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DRUG REGULATIONS: COST VERSUS BENEFIT

Recently the Food and Drug Administration came under one of the sharpest public attacks in recent years. The attack came in Milton Friedman's NEWSWEEK column, in which the eminent economist suggested that the costs imposed on consumers by the 1962 new-drug regulations far outweigh the potential benefits. Friedman even went so far as to suggest that perhaps the FDA itself should be abolished, on similar grounds. The source of Friedman's conclusions was a brilliant research effort carried out by UCLA economist Sam Peltzman (see "Working Within the System: An Interview with Sam Peltzman," REASON June/July 1972). Peltzman's method and findings are set forth below.

The 1962 Amendments to the Food, Drug, and Cosmetic Act conferred on the FDA new powers to regulate the ethical drug industry. The basic changes which resulted from the Amendments are that:

(1) Drugs must not only be proven harmless, but additionally they must be proven effective in a manner established by the FDA, and (2) Although prior to 1962 a new drug application was automatically approved if not denied by the FDA within 180 days, there is no longer any such time limit on FDA action on application. It would be natural to expect that the Amendments and the ensuing regulations would diminish the number of new drugs entering the market and delay the introduction of those drugs which do enter the market. What Peltzman set out to do—and what he did rather admirably—was to estimate not only the magnitude and direction of these effects on drug flow and timing but also the value of benefits and costs associated with these effects.

In order to measure the effects of the newer regulation on the flow of drugs to the market, Peltzman constructed an economic model of drug development. Data prior to 1962 were used to estimate model parameters, and the model correctly "predicted" the major changes in drug innovation in the pre-Amendment period. But when Peltzman used the same model to predict innovation in the post-Amendment period, he found a persistent "deficit" between the predicted and actual flow of new drugs. (He was careful to distinguish between new chemical entities and other new drugs, for example those which represented merely recombinations or forms of previously available drugs.) Peltzman attributed this difference to the existence of the regulations. He further cited evidence which suggests that the Amendments have added at least two years to development time for new drugs.

The gains from the stiffer regulation arise primarily from the reduction in the number of ineffective drugs and elimination of some drugs which would otherwise have caused major harm to users. Against these gains, one must compare the losses arising from implementation of the Amendments: elimination of some effective drugs, because of the higher cost of development and approval; delay in the introduction of major drug innovations; higher drug prices owing to reduced competition (fewer drug treatment alternatives); and more costly (hence less) drug information supplied to potential users.

Assigning to each of these a dollar measure is a technically difficult task, and Peltzman admits that margins of error are necessarily large in this sort of undertaking. Rather gamely, he consistently gives the FDA the benefit of the doubt; still, his conclusion is that the losses to consumers from the regulation vastly outweigh the gains. Exclusive of the gains and losses associated with fewer expected major drug disasters and delays in the introduction of important innovations, the net loss to consumers from the Amendments is on the order of $250-500 million annually, or five to ten percent of annual drug purchases. Including these added safety benefits and delayed innovation costs would further increase the probable consumer loss, although Peltzman refrains from citing a specific annual dollar amount owing to the uncertainty of predicting these relatively rare phenomena. He does show that a "typical" innovation (e.g,, streptomycin in the treatment of TB) whose delay would cost around one billion dollars is at least as likely as the realization of a $100 million benefit from preventing a "typical" drug disaster (e.g., Thalidomide) through two years of additional FDA-mandated testing.

The technical excellence of Peltzman's paper is such that the FDA is unlikely to rebut it with an equally good evaluation showing net benefits attributable to the Amendments. Rather, a more likely defense will be to reject the underlying premises—such as the relevance of consumer sovereignty in judging drug effectiveness—or to divert attentions by offering anecdotes about FDA "successes" and the need for a bigger budget.

SOURCES:
• "Frustrating Drug Advancement," Milton Friedman, NEWSWEEK, 8 January 1973.
• "The Benefits and Costs of New Drug Regulation," Sam Peltzman, 1972, Center for Policy Study, University of Chicago, summarized by Tim O. Ozenne.

A NEW GOLD STANDARD?

According to financial expert Dr. Harry Schultz, developments are rapidly moving toward establishment of a new international monetary order, based on gold. In February, Rene Larre, manager of the Bank of International Settlements (Europe's "bank for banks," the "Supreme Court for money") told VISION magazine that to be credible, a new monetary system will require a continued role for gold. However, it is impossible to restore even partial convertibility at an arbitrary price, nor can the world wait 5 to 10 years for the U.S. to raise the price sufficiently. A better method, Larre said, would be for central banks simply to trade in gold at the going market price. "Whatever we do, we can't reform the monetary system without dealing with gold.…" he stated. From this Schultz concluded that "Europe won't let the U.S. dethrone gold and it means gold will not, on future dips, fall far…EEC's new monetary fund will define its unit-of- account as 0.88867088 of fine gold. Make no mistake, Europe is opting out of the dollar and into gold."

In another development, Schultz reported that the Arab nations are exploring the possibility of issuing their own international currency, to be known as the dinar, backed fully by gold. The idea is to avoid the kind of losses they have suffered in recent dollar devaluations. The U.S. would then have to pay for Arab oil in gold-backed dinars rather than dollars.

The moral of all this should be clear: despite the government's anti-gold propaganda, the yellow metal will continue to play a major role in international monetary affairs.

SOURCES:
THE INTERNATIONAL HARRY SCHULTZ LETTER, Numbers 292 (8 February 1973) and 296 (30 April 1973), quoted by permission.

LIMITING GOVERNMENT SPENDING

According to the latest report from the Tax Foundation, Inc., the total tax burden on each of the nation's households will increase an average of $341, to a total of $5,070, in fiscal 1973. Overall, American taxpayers will pay $339 billion in taxes in 1973, with $125 billion of the total going toward state and local taxes. The rate of increase of state and local taxes is about 9% per year.

Against this background of seemingly uncontrolled growth, California governor Ronald Reagan has proposed a major program to reduce the size of state government, by limiting its power to tax. Reagan's plan, prepared by a prestigious group of economists and consultants, would place a progressively lower ceiling on state tax collections over the next 15 years. The plan, which requires a constitutional amendment, begins with the fact that all forms of California taxes now take 8.75% of Californians' personal incomes. Over the next 15 years, this percentage would be mandated to decrease 0.1% each year, to a bit over 7%. Thus, given this constitutional ceiling, the legislature would have to set priorities and make trade-offs among programs, rather than continuously thinking up new spending schemes and raising taxes to pay for them.

The plan was developed by a task force of economists and political scientists. A group including Prof. Craig Stubblebine of Claremont Men's College and several UCLA economists examined various issues dealing with the current high level of taxation and spending. The factors motivating government spending were then addressed by a task force of economists from Virginia Polytechnic Institute, directed by James M. Buchanan. And a group of six task forces, drawn from UCLA, U.C. Berkeley, U.C. San Diego, and Cal State Hayward looked at alternative ways of reducing government spending, finally concluding that limiting government revenue was the best way to limit spending.

The plan has already sparked heated controversy in California, where Reagan is leading a petition drive to get it placed on the ballot. Although endorsed by such scholars as economist Milton Friedman, urbanologist Martin Anderson, and management consultant Peter F. Drucker, the plan is strongly opposed by free-spending politicians and professional bureaucrats. Reagan himself sees the plan as a prototype for adoption at the federal level. Indeed, since federal spending has increased 130% since 1964, some sort of limiting mechanism is urgently needed.

SOURCES:
• $341 Increase Expected in Average Tax Burden," Associated Press (New York), 16 April 1973.
• "Reagan Seeks to Lower Taxes Annually Over 15-Year Period," Robert Fairbanks, LOS ANGELES TIMES, 9 February 1973.
• "Revenue Limitation Proposal for U.S. Suggested by Reagan," Tom Goff, LOS ANGELES TIMES, 14 February 1973.

RENT CONTROL AS POOR RELIEF

There is a fairly extensive movement afoot to impose rent controls, on either a national or local level. Radical-liberal coalitions have already voted measures in at Berkeley and Cambridge, with the predictable consequences to property values. Massachusetts has a state-wide enabling act and several other communities have used it to adopt controls. There are currently bills in the state legislatures of New Jersey and Maryland to impose similar controls in those states. The Economic Stabilization Act recently passed by the Senate calls for compulsory rent controls whenever local occupancy rates go below 5.5%. All in all, one gets the impression that rent control is an idea whose time has come.

An interesting assumption behind the popular appeal of rent control is that the poor tenant is being taken advantage of by the rich landlord. One wonders how the program would be received if the public saw the issue as one in which prosperous tenants were using their political muscle to extract cheap rents from impoverished elderly landlords.

The interesting thing about this speculation is that it has some basis in fact. While there seem to be no data published for current conditions, there are two studies dealing with rent controls of the 1949-50 period. In the first, University of Chicago Professor E. Gale Johnson concluded:

I do not want to argue that the evidence indicates that landlords are poorer than tenants. But the data certainly do not prove the contrary.…[Rent control] has, in my opinion, no justification except the political one that there are more tenants than landlords.

In the second. Dr. Willys Knight found that the median income of tenants was actually greater than that of landlords in a Lansing, Michigan, study. He also observed that if you excluded the income from outside employment, those landlords dependent upon rental income constituted one of the poorest groups in the city.

This disparity is largely explained by the factor of age. Knight found that 57% of the landlords in his study were 56 years of age or older, with 28.9% of them 66 or older. By contrast, only 16.6% of the tenants were 56 or older, while 68.1% were aged 45 or less. The tenants, as a group, were of an age group which could have one or two wage earners per family, while many of the landlords were too old for regular employment and were dependent upon rental income to flesh out pensions or savings.
—Davis E. Keeler, Institute for Humane Studies

SOURCES:
• "Rent Control and the Distribution of Income," E. Gale Johnson, AMERICAN ECONOMIC REVIEW, May 1951, p. 569.
• "Postwar Rent Control Controversy," Willys Knight, Research Paper No. 23, School of Business, Georgia State College, Atlanta, 1962.

FREEDOM TO BE DIFFERENT

A prominent legal expert has joined the ranks of Thomas Szasz, Nathaniel Branden, and others urging the abolition of involuntary confinement for those considered mentally ill. Thomas Shaffer, dean of the University of Notre Dame Law School, said in an address to the American Health Congress that the doors of mental institutions should be unlocked, so that anyone who wants to can leave. Shaffer argued that if those who leave have to be locked up, they should be in jail and not in a hospital. "It is surely not the business of healing to operate jails," he said.

Shaffer's position stems from a strong commitment to individual rights, including the right to be different—even bizarre—so long as no coercion of others is involved. "One might wonder," he noted, "why bizarre people should be locked up when the more devious and more dangerous among us are not locked up." He pointed out that "Almost none of these so-called mental patients is dangerous; the arrest rate among former mental patients is about half that of the general population." Shaffer also pointed out the lack of due process involved in most commitments to mental institutions.

What alternative is there to involuntary confinement? Dean Shaffer suggested "that mental health services be put on the same basis as dental health, a free-enterprise system in which those who want the service seek it voluntarily."

SOURCE:
• "Free Mental Patients, Law Dean Proposes," Associated Press (Chicago), 11 August 1972.

VOUCHER SYSTEM TRIAL RUN

One promising proposal for phasing out the public school monopoly is Milton Friedman's voucher system (see "The Case for Education Vouchers," REASON, April-May 1971). Under this plan, a state or city would turn overall school tax monies to parents, in the form of vouchers cashable at any school, public or private. The idea is to put private schools on an equal footing with public schools, restoring competition in the education marketplace.

California has initiated limited testing of a watered-down version of this plan, but now New Hampshire appears ready to give the "pure" Friedman version a large-scale test. The state will shortly receive a $100,000 federal grant to plan a two-year statewide test of the plan. If given the go-ahead, another $5 million in federal funds would be received for administrative costs of the two-year demonstration. While the voucher system will not put public schools out of business overnight, the results of the New Hampshire experiment should prove to be interesting.

SOURCES:
• NATIONAL REVIEW, 11 May 1973, p. 502.
• For background, see "The Voucher System," Yale Brozen & Roman L. Weil, American Conservative Union, 1971 (available for $1.00 from ACU, 422 First St., SE, Washington, DC 20003.)

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