Sunday, October 17, 2004

One Flu Over the Cuckoo's Nest

Tim’s post last week about the sudden price increase in the flu vaccination (from $70 to $900) has received a great deal of attention (about 17 comments, last I checked), mostly people challenging his (and my) protection of a company that’s “gouging” the public.

Russell Roberts at Café Hayek posted this lengthy article about the flu vaccine shortage (explanation why the company in question rose it’s price). I think we can learn a lot from it.

Many the comments point (rightly) that the supply of vaccinations are time sensitive; it takes time to produce them and the window for the market is very small. Mike particlular emphasizes this point, saying “If there were sufficient time between now and November for an entrepreneur to hop in, build a vast supply of vaccine, and market it, then David and Tim, you're right. But somehow I doubt such speed is possible, or else we wouldn't even be afraid of such a shortage.”

Flu vaccine manufactures know this so they tend to overproduce the vaccine (because they never know how much they’ll need). Over past few years, they’ve litterally been throwing out millions of vaccines eash season because they didn’t sell them. And it’s not like they can keep them for a later year. The virus mutates just slightly each season, requiring the companies to start from scratch over and over again. (Thus calling the whole idea of “stocking piling vaccines” into quesiton.)

These vaccines aren’t cheap, either. It takes time and skill to make them. The industry standard it to inject a fertilized chicken egg with the flu so the embroyo makes the vaccine. A single eggs yields just four or five doses. This has to be done by hand.

The market’s also very small (and more prone to sudden changes); with a size of less than 1/50th of the drug industry ($6 billion versus $340 billion), there’s not a lot of room for lots of drug makers who would keep the price low.

In fact, the price would be very low because the vaccine is so elastic. Vaccines are identical across companies so very minor changes in price greatly affect revenue. In short, profits from these companies are very slim. This price is even lower because of government purchases, who bought 55% of all vaccinations last year.

This is from the National Center for Policy Analysis:

The root of this government role goes back to August 1993, when Congress passed Clinton's Vaccines for Children program. The plan, promoted by the Children's Defense Fund, was to use federal power to ensure universal immunization. So the government agreed to purchase a third of the national vaccine supply (the President and Mrs. Clinton had pushed for 100 percent) at a forced discount of half price, then distribute it to doctors to deliver to the poor and the un- and under-insured.


According to siliconvalley.com, the market share for 2004 is now 60%.

For the record, in 2000, the Department of Health and Human Services spent $449 million for the Center for Disease Control and Prevention for immunizations. In 2003, that number was $556 million.

So on one side, vaccine companies face a really tough market: their good is really elastic, their production is really expensive, their market share fluctuates greatly and it’s not too big to begin with. On the other side, government purchases are depressing the prices more and more every year by exposing the high elasticity of the good. As their market share climbs, governments represent a monopsony (the demand version of a monopoly) closer and closer, dangling their market share to force a company to drop their price or loose the increasingly important government contract. This is why there were over two dozen vaccine companies thirty years ago and only one now.

But with just one left, it has the opportunity to offer a price more incline to represent the costs of doing it’s business, including a wide profit margin for all the risk they shoulder.

Some readers suggest that vaccines should be an exception to this sudden jump in price. They save lives, after all, and lives have infinite value. I’ll agree that each person has infinite potential to make the world a better place, but I deny that every person should be saved no matter what the cost. Very few people ever come close to realizing this potential and some of saved go on to be pretty awful people. Saying that everyone needs to be vaccinated no matter what isn’t a good argument.

They also deny others life because they commit a classic fallacy in economics: the broken window fallacy. Considering how expensive the vaccines are to produce, it’s pretty clear that there’s lots of room for improvement; improvement that will only be discovered if the incentives are good enough to discover it. In classic Bastiat style, these people who criticize the “gouging” company see the person that’s suffering now; they don’t see the countless others that live because of the creation of a more effective or cheaper vaccine.

2 comments:

Illy said...

That's an awesome post, David. The fact that there is only one vaccine manufacturer on the market -- and the reasons why that is so -- are the real issues one should be concerned about. As you pointed out, the current limbo is entirely the government's doing. Now there's a lesson in there, wouldn't you say?

Tim said...

Davey, who loves ya, baby?

By the way, I'll be in town some time next month, and we'll have to hang out. I'm still working out when.