A SYMPTON OF A GREATER DISEASE / BARRON´S MAGAZINE EDITORIAL COMMENTARY ( A MUST READ )

Editorial Commentary

SATURDAY, JUNE 19, 2010

A Symptom of a Greater Disease

By THOMAS G. DONLAN

Price-fixing is a gateway drug and a sign of financial ruin to come.

PRICE-FIXING IS THE third-greatest refuge of scoundrel governments, right behind inflation and outright default. So it was no surprise to discover Greece imposing price cuts on pharmaceuticals, no more than it was a surprise to find Moody's downgrading Greek bonds to junk.

This is austerity, Greek style: Because the government spends too much on health care (among other things), it will cut the prices it pays pharmaceutical companies for the medicines that Greeks consume. The Greek government announced unilateral payment cuts averaging 21.5%, simultaneously denouncing high drug-company profits.

Greek drug prices were already among the most harshly controlled in Europe, which is going some. But the new round of price decrees will have at least two secondary effects that will lower prices across the continent: Some other European countries base prices partly on Greek prices, and those that don't will be tempted to order from Greek sources.

One of the minor debts of the deadbeat Greek government is about six billion euros ($8.7 billion) in payments owed to drug companies—about a year's worth of its consumption of pharmaceuticals. The worldwide pharmaceutical industry, however, didn't balk at the new demand. Drug companies are all too accustomed to being told what to charge, except in the U.S.

Flirting With Principles

The European Federation of Pharmaceutical Industries and Associations mumbled that cutting manufacturers' revenue "will impact European economic recovery and employment." It was a declaration of economic common sense, but hardly a declaration of war.

Two Danish pharmaceutical companies, Novo Nordisk and Leo Pharma, did resist the Greek decree, but they really were just haggling about the price. After a couple of weeks of negotiations, the Greeks cut prices by somewhat less, and the companies agreed to keep on serving the Greek market.

This isn't merely a Greek disease. Spain is cutting prices of patented drugs by 7.5% and of generic drugs by 25%. Italy has announced cuts for later this summer, and the German Ministry of Health has asked the federal parliament for authority to impose a 10% price cut and a three-year price freeze thereafter. Even in the relatively free British market, the new government is proposing "value-based pricing," which means the government will decide how much drugs are worth.

Europe as a whole is almost as large a drug market as North America, and analysts said wide-ranging price cuts could knock 10% off industry earnings, with a few mid-sized companies focused on the European market losing as much as 30% of profits.

The important concern isn't the loss of pharmaceutical profits. It's the foreshadowing of much greater problems to come, and not just in Greece, not just in Europe. Deficits and debts are rising around the world, and price-fixing looks to many like an answer.

Under the Wheel

When profligate countries borrow too much, they inflate to stay afloat. When inflation pushes prices up, they maintain their citizens' purchasing power by controlling prices. When they control prices, they invite shortages, black markets and boycotts, and they need capital controls to prevent wise money from fleeing the country. Eventually they need inflows of intentionally dumb money from international donors.

This economic wheel can turn again and again until it breaks under the strain, producing default—either outright repudiation of debts, or default covered by a gooey coating of indefinite postponement.

The breakdown is called a sovereign-debt crisis, which Europeans should have graven in their memories as in their cemeteries, along with two world wars and a daunting assortment of minor conflicts.

The European Union, featuring a single European currency and a powerful European central bank, was supposed to prevent such horrible outcomes. Member countries signed up for fiscal discipline—national budget deficits no greater than 3% and debt no greater than 60% of gross domestic product.

These were honored in the breach, not merely by little, poor countries but by France and Germany. The big countries then pushed to make the limits unenforceable, which a European summit adopted in 2005.

In 2006, a rather prosperous year, seven euro-area countries had government debts greater than 60% of GDP—Belgium, France, Germany, Greece, Italy, Portugal and Spain. In this crisis-bound year it is a dishonor acknowledged by the same seven plus Ireland.

Paying the Bills

The productive postwar German economy has been financing the rest of Europe's agricultural, industrial and social subsidies since the mid-1950s. The historian Niall Ferguson, author of the recent book The Ascent of Money, says, as many do, that the German people are getting tired of the burden, which he compares unfavorably to the reparations imposed on Germany by the victors in World War I.

In a recent speech to international economists, Ferguson said, "I think the desire to pay some kind of subtle reparations for the past is now gone, and the German attitude isn't really 'what can we do to atone for the sins of our forefathers?' It is 'why the hell can't Greeks pay their taxes the way we do?'"

Ferguson isn't an economist, but he is acutely aware of the influence of money upon history. Recalling that the euro was created to bind Europeans into one economy, preparatory to binding them into one nation, he suggests the path forward to a United States of Europe is looking rocky.

The Germans simply wouldn't vote for the American kind of arrangement, in which the federal government taxes rich states and subsidizes poor ones. (Americans have had the system so long they scarcely recognize that it exists, much less agitate to end it.)

The other path, over the cliff and back to European disintegration, is where Ferguson lays his bet, and it looks like a sound one.

Ominously, to those who have noted how often business crises follow the construction of new headquarters buildings, the European central bank is in the middle of building a new skyscraper in Frankfurt. It will open in 2014, if the central bank survives that long.

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