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The FTA

and the PBS

A submission

to the Senate Select Committee on the

US-Australia Free Trade Agreement

Professor Peter Drahos

Professor of Law

Australian National University

Dr Thomas Faunce

Senior Lecturer, Medical School

Lecturer, Law Faculty

Australian National University

Martyn Goddard

Former consumer member, Pharmaceutical Benefits Advisory Committee (PBAC)

Professor David Henry

Professor of Clinical Pharmacology

University of Newcastle

Former member, PBAC

Former chair, PBAC Economic Sub-Committee

Executive summary

HIGHER DRUG PRICES

In a number of statements, government ministers have claimed that the US-Australia Free Trade Agreement will not have the effect of increasing drug prices and will not contribute to the long-term financial sustainability pressures on the Pharmaceutical Benefits Scheme. A close look at the FTA indicates that this is not the most likely outcome. The text of the Agreement is unbalanced and most of the measures increase the pricing power of US drug companies operating in Australia. It is inconceivable, based on past practice, that they will not make use of that new pricing power.

How much will this cost? American consumers, insurers and health programs pay two to three times as much for many important drugs as their Australian counterparts. Because most of the measures in the FTA apply to new drugs rather than existing ones, and because legislation will need to be enacted, regulations changed and new procedures put in place, there will be a substantial time-lag between the signing of the FTA and its full effect on prices. The full effect of the FTA on the pharmaceutical market is therefore unlikely to be felt for about five years.

By that time, however, it is plausible that the gap between US and Australian drug prices could be cut in half. We estimate, very conservatively, that Australia’s PBS will have to pay at least one third more for its drugs with the FTA than without it. If the likely FTA effects are applied to 2003 figures, the extra cost to of the PBS to the government last year would have been around $1.5 billion for the same drugs at the same levels of use and with no increase in the health benefit to Australian patients. Similar pressures would be felt by other buyers of prescription pharmaceuticals, particularly hospitals.

INTELLECTUAL PROPERTY MEASURES

Under the FTA, Australia is required to go much further in extending intellectual property rights than is required by our obligations under the existing rules of international trade. In a substantial number of measures, the previously accepted boundaries of the World Trade Organisation’s Trade Related Aspects of Intellectual Property treaty have been pushed forward, greatly strengthening the power of the seller in the pharmaceutical marketplace.

The FTA concedes to the US standards on intellectual property rights (IPRs) that it would not have been able to obtain in the WTO or would have had to make considerable concessions to obtain.

The FTA throws away IPRs as a bargaining tool in the WTO with respect to other countries, most notably Europe and Japan. In other words, Japanese and European IPR owners also benefit from the IPR chapter.

This agreement aids the US strategy of using FTAs to divide and conquer countries that are interested in agricultural trade liberalisation. Both Cairns Group members and G-20 members are agreeing to FTAs (in the latter case the price of the FTA is departure from the group) thereby undermining their effectiveness as collective entities in multilateral bargaining over agriculture.

A number of other countries have rejected US trade pressure to redefine intellectual property laws as they affect the American pharmaceutical industry. They have, instead, sought to protect competition and their own export industries. Canada, for instance, has legislation before its Parliament to offer generic drug companies export potential for medicines used in HIV/AIDS. By complying with US-developed standards rather than the accepted norms of global trade, Australia is throwing away substantial export opportunities.

EFFECTS ON GENERIC COMPETITORS

The major trans-national originator drug makers do not compete on price. Even where several interchangeable drugs exist in a therapeutic field, prices stay the same or rise when alternative patented products are marketed. The only real price competition in the pharmaceutical market comes from generics manufacturers – those companies, usually much smaller, that make their own version of a medicine once it comes out of patent. When generic versions of a drug become available, prices usually fall dramatically.

Measures extending the large originator companies’ rights in data protection will, in many cases, force generics makers to repeat clinical studies that have already been conducted. It is unlikely that ethics committees would approve such studies: to put patients at risk to provide data that are already well known would contravene basic international standards of human research ethics.

Other measures will also have the effect of delaying the development and approval of generic versions of drugs. The major companies will, therefore, have a longer period free of competition, during which they can enjoy much higher prices than they could achieve in a competitive environment.

A recent study by the Australia Institute found these measures were likely to delay the development of generic drugs in Australia by around three years. It estimated the cost of this to the PBS for the five drugs examined by the study was more than $1.1 billion for the period 2006-2009.

THE PBAC APPEALS PROCEDURE

Under the FTA, Australia has undertaken to “make available an independent review process” by which a manufacturer can challenge PBS listing decisions made by the key committee, the Pharmaceutical Benefits Pricing Authority.

The government has repeatedly promised that this would not be able to set aside or overturn PBAC decisions. However, the realities of the FTA are that Australia is likely to face very large sanctions under the dispute resolution and enforcement sections of the FTA if it does not provide an appeals process that the US and its drug makers find acceptable. Any process that does not have the power to reverse decisions, and which merely returns a submission to the committee for further consideration, will not represent any advance for the American side or the US companies. According to several statements from the industry and the American side, an appeals process without power is not what they think they have secured.

Such a process will seriously compromise the negotiating position of the PBAC. At present, the committee commissions sophisticated economic evaluations of each new drug and decides whether the price requested by the company represents fair value in terms of the health benefits the drug is likely to provide. If the answer is no, companies must reduce their price or find new data to justify the price they want. Often, the price comes down.

If, rather than re-submitting to the PBAC, sponsor companies could go to an alternative forum to have the PBAC’s decision overturned or changed, the committee would find it far more difficult to enforce price discipline on major drug makers.

DISPUTE RESOLUTION AND ENFORCEMENT

Often, when trade negotiators cannot finalise contentious points of detail, they produce a text that is deliberately unclear on these matters and that can be sorted out later. These “constructive ambiguities” abound in those elements of the FTA that affect the pharmaceutical market and the PBS. These ambiguous clauses allow each side to claim a “win” and to secure endorsement from each nation’s legislatures. But further consultation and dispute resolution processes will be put in place to sort these matters out later, outside of public and parliamentary scrutiny.

Two such processes are included in this FTA: a consultative Medicines Working Group, and the overall disputes resolution processes.

The Medicines Working Group will comprise federal officials from each country. Decisions will effectively be binding on Australia unless the draconian provisions of the FTA’s enforcement processes are to be risked. The Australian parliament is being asked to endorse an agreement that does not specify what will happen to key elements of one of its central national health programs, the PBS; and that gives immense power to a non-Australian group meeting behind closed doors, with no published agenda and no accountability to the Australian people, parliament or press.

Matters likely to be discussed by the Medicines Working Group include the PBAC appeals procedure, crucial technical aspects of PBAC economic evaluations, involvement of companies in PBAC decision-making, whether the Australian government will still be able to remove drugs from the PBS and demands about speed of listing. Most of these matters would potentially diminish the negotiating position of the PBS in dealing with overseas drug companies and would lead to higher drug prices.

If Australia does not comply with US demands, or does not change its laws, regulations and processes to put into effect the FTA and the judgements of the Medicines Working Group, the disputes resolution and enforcement processes will come into force. These involve the establishment of committees and working groups that “seek the advice of non-governmental persons or groups” – a measure that brings the industry and its lobbyists directly into the processes of administering and enforcing the FTA.

If Australia is found to be in breach, a fine can be set of up to 50 percent of the value of the benefit Australia is calculated to have gained by its breach. As some single drugs cost the PBS more than $100 million a year, these fines are likely to be very large indeed. Ongoing penalties of up to $US15 million may also be imposed for each instance of each breach.

And “benefits under the agreement” may be suspended. This means the US could deny Australia any or all of the access achieved under the FTA to its market for any Australian product, including primary products such as beef and lamb.

PRESSURES ON THE PBAC

As discussed above, the PBS listing process is a combination of valuation followed by negotiation, built on objective economic and clinical evaluation of their products. The PBS does not attempt to gain the lowest possible price: rather, it attempts to pay what it believes, based on the evidence of clinical safety and efficacy, is fair and consistent with what is paid for other medicines. It is a sophisticated and very successful program that has been copied by other countries. The PBS has provided Australia with very competitive drug prices. Local branch offices of global drug companies are under immense power from their overseas head offices to achieve prices closer to those ruling in the US; therefore, anything that weakens the power of the PBAC to reject unsatisfactory prices, and to hold out for better value, will inevitably cause costs to rise and add to the long-term problems of financial sustainability facing the PBS.

Australia’s ban on direct-to-consumer advertising of prescription medicines will become easier for companies to circumvent. This will add to the pressure on the PBAC to make new drugs available whatever the cost. It will also increase total cost as patients are induced to switch to new, expensive drugs from older, cheaper ones or from no drug at all.

Company representatives will become involved in the actual meetings of the PBAC and its technical sub-committees, and will be able to make personal sales pitches to the meetings deciding on the value of their products. The FTA will reinforce companies’ ability to seek higher prices for already-listed drugs, but there will be no capacity for the PBS to review prices downwards if (as often happens) drugs perform less well in the “real world” of actual clinical use than they did in the original clinical trials.

The combined pressures of all these measures on the PBAC and its members will be enormous and extraordinarily difficult to resist. The committee will effectively be under siege: the number of interests attacking any negative decision will have multiplied both in number and in strength. Despite its present powers under the National Health Act, it is difficult to see how the committee will be able to continue serving the public’s interest properly under such conditions.

Introduction

MAIN POINTS

· The FTA will substantially increase the cost of the PBS. We will be paying more for the same drugs.

· It is plausible that the cost to government of the PBS is likely to rise by around 30 percent as a result of the FTA. For calendar 2003, this would have meant an extra cost of around $1.5 billion with no increase in the health benefit to Australian patients. We believe this to be a conservative estimate.

· Other drug buyers, including public and private hospitals, will also have to pay more.

· To compensate for this drain on their budgets, public hospitals are likely to cut back on drug availability and on non-drug services such as elective surgery.

· Private hospitals will pass costs onto patients and insurance funds.

· Private health insurance premiums will rise.

COSTING THE FTA

The US-Australia Free Trade Agreement contains a large number of measures that effectively extend the intellectual property rights of US pharmaceutical companies, and that put them in a far more favourable position when negotiating with Australian government authorities for inclusion on the Pharmaceutical Benefits Scheme. These measures will have the inevitable result of substantially increasing the price paid for new drugs, not only by the PBS but also by hospitals, clinics and the general public. In turn, unless significantly greater funding is found from Commonwealth, state and private sources, this will cause distortions throughout the health system as money is taken out of non-pharmaceutical services to pay the higher drug bills Australia will face.

This effect will not be felt immediately. Many of the measures that will boost drug prices will not apply to items already listed, but the effect on the cost of the PBS will steadily increase as legislation, regulations and procedures are amended, and as new drugs are introduced and manufacturers are able to secure prices closer to those in their US home market. Because the bulk of PBS spending is always on relatively new drugs, the full effects can be expected within five to ten years.

It is beyond the scope of this submission to estimate accurately what that cost will be. However, a clue can be found in the difference in drug prices between the United States and Australia. A comprehensive study of international comparative drug prices was conducted by the Productivity Commission in 2001. This study examined 150 drugs accounting for 83% of PBS expenditure. According to the study’s weighted average, prices for prescription drugs in the US are around three times (range 2.6 and 3.5 times) as high as in Australia. US prices are the highest of any of the eight countries examined; Australia’s are in line with those in France, Spain and New Zealand but below those of Canada, Britain and Sweden.[1] These figures were accepted by the industry as accurate. Similar results were found last year in a more narrowly focussed study by the Australia Institute.[2]

It is plausible that, as a result of measures in the Free Trade Agreement, the difference in prices paid by the PBS and by US buyers could halve within five to ten years. In calendar 2003, the total cost to government of the PBS and the Repatriation Prescription Benefits Scheme (not including patient copayments) was almost $5.2 billion.[3] Since exchange rates have changed since 2001, it would be wise to base any calculations on the lower of the Productivity Commission’s range of estimates.

On the basis of these assumptions, it is plausible that if the full effects of the FTA were in place in 2003, the PBS cost-to-government would have been around 1.3 times as high as it actually was: $6.76 billion. In other words, the Australian government would have had to pay around $1.56 billion more for the same drugs at the same levels of use and with no additional benefit to the nation’s health.

There would be strong budgetary pressure on the government to transfer some of these costs to the individual consumer, either through higher PBS copayments, deleting drugs from the list, or both.

Because the PBS provides a powerful price benchmark in the Australian market, other purchasers – such as public and private hospitals, some clinics, and the private buyer – would experience similar percentage increases.

These increased prices would significantly reduce the amount of money available for treating patients, both with and without drugs. Unless public hospital funding was increased to compensate fully for the rise in drug prices, general services would have to be reduced. It is also probable that the number of items available on hospital drug formularies would fall: hospitals would no longer be able to afford their drug bills. But other services, such as elective surgery, would also be likely to be reduced. Hospitals would find it more difficult to buy and replace equipment, and to meet salary increases.

Private hospitals would also be affected, and would have to pass on these costs to individual patients and to private health insurance funds, whose premiums would rise. Many consumers would pay these increases, though others would not. But because private hospitals and insurers find it relatively easier than their public counterparts to pass on increased costs, the gap in service standards between public and private hospitals would widen.

Finally, because rising pharmaceutical prices already provide significant upward pressure on the cost price index, the measures in the FTA affecting drug prices would contribute to the national inflation rate.

Intellectual property

and the PBS

MAIN POINTS

This section focuses on the intellectual property chapter of the FTA, including its implications for the PBS. There are four types of costs that are created by this chapter:

· Bargaining and strategic costs;

· Regulatory sovereignty costs;

· Competition costs;

· Dynamic efficiency costs

Depending on the quality of economic modelling, some of these costs may be picked up in a conventional modelling exercise. However, not all will be because they are costs that relate to dynamic processes. This submission provides examples of each of these types of cost, but it does not, for reasons of length, cover all cases in each category.

ASSUMPTIONS OF THE SUBMISSION

The arguments in this submission are underpinned by the assumption that intellectual property rights (IPRs) are not natural rights or primary human rights.[4] Rather they are instrumental tools that governments use to regulate free markets, because without that regulation markets would not allocate an optimal level of resources to invention and creation. The assumption that IPRs are essentially regulatory in character has been part of English and Australian law for a long time. As the High Court pointed out in Victoria Park Racing v. Taylor, IPRs are “special heads of protected interests” that form an exception to general principles and values of market competition.[5]

One of the fundamental things that the US is attempting to accomplish with this and other FTAs is to turn IPRs into a natural right of investment. Essentially the US is creating a new paradigm in which the granting of monopoly rights is no longer seen as something that is special or exceptional, but rather something that is a permanent feature of the regulation of global knowledge markets. In this new paradigm, it will be US multinationals that will be the private regulators of global knowledge markets.[6]

BARGAINING AND STRATEGIC COSTS

Historically, Australia’s strategy on international standards of intellectual property has been based on the fact that it has to participate in the international IPR regime, but its interests in that regime are those of a net intellectual property importer. Summarizing a history of indigenous policy development that goes back to the 1980s and the reports of the Industrial Property Advisory Committee of that time[7], the position that Australia developed was to abide by but not argue for an extension of multilaterally agreed standards of IPRs, or, if necessary, agree to an extension of such standards if there were gains to it in other sectors (for example, agriculture). This strategy was based on a commitment to multilateralism. In the Uruguay Round of trade negotiations (1986 –1993) Australia supported the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) while forcefully pushing its interests in agricultural trade liberalization through its leadership of the Cairns Group.

By signing the FTA with the US, Australia has signalled a fundamental change in the strategy that it has developed over the last few decades. In specific terms, the FTA has the following bargaining or strategic costs:

1. The FTA gives the US standards on IPRs that it would not have been able to obtain in the WTO or would have had to make considerable concessions to obtain.[8]

2. The FTA throws away IPRs as a bargaining tool in the WTO with respect to other countries, most notably Europe and Japan, because the TRIPS MFN clause picks up the Australia - US FTA.[9] In other words, Japanese and European IPR owners also benefit from the IPR chapter.

3. The FTA aids the US strategy of using FTAs to divide and conquer countries that are interested in agricultural trade liberalization. The table below shows that both Cairns Group members and G-20 members are agreeing to FTAs (in the latter case the price of the FTA is departure from the group), thereby undermining their effectiveness as collective entities in multilateral bargaining over agriculture.

DIVIDING AND CONQUERING

The use of FTAs by the US to break up developing country groups

	G20	Ex –G20	Cairns Group	FTA with US?
Argentina*	Y		Y
Australia			Y	Y
Bolivia	Y		Y	Proposed
Brazil*	Y		Y
Canada			Y	Y (NAFTA)
Chile	Y		Y	Y
China*	Y
Colombia		Y	Y	Proposed
Costa Rica		Y	Y	Y (CAFTA)
Cuba	Y
Ecuador		Y		Proposed
Egypt	Y
El Salvador		Y		Y (CAFTA)
Guatemala		Y	Y