A few days ago, when I remarked that U.S. pharmaceutical prices subsidize much of the research that benefits the rest of the world, I got various forms of push back, so it seems worth running, briefly, through the logic:

1. Both critics and boosters of pharma agree that prices are higher here than elsewhere.

2. Therefore, the U.S. accounts for a disproportionate share of pharmaceutical profits for companies that develop new drugs.*

3. Profits provide both incentive to develop new drugs and the cash with which to do so.

4. Drug companies are, in fact, needed to bring large numbers of drugs to market.

5. New drugs are valuable.

That's not a very interesting argument, though it is one we'll surely be having over and over again. But there was an interesting question asked in the comments: How do we make Europe and Canada and Japan bear part of the costs of drug development? I'm going to sound like a Negative Nellie here, but the answer is, we don't.

Let's start by pointing out that the problem is not that we're paying Canada's "share" of development for the drugs we get. This is not how markets work. Drug companies charge what the market will bear for the drugs they make, both here and abroad. Here, where the market is largely private, that share is small. Abroad, where the "negotiation" consists of governments telling you what they are willing to pay, even as you know that they can always change the law to shorten your patent term so that other countries can manufacture your product, using your research for free.

There's more to it than that, to be fair. Yet when negotiating with other governments, pharmaceutical companies operate at a severe disadvantage, not because the governments' buying power is so vast (the national health-care systems of Canada and many European countries cover fewer people than Aetna), but because the people you're negotiating with can change the rules under which your product gets sold. At any point they can say, like Lord Vader, "I am altering the deal. Pray that I do not alter it any further."

But if Canada started paying more, that wouldn't mean we'd pay less. Drug companies are charging what they think we will pay. The result of Canadians and Europeans paying less is not that we pay more for drugs; it's that fewer drugs get developed. To the extent that they are harming us, it is in hindering the development of cures or better treatments that we are missing, and don't even know about.

Unfortunately, this is a classic case of Bastiat's dilemma. It is easy for each country's government to see the high prices that people are paying and intervene to lower them. It is hard for each country's government, much less its citizens, to envision the new medical treatments that they might get if they paid more for drugs. So their incentives are heavily skewed toward controlling the price here and now, even if that means losing future cures.

Drug development is essentially a giant international collective-action problem. The U.S. has kept it from being a total disaster because we don't have good centralized control of our insurance market, and our political system is pretty disorganized and easy to lobby. If that changes -- and maybe we just changed it! -- we'll knock down the prices of drugs to near the marginal cost using government fiat, and I expect that innovation in this sector will grind to a halt. Stuff will still be coming out of academic labs, but no one is going to take those promising targets and turn them into actual drugs.

I don't expect this to happen right away, but if the Affordable Care Act does result in some form of pharmaceutical price controls, I think we'll see the death of Big Pharma, after which we will realize, much to the surprise of folks such as Marcia Angell, the former editor of the New England Journal of Medicine, that they did a bit more than just printing pretty labels and inventing new cures for baldness.

There are some promising alternatives. The main two that have been suggested are prizes and having the U.S. government get into the business of developing actual drugs, rather than just funding basic research. I'm in favor of trying both of these approaches. But so far, prizes have not proved themselves as ways to fund what is essentially commercial product development -- at least, not at the same level that patents do. Nor has the government. As we've just seen from the government's attempt to develop a Travelocity-like site for health insurance, there are reasons to think that government might not be very good at that sort of thing. I don't mean to slur the government -- governments absolutely have developed drugs in the past. But these are not the majority, and government processes often make it hard to do things that companies do easily.

What I don't think we're going to do is find a way to make Canada and Europe raise their prices so that we hopefully get some more drugs. The politics are utterly toxic, and everyone's under budget pressure. The most hopeful thing I can say, in fact, is that we may naturally be running out of feasible drug candidates, so maybe it doesn't matter much.

* This is somewhat complicated, because Americans actually use more generics than do people in many other countries. But in the first 10 to 15 years of a drug's market life -- the time that companies care about most -- we represent a disproportionate share of the profits.

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To contact the author on this story:
Megan McArdle at mmcardle3@bloomberg.net