Article published on TCS on January 6, 2005.
Dorette Corbey, who serves on the European Parliament’s Environment, Public Health and Consumer Protection committee, told the audience at a recent conference sponsored by TechCentralStation in Brussels that she is firmly opposed to liberalizing consumer information on health. In addition to raising various ethical concerns, she quoted an economic argument frequently raised against direct-to-consumer advertising (DTC) of medicines: that it would raise retail prices. However, no such link exists between advertising/information and consumer prices.
Classical economic analysis argues that the marketing and advertising costs of a painkiller such as doliprane or dafalgan are added on to production costs (in essence, research, development and manufacturing costs). At the end of the production process, the price hike is a fact. But this assumes that the value of a final good (i.e. the price of the drug) is composed of a series of costs occurring during the various stages of manufacturing.
Hence, the price of a product would be the result of a chain of value-added stages proceeding from the top to the bottom, from the factors of production towards a final product. This is a common belief (in particular in the debate on outsourcing) which leads to thinking that if a drug has a value for the patient, it is because of its basic components: paracetamol, citric acid, carbon, etc.
But this isn’t quite right in this case. If we adopt this thinking it would be impossible to determine the value or the price of goods which are given by nature, e.g. land, fruits growing in the wilderness, and so forth. How is it that an individual may pick an apple from a tree or grow a piece of land? The previous argument does not answer this, because it ignores the upgrading of goods, which are not the outcome of combining the various factors of production.
Taking into account things which have a value for us, e.g. ecologically grown apples or wild mulberries, we realize that this value corresponds to an individual desire, and not the other way round. Hence, the entrepreneur who realizes that she is not the only one to like apples may imagine ways to produce these on a larger scale, which will lead her to invest in land, work, tools and fertilizer. Therefore, these elements will draw their value from the fact that the apples will have a similar value to the consumer, once they have been produced and brought to market.
In the same vein, if companies spend a portion of their resources on advertising, it is not because this has an intrinsic value, but because the final product — be it Viagra or the antiretroviral Epzicom — has a value to the consumer.
The price is a ratio representing the value of goods exchanged on a market. It is therefore neither logical nor realistic to cling to the idea (shared by both the Commission and the European Parliament) that advertising budgets are bound to increase the price of drugs, nor indeed of any other product. This brief lesson in economics may prove useful to the incoming Health and Consumer Protection Commissioner Markos Kyprianou, whose training was exclusively in law.
When it comes to health concerns — over drugs, food or tobacco — advertising is often blamed with creating artificial, fictitious and imaginary needs. But two arguments counter this simplistic view (which often leads to calls for bans on advertising) in favor of consumer choice.
First, remember that material things don’t automatically become tradeable goods among individuals. As the famous economist Carl Menger taught, there are conditions to make this happen. He stressed in particular that an individual must first recognize the existence of an object that has the potential of satisfying his or her needs.
Without this crucial knowledge, the individual is unable to find medicine to cure his diabetes or food to prevent him from starving. Knowing that a product exists is not only useful, it is indispensable for satisfying a given need. Businessmen and politicians alike are aware of this: their respective products might just as well not exist as long as people do not know about them. Hence the importance of political campaigns and advertising budgets.
The second argument has to do with another characteristic highlighted by Menger, i.e. the real nature of the need and its link to the advertising, which supposedly creates this need. Hence, it is because an individual seeks health care services that a company may place commercial ads, and the patient may look for access to this kind of information.
Some warn that consumers would be defenseless against advertising — that they would simply succumb to it. Apart from being deterministic, this argument asserts that commercials in and of themselves are powerful enough to account for the success and failure (bankruptcy) of firms. “However”, as Ludwig von Mises reminds us in Human Action , “nobody believes that any kind of advertising would have succeeded in making the candle-makers hold the field against the electric bulb, the horse-drivers against the motorcars…” According to this notion of the power of advertising, the quality of the advertised product would only be secondary in terms of the success or failure of an ad campaign. Don’t forget that the tricks of the advertising trade are available to those who sell the best and to those who sell the worst products. But only the first will benefit from the advantages given by the better quality of their goods.
Advertising cannot create needs or desires in consumers for the simple reason that they must integrate the ideas and values on which that desire rests. As such, it is not a bad thing. Rather, it is very useful to the consumer in the sense that it communicates that a good is available and the potential benefits it brings. Advertising also tries to convince consumers that a product may satisfy their needs — a risky business, which may prove a success or a failure if the product doesn’t live up to its promise. In the end, the consumer has to choose which products will survive on the market.
Cécile Philippe is the Director of the Institut Economique Molinari.