PHARMA, PART 2….Andrew Sullivan returns to the Big Pharma debate today, stepping back a bit from yesterday’s claim that European pharma companies have been “decimated” by Europe’s widespread adoption of universal healthcare. And a good thing too. After all, the market for pharmaceuticals is global. Every pharmaceutical company, no matter where it’s based or where it conducts R&D, sells into the exact same market. If European national healthcare had really decimated European pharma companies, it would have decimated American companies too.

But it hasn’t. So today Andrew moves on to a different, and more common, conservative claim. With some coaching from Mark Kleiman, he argues that the real issue is drug innovation, which he thinks is driven largely by profits from U.S. sales. If we introduce national healthcare in American and start bargaining down the price of drugs, Big Pharma will no longer have an incentive to invest lots of money in R&D. Result: no new drugs.

On its face this sounds reasonable. Pharma companies are like anyone else: they invest in R&D to the extent that they can earn a return from the drugs they develop. If drug company profits are driven mostly by high-priced U.S. sales, then the rest of the world is getting a free R&D ride on our backs.

But I don’t think that’s quite what’s happening. There’s a free ride happening, but it’s not a free ride on innovation. It’s a free ride on pricing.

As Mark points out, pharma companies have to raise capital in the same markets as everyone else, and that means their overall pricing has to be high enough to provide them with the risk-adjusted returns on equity that the market demands. So what happens if prices in America are gradually pushed down? Answer: prices everywhere else will be gradually pushed up. Americans will pay a bit less and Europeans will pay a bit more — which suits me just fine — and both profit levels and risk-adjusted returns will remain constant, just as basic economics demands. The only difference is that Europeans will be forced to pay their fair share of pharma R&D budgets. No more free ride on pricing.

Now, the scaremongering alternative to this is that basic economics will fail because governments around the world are such ruthless bargainers that they’ll literally drive pharmaceutical companies into the ground with their demands for ever lower prices. But seriously, how likely is this? The global aerospace industry is highly dependent on military sales, and their profits haven’t been driven into the ground. Quite the contrary: Europeans are forever complaining that Boeing, for example, is essentially subsidized by the U.S. government because its high-profit defense business is more lucrative than its civilian business.

The fact is that selling to the government — or, in this case, to a hundred separate governments — is every bit as profitable as selling to private industry. (Does anyone seriously want to make the case that federal procurement is more ruthlessly efficient than, say, Wal-Mart?) Right now, the only reason European countries can get such low prices on drugs is because pharma companies know they can make up for it in the United States. If we stopped acting like chumps, they wouldn’t be able to do it anymore.

So in the end, pharma profits will remain healthy and innovation will continue apace. What’s more, as Mark points out, we already spend a lot of federal dollars on basic pharma R&D. If it turns out that lower U.S. prices have an impact on innovation after all, “then we need to budget some public R&D funds (as grants, as prizes, or as patent buy-outs) to make up for that loss.” Dean Baker has more on that here.