Governor Schweitzer is proposing Montanans be allowed to re-import U.S. prescription drugs from Canada. He believes this could save consumers up to 40 percent on their medical prescriptions, totaling some $280 million in annual savings.

On average, prices for U.S. manufactured drugs are much lower abroad than for the same drugs sold at home. This has long irritated American politicians. Claiming the pharmaceutical industry is “gouging” customers, Governor Schweitzer says, “We import meat, wheat, oil, and pick-up trucks from Canada, why not safe prescription drugs?” The short answer lies in understanding the social analogue to the Laws of Thermodynamics: “There is no such thing as a free lunch.”

The prescription drug market is not like the market for cows, cars, or combines. What makes it different is that the cost of developing new drugs and getting them through FDA approval is risky and expensive. As a result drug makers spend a higher proportion of their revenues on research and development (R&D) than most other firms. And just as oil companies must recover the drilling costs of dry holes, the research costs from drug failures must be recouped by sales from the relatively few successes.

Other countries (e.g., Canada and the EU) offer cheaper prices by subsidizing the cost of drugs. Just as they do in matters of national defense, these governments are free riding on American consumers who pay the full costs of drug development. If we want the benefits of pharmaceutical progress, we must pay for it, even if other nations won’t. (Since 1970, drugs have increased our life expectancy by one percent each year.)

Foreign governments know that if they want pharmaceutical makers to continue to export drugs they must pay a price that covers the marginal cost of production. Further, they understand if America enacts similar drug price controls the incentive to develop new drugs will be greatly diminished. Harvard economist Greg Mankiw offers this thought experiment:

“Suppose a drug company offered an AIDS drug to a poor African country at slightly above marginal cost. (This is much below the U.S. price, which includes a markup due to the monopoly power granted by the patent). Should American AIDS patients be allowed to buy the drug in Africa and bring it back to the United States? If policymakers allowed this re-importation...the likely result: The drug company wouldn’t offer the low-cost drug to the poor African country.”

If Montanan’s purchase drugs from Canadian pharmacies, they will face an increase in demand. U.S. drug companies will face losses that are unsustainable. In response they will refuse to ship the additional drugs needed to meet supply. Hence, to assure American drug suppliers will remain in the market, Canadian pharmacies will be forced to raise prices. Such an outcome is likely to fail the political calculus, especially in countries where policies have increased citizen’s dependence on the state.

When drug re-importation was last floated in 2003, the Congressional Budget Office (CBO) concluded that permitting importation from Canada would produce a negligible reduction in prescription drug spending. The logic of their analysis has not changed. The Governor’s idea, like so many others cooked up by our political class, is simply for show. His numbers, like others politicians throw around (Green jobs comes to mind), have little basis in reality.

When faced with spiraling prescription drug costs, it’s tempting to favor re-importation of U.S. drugs. But the adage “there is no free lunch,” reminds us someone has to pay the cost of producing these drugs. Physicists never complain about the Laws of Thermodynamics or aeronautical engineers about air friction. These are merely forces with which they must contend. Our Governor would do well to apply this lesson to his public policy proposals.