitous and digital music threatens to destroy the entire existing business model of music production.

I’m not going to address the conservative rebuttals, but I’ll take a look at this from a libertarian perspective. Libertarians aren’t opposed to profits. We are not opposed to competition. We are not opposed to market-based prices that may, in some cases, not cover the costs of drug development. We don’t view medical innovation as a simple question of “should WE spend X or 2X or 3X?” Not because we don’t have an opinion on optimal spending — we may or may not — but because we oppose to the WE. We implies collective action, and usually implies forced collective action.

The WE, of course, has a lot of unintended consequences to it. If the WE becomes too large [cough]medicare[/cough], it tends to crowd out private spending. When private spending is crowded out, prices become opaque. They cease to be a clear sign of market value and cease to be a proper incentive for producers. As I said above, $50B a year in research money would entice quite a few drugmakers to focus R&D onto cancer. But is that the optimal amount to spend? Would that be useful or wasteful? What is the opportunity cost of pulling that money out of the economy through taxation and redistributing it through the government? All these questions distort the free market, and when you try to distort the free market you end up with problems.

There are two SIGNIFICANT government distortions specifically into drugs: the patent scheme and the FDA.

The FDA:

Simply put, the FDA’s job is to restrict access to medicine until in meets very stringent guidelines. The doctrinaire libertarian position on the FDA is that it needlessly delays medicine that has some efficacy and takes away freedom of choice from individuals who may wish to take personal risks by purchasing that medicine despite the FDA’s lack of recognition.

The doctrinaire libertarian position is a moral position on individual choice, but the economic case is much simpler and stronger. FDA regulation artificially raises the cost of creating new medicines. If your R&D division knows that of all the medicines they research, only 40% will be effective, and only 10% will be approved through FDA trials, you know that 75% of effective drugs they create cannot be purchased. This means that they must more than double the price of drugs to cover R&D on those which wouldn’t be effective, and then quadruple the price beyond that for those which would have been effective but not meet FDA approval. Prices charged for drugs are dependent as much on covering the cost of failure as the cost of success.

Patents:

From a doctrinaire libertarian perspective, you can go two ways on patents. First is that intellectual property isn’t property, and patents are simply government distortion into the market that should be distorted. I like the argument, but even as a doctrinaire libertarian, I’m not far enough behind the anti-IP program to defend it (see mises.org for that one). The opposite (yet still doctrinaire libertarian) argument is that intellectual property should not be arbitrarily time-limited by the government, and that the patent protection time is too short.

The second argument is an explanation for the price of drugs. When you develop a new drug, have to recoup the development & testing costs of that drug, need to recoup all the development costs of the failed drugs, you need to forecast the expected use of that drug between the time it launches and the time your patent expires. Once that patent expires, you’re fighting generics for market share. If you think that 10,000 people per year might need your drug, and you have patent protection for 5 years, you know what price you need to set to recoup your investment and make a profit. If your patent protection extends for 10 years, though, you can set the price at roughly 1/2 the level and still make your profit.

Either way, from an economic standpoint the extension of patent protection might reduce costs and improve pharmaceutical innovation. Reducing patent protection might increase short-term costs (reducing them long-term) but at the expense of pharmaceutical innovation. There are trade-offs and issues no matter what you do.

The solution:

Frankly, the solution isn’t to ask what WE should spend on health care or medicine, just as WE don’t ask what WE should spend for iPods, HDTV’s, heads of lettuce or pickup trucks. The difference is that in those products, we have a functional market. In a functional market, competition and choice lead to efficiency and an optimal mix of innovation vs. price.

The solution is NOT price controls. Economic history shows that price controls lead to shortages.

The solution is NOT rationing. Rationing doesn’t control prices but controls expenditures (unit volume). Rationing increases prices and/or leads to shortages.

The doctrinaire libertarian solution is to reduce the role of the FDA and put more responsibility on the individual to choose health care options, and to ensure that intellectual property laws are set optimally to protect innovation. The free market is known for reducing prices and increasing innovation. Perhaps we should have more of this “free market” thing.

More on the subject: Megan McArdle

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4 Comments

  1. Likewise, if government really put its mind to drastically advancing medical innovation, and threw out, say, $50B a year for drug research to stem the growth of most types of cancer, I’ll bet within two decades they might have results.”

    Or not.

    Comment by KipEsquire — September 18, 2009 @ 7:26 am
  2. I also found that I couldn’t get an answer to a very simple question: What level of spending on health care was optimal for innovation? Should we double spending? Triple it? Cut it by 10 percent? Simply give a larger portion of it to drug and device manufacturers? I’d be interested in a proposal meant to maximize medical innovation. I’ve not yet seen one.

    Here is the simple answer to Klein’s simple question… If you believe that a number can be determined in advance that will answer your question, you’re too ignorant to be participating in the health care debate.

    The incentives, disincentives, and other economic pressures that make innovation possible are so numerous and intricately tied together that they cannot be understood by central planners. Period.

    By suggesting that an optimal number could be found to spur maximum innovation, Klein is so massively simplifying reality that his view on this particular issue is completely divorced from it. To Brad’s point, there is no we when it comes to the economy. There are thousands or millions of different actors with different wants, needs, and values who respond differently to incentives. If anyone on Earth thinks they can quantify and understand these well enough to answer Klein’s question, that person is simply delusional. Only the free market can answer Klein’s question precisely, and only after the fact.

    Comment by Quincy — September 18, 2009 @ 11:35 am
  3. If only this debate had anything at all to do with healthcare instead of with the search to create a big enough federal beauracracy for politicians to efficiently and stealthily launder political contributions and graft though for the next 50 years, not to mention Barack Obamas desire for an historic “monument to me.”

    The healthcare “crisis” will exist for 20 or 30 years max, either til the baby boomers pass or we innovate our way out of this…these government programs are near eternal.

    Comment by Persnickety Cuemudgeon — September 18, 2009 @ 1:50 pm
  4. I always find it amusing it when muddleheads like Klein come to a “realization.” It’s as though he’s standing there in clown nose and floppy shoes, demanding that someone else help him clarify his thoughts or he won’t take them seriously.

    Your observations on the FDA are correct. Tufts published an analysis a few years back on the cost of bringing a new drug to market. Since approval of a new drug typically takes over a decade, much of the profitable “patent life” of a drug has already been consumed by regulatory burden. Worse, despite being tasked to assure that drugs are “safe and effective” the FDA assumes no liability over problems found with clinical experience.

    In short, a hopeful drug manufacturer is faced with enormous development costs, formidable and time-consuming obstacles to market a drug, but no relief from liability despite the process.

    This is far from competitive and favors large concerns who can carve profitable exceptions with money and influence, which they wield in abundance.

    I’ve often argued that the FDA should be replaced with something like Underwriter’s Labs. The safety of drug or device could be investigated (more efficiently, I would argue) against the need to maintain product liability insurance.

    Comment by RDH — September 19, 2009 @ 8:46 am

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