Opinion: Free Market Minute

Flu vaccine shortage is no fluke

The 2004 flu vaccine shortage offers a number of lessons about how regulation can really damage a market, and about the tendency of markets to attempt to compensate in an effort to serve consumer interests.

Like all pharmaceuticals in the U.S., the vaccine industry is and has been highly regulated. Drugs manufactured for sale in the U.S. are subject to Food and Drug Administration (FDA) oversight at both the production and the testing stages. It is also true that the U.S. government has made it increasingly more costly to produce vaccines in recent years, primarily due to added regulation. The U.S. government’s meddling in the production end of the vaccine market, added to its activity on the patient delivery end, almost guaranteed that a vaccine crisis would occur eventually.

Since 1999, two out of four manufacturers supplying the U.S. market with flu vaccines have quit production of the drugs. The reasons include expensive new inspection and licensing requirements (without any evidence that the existing system needed a stricter regulatory overhaul), and the fact that government purchase of a large percentage of the available doses keeps prices and profits extremely low relative to production costs.

Rising costs and artificially low revenues are sure ways to squeeze producers out of the industry, which is exactly what has happened. Government pays manufacturers a per-dose price well below the private market price ($6.80 vs. $8.50, by one recent estimate), then gives the shots away in selected programs like Vaccines For Children. Private doctors cannot compete on costs or price with the government, and may even steer private patients to clinics and other government-supplied sources. The result is a substantial increase in the demand for low and zero price doses.

Unfortunately, there is no corresponding incentive for manufacturers to step up production and supply. No wonder fewer producers find it worthwhile to manufacture flu vaccine, and fewer private practitioners feel the need to keep patient doses in stock. When British-operated Chiron’s production process (not its flu vaccine product) did not pass tougher new regulatory standards, increased scarcity of vaccine for U.S. consumers was guaranteed. If the scarcer vaccine had been available to consumers at a market-determined price in 2004, other forms of rationing would not have been necessary, and producers would be getting the right signals about production for the 2005-06 flu season.

What turned increased scarcity into shortage this year? Many U.S. consumers receive subsidized doses of vaccines, which keeps demand high. In fact, that is precisely the intention of public health programs that offer vaccines. Since people who are not vaccinated themselves benefit indirectly—less exposure to sick individuals—from the vaccines, the argument is that few people would be willing to pay for the vaccines outright. They can become “free riders,” allowing others to pay for and receive a vaccine while they benefit at no cost.

If everyone decides to “free ride,” no one pays and no one is protected. This is unlikely to occur, but it is the excuse for government’s deliberate tinkering with the demand side of the market. As long as the government subsidizes the shots with extensive giveaway and voucher programs, some people who could pay will demand vaccinations for free, while others who would forego the shots altogether will get them only because they cost nothing. The result is to artificially inflate demand, instead of letting consumers weigh risks, benefits and costs in consultation with their doctors.

A market skewed on both the supply and the demand sides, as this one has been, has little chance of coordinating the plans of producers and consumers. And even though many of the restrictions for prospective flu shot patients have now been lifted, rationing by age, health, and occupation are still preventing some U.S. citizens from purchasing flu shots if they want them.

Happily, the market has a tendency to try to work around even the most intractable problems. Barred from obtaining the vaccine, consumers are flocking to what they regard as the next-best substitutes (subscription only). Retailers are having an easy time selling disinfectants, anti-viral tissues and antibacterial wipes, cold and flu medications, surgical masks and latex gloves, vitamins and other items designed to prevent or limit the exposure and duration of winter season diseases. Consumers know these items aren’t the perfect substitute for a flu shot, but demand is creating a mini boom in the personal and home hygiene markets nonetheless.