Tuesday, November 20, 2007


Chetan alerted me to this video of Milton Friedman where the stalwart economist introduces libertarian ideas and basically counters every matter advocating government intervention that the questioner puts in front of him.

At one point, the questioner asks him if having the FDA around does not prevent tragedies like the Thalidomide tragedy, where it was the FDA that kept a drug with devastating effects away from the US market on the grounds of insufficient testing. Friedman's answer is not surprising to those who are familiar with libertarianism; he says that it is in the interests of the FDA to delay the approval of drugs for fear of backlash from ill-approved drugs. The solution? Again predictable; let the companies themselves do the testing. They won't dare to get a drug with harmful side-effects into the market because then their share-holders will be displeased and they might even go bankrupt from all that class action legislation.

Does this actually work? When I told this second argument to a veteran in the drug industry who has many years of experience with both the business and science of making drugs, without batting an eyelid he answered, "That simply does not happen. For companies, most out-of-court settlements constitute a fraction of the profit they make from drugs. For a company, bringing a product with a side-effect on the market does not carry a very great risk, because any cost they may have to pay in the form of fines or court settlements usually is much lesser than the profit which they make". Plus, exactly why are shareholders going to bring down the company? Surely not because of morality. Did shareholders stop buying Union Carbide products because of Bhopal? They only care what the shares look like. For a giant drug company, a temporary setback does not affect the long-term value of their shares. Even if such a company loses a few customers temporarily, it can gain many more customers in the future.

So Friedman's contention that customers will regulate the company (or rather, that the free market will regulate itself) may work in principle, but it is hard to imagine it working in practice. And there are examples in the real world where it has not worked. And not just with drug companies. Let's take companies which have extensively polluted the environment. Have these companies stopped their practices because of litigation? No, in most cases they have simply paid the fine and moved on with the same practices. That's the point; for companies, everything is a business decision, and many times paying punitive damages is much less expensive than changing manufacturing practices or testing drugs extensively.

This is the problem I have with some of these libertarian ideas; while I agree on many points with libertarians, to me their solutions often sound theoretical and many times generalised, with real-life examples providing plenty of counterexamples. Now when you point out these counterexamples, they will say "Yes, but you wouldn't have had these counterexamples in a perfect, libertarian world" But that's the point; the world is not perfect, even if we should continue to strive to make it so. In the real world, not everyone has property rights to shield themselves from corporate malpractices. Many people simply don't have the financial and political muscle to go to court against corporations. I always cite the example of Pacific Islanders facing sea-level rise from climate change. How many oil companies will they sue and how? And will the oil companies change their practices even then? The problem I have with some libertarian views is that they are extreme; they assume that government in any and every form is evil in any and every time, and that it is anethema to even think of any degree of government regulation. With governments of the kind that we have in India, I can sympathize with their viewpoint. But isn't there a second perspective here? Until their perfect libertarian world materialises, sometimes to me government regulation seems like the only option, even if it may be a necessary evil. We should certainly strive to give everyone property rights, but until that can happen we need to have some way of preventing catastrophe and disasters. Moreover, there are bad government agencies and good government agencies. Wouldn't a moderate standpoint be to advocate increasing the efficiency of some government agencies rather than simply doing away with them? Why doesn's anyone talk about improving systems rather than advocating getting rid of them by default?

I feel sad because libertarians often take an extreme stance and espouse a catch-all viewpoint. There is one fundamental rule of debate or analysis; don't adopt an extreme viewpoint, because then you automatically open yourself up to criticism. But in this case, I would go a step further and say that with their extreme viewpoints, libertarians force others who agree with much of what they say to become their critics.

P.S. The really galling question is, what do you do if government itself is more evil than anyone else? That's a tough nut to crack. Who do the people turn to then?

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Blogger gawker said...

Amen brother. You echoed my own thoughts. Especially :

"But in this case, I would go a step further and say that with their extreme viewpoints, libertarians force others who agree with much of what they say to become their critics."

9:57 AM  
Blogger Ashutosh said...


1:03 PM  
Blogger Vivek Gupta said...

Yes, that is a nice video, there are plenty more on google video and youtube. Especially worth watching are the videos of his famous PBS series 'Free to Choose' available on Google Video and may be on youtube now since Google bought it.

His argument about companies regulating themselves without any intervention may be a bit tenuous but the larger point about market based solutions is valid. Explicit government regulation can do more harm then good. Everybody quotes the thalamide example however nobody is aware how many potentially life saving drugs have been prevented from coming into the market because of FDA's sometimes excessively stringent requirements.
The fact that no one in FDA will ever be held accountable for rigid rules whereas even a slight misstep perceived as laxity could be career threating, makes FDA and other government agencies loathe to change. By some estimates, the cost of drug development in US has increased 10 times after adjusting for inflation since FDA came into being. This is another reason why it is so costly and time consuming to develop a drug and why firms are increasing driven towards making blockbuster drugs. Efforts towards developing drugs that do not result in billion dollar sales are no longer profitable and many diseases with less than big enough ''customer base" are not seeing any new drugs developed for their treatment. Another problem which FDA has been responsible for accentuating is that drug industry is now completely monopolized by big pharma since smaller start ups can not afford to comply with outdated, stringent government regulations and still make a profit. So, unwittingly, FDA has actually helped make the drug industry an inefficient industry not subject to the process of ``creative destruction'' that invariably leads to improvement such as in technology industry with little regulation.

The larger picture painted by Friedman is that government regulation once put in place usually tends to get out of hand. A government agency has only the hammer of regulation as its tool and it sees every problem as the proverbial nail. No government agency will ever say that it needs to regulate less, it will never willingly take a budget cut and it will always keep its own survival above the interest of the general public whose interest they seek to guard. They are precisely like the much viled ''profit-hungry corporations'' whom they wish to reign.

So what are the possible so-called market-based regulatory mechanisms and how do we implement them.
The basic trouble with the government agencies is that they don't have any risk/reward structure in place which gives them an incentive to let good products come in market while preventing bad products. One possible solution is that the government should scrap FDA, and in its place allow private firms to fill in as a de-facto ''regulator''. What I mean by this is that government can provide licenses to some private firms who show competence and good judgment in rating the effectiveness and safety of the new drugs. The companies earn a fee from the companies whose drugs they are rating. These companies must be held liable along with the drug developers for any lawsuits if the drugs they approved turn out to be dangerous. Thus, they have an incentive (a lucrative fee) for approving a good drug but a punishment (lawsuits, loss to reputation) if the drugs are not safe. A structure such as this is in place, for example, in Fixed Income Securities market in US where the government has given licenses to many credit rating agencies, e.g., Moody's corporation, the company I work for. Such a system has worked well over the years and though it has flaws (which system does not!), being a market-based solution allows it to correct those flaws and continuously improve which is precisely the inherent strength of the market system.

Sorry for such a long comment but this is a topic close to my heart and Milton is my hero. I am sure that Milton is aware of the extreme position he has taken and the pitfalls his position can encounter, after all he is a Nobel prize winning economist. But, I have heard, that Milton still espouses this view in public for the sake of argument.

1:16 PM  
Blogger Ashutosh said...

Vivek, thanks for the input. I appreciate it and will pen a more detailed comment later; I seem to be a little busy this weekend.
My main concern is whether firms such as the ones rating the drugs will be willing to get established in the first place. If such firms are also going to be held liable for any problems and face huge potential lawsuits, I would be doubtful if the cost-benefit analysis would seem favourable to them, since rating the drugs and evaluating them will be a lengthy and expensive process. Another question is; even if in theory a company can be sued and brought to its knees by customers/investors, in the real world, how many people would die or face harmful effects from the drugs before this happens? Would that number be less than the number Friedman says has been indirectly "killed" by the FDA?

As a general point, I have spoken to a few people who have worked in the industry for a long time, and while their opinion is not representative of the general view, I have basically heard them say one of two things; either they think the FDA is superb (which is a little naive, but they are actually praising the efforts of the underworked and overpaid personnel there) or that the FDA is a necessary evil, and while some of its laws may seem more stringent, some form of govt. regulation seems to be necessary for drugs. I myself belong to the latter category and think that if not FDA in all its gory details, something like the FDA is a necessary evil. If you are a drug developer, FDA can make life miserable for you, but it often seems to be erring on the safer side for many. As usual, the Bush administration has further tarnished the image of the FDA by politicising it and delaying the approval of certain drugs (such as the one which it though would "increase promiscuity"). In any case, I understand this is a complex matter, and I agree that it is premature and one-sided to think that market-based solutions just would not exist.

9:57 AM  
Blogger Dídac López said...

Courts are a public institution also. So, Friedman in this case want to shift responsability from FDA to Courts, from prevention to justice. A sounded libertarian would defend the abolition of compulsory Courts.

10:39 AM  
Blogger Chetan said...


I think the suggestion given by Friedman is a tad bit idealistic. It looks great in theory and it is very difficult to not nod your head when he puts forth his case so eloquently. However, in practice there are several problems which he neglects to mention.

Let's take the case of liability: The system of having strict liability is problematic in itself. There are several avenues for corruption in the system. Read this story about a law firm which operated like a lawsuit factory suing corporations by co-opting with fake and corrupt litigants. The case you make about small corporations not flourishing because of FDA will fall flat when you consider that these small firms and their trial lawyers will have to face such potential lawsuits. In the story it is mentioned that lawsuits are such a nuisance to firms being sued that even when they know that they will eventually win, firms prefer to settle and get on with their business. Small corporations are always going to be exposed to that kind of a financial risk, especially in the pharma sector, regardless of whether FDA is present or not. So it will be doubtful whether the technology industry's unregulated success in creative destruction can be replicated in the pharma sector. Sebastian Mallaby had written a piece about how juries are biased against corporations and deliver verdicts without taking into consideration the complexities involved. So to suggest that strict liability is an ideal solution (will prevent costs and make companies more responsive to concerns)instead of regulation is open to argument. Besides billion dollar lawsuits can be absorbed by big corporations but small firms responsible for innovation and creative destruction will always find it difficult to survive. Also, such lawsuits raise costs of drugs too, and its not just complying with FDA regulations are responsible for higher cost of drugs.

Efforts towards developing drugs that do not result in billion dollar sales are no longer profitable and many diseases with less than big enough ''customer base" are not seeing any new drugs developed for their treatment.

I don't see how you tie this with the presence of FDA. I mean this is a problem with any capitalist enterprise. This is a good primer about a delightful book by the name of The tyranny of the market. This book is not written by a left wing guy but rather a well respected economist. He does not even make a case for government intervention, but just states facts on the ground caused by demand supply logic of the markets. Even if FDA is abolished it is hard to imagine that drug companies will come with drugs which have no profit potential possible.

Forgive my snark, but working with Moody's, you, more than anyone else, should be wary of advocating market based regulatory mechanisms, especially, in the light of sub prime mortgage crisis. We have all read about the A and A+ ratings given to questionable mortgage backed securities. There is always going to be a conflict of interest when there is a market based regulation and I doubt if society which tolerated the sub prime mess without too much clamor for regulation, can handle a similar crisis where health of the population is concerned.

3:40 PM  

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