By Kenneth Rapoza, Industry Analyst, CPA
President Trump and many members of Congress are talking about reshoring pharmaceutical production. We look at the benefits of reshoring in health security, national security, and the economy. We also look at challenges to this objective, including the shortcomings in current Buy American and related legislation, the vague definitions of true US-based production that need to be cleared up to give us a solid path to reshoring, and the importance of reshoring production of both active pharmaceutical ingredients and final production. Finally, we look at several pieces of legislation now under consideration that could lay the groundwork for a large-scale reshoring effort.
President Trump’s Executive Order on Essential Medicines was signed on August 6 to help assure that the U.S. has its own supply of the chemical compounds and materials needed to make drugs deemed essential. It’s a step in the right direction. But the Buy American Act of 1933 and other laws do not go far enough to specify the requirements for rebuilding a US pharmaceutical industry that will be able to give the US the security of supply the EO hopes for.
The EO states that its intent is to “ensure long-term demand for essential medicines, medical countermeasures, and critical inputs…are produced in the United States.”
Going forward, what is needed beyond the EO is a clearer definition of what constitutes a secure supply of pharmaceuticals, which pharmaceuticals should be included, and what federal agencies will manage this process and make the decisions. We look at some of these issues here and give some ideas to remedy the uncertainty in the long term. The FDA and the Congressional Research Service have made similar points in their deep dives on the matter.
As it stands, there is vagueness about how to define a US-made product in at least two buy America trade acts. The Customs and Border Protection has taken its own position at times, labeling active pharmaceutical ingredients from abroad as constituting a foreign-made product even when encapsulated and manipulated in a US lab. Those views have been the source of legal disputes. There is a lot of uncertainty still to be cleared up.
The EO eliminates the exemptions for 20 countries that are part of the World Trade Organizations’s Government Procurement Agreement (which includes Hong Kong, a China gateway), but many of the active pharmaceutical ingredients (API) necessary to make essential drugs here will continue coming from foreign labs unless existing trade laws are updated.
The US can expand its footprint domestically. Labs already exist to do research and development. American manufacturers of API, the chemical compounds that are then formulated into tablets, capsules, and injectables, account for roughly 28% of the market. The remaining 72% of the API manufacturers supplying the US were overseas, with 26% coming from Europe, 18% from India, and 13% in China, the Food and Drug Administration’s director for drug evaluation and research, Janet Woodcock, noted in her October 30, 2019 testimony before the House Committee on Energy and Commerce, Subcommittee on Health.
Trump’s Executive Order is good in the immediate term to initiate reshoring production, but it is not permanent. A new President can do away with it. Changes need to be made to existing laws to make this a long term, domestic investment, and an established business.
Many advocate the strengthening of Buy America laws, but don’t know how the Buy American Act of 1933 and the Trade Agreement Act of 1979 work or, even if strengthened, would be sufficient to reshore production. The Congressional Research Service recently released a report explaining the relationship between US government purchasing laws and international trade laws and their report shows the holes in two main government purchasing contracts designed to support domestic business.
The Buy American Act, for example, is a price preference law, not a mandate to buy domestic goods. The Trade Agreement Act prohibits the government from purchasing products and services from countries not part of the WTO GPA.
“Congress may wish to clearly define terms and requirements and set uniform guidelines regarding foreign sourcing in federal procurement. This could promote transparency, consistency, and proper application of standards in procurement decisions, thereby ensuring that agencies carry out procurement objectives as prescribed by Congress,” Andres Schwarzenberg, an analyst in International Trade and Finance for the Congressional Research Service (CRS), wrote in its June 18 In Focus report titled U.S. Government Procurement and International Trade.
The Buy America Act mandates that over 50% of a product made for order by a U.S. government agency come from the U.S. If 45% came from China, that’s still fine under the BAA. If the product currently cannot be purchased locally, then government would be allowed under BAA to find it elsewhere. The contract is awarded primarily based on price, and the government will put a “penalty” of anywhere from 6% to 12% above the bid price for foreigners looking for civilian government work, and as much as 50% for foreign firms bidding on Defense contracts. If the product cannot be found here, like many essential medicines, then the government can contract foreign firms. In other words, the Buy America Act is unlikely to lead to any significant reshoring of anything.
The Trade Agreements Act doesn’t give a percentage of what part of the end product has to be made in the U.S. It simply states that a “substantial part” should be domestically produced, sourced. Any inputs used should not be recognizable in the finished product. Also, if you are part of the 20 countries that make up the WTO GPA, then the “substantial part” portion of the rules is exempt. Those countries can be found here. If the latest EO were to be revoked by a new president, the WTO GPA rules would once again apply and not a single item would be required to be made in the USA under TAA rules.
The vagueness here, which can be remedied, is the part about “substantial transformation”.
“When an item in trade does not come entirely from a single country, this legal principle is used to determine the origin of the item for purposes of recording trade data, assessing duties, marking, or applying other measures. As developed by U.S. courts, the term means that the item underwent a fundamental change (normally as a result of processing or manufacturing in the country claiming origin) in form, appearance, nature, or character, which adds to its value an amount or percentage that is significant in comparison to the value which the item (or its components or materials) had when exported from the country in which it was first made or grown.”
When considering essential medication, for the sake of argument, we think all essential ingredients should be made in the US. For example, with a low-priced antibiotic like tetracycline, of which China dominates production, it may be that the APIs are worth $1, but once it is turned into an injectable medication, it may be worth $5 per injection. The APIs may be only 20% of the value. But those APIs are essential to that $5 antibiotic drug and should all be produced here because without, the $5 injectable cannot be made,.
If they are not made here, in the event of an emergency, it could take months to build a high capacity manufacturing facility to make the APIs and the final product here in a moment of spiking demand. We saw this with ventilators during the height of the pandemic in the northeast. Whoever thought ventilators were top of mind? These are $10,000 products American manufacturers were able to make in an emergency, but we had shortages in the spring because certain parts were hard to get. They were likely only a minority of the value of the ventilator, and surely they were substantially transformed and would not change the final product’s manufactured origin in the event of a government purchase. But they were essential parts that stopped assembly lines and left some COVID patients in intensive care without life-saving ventilators. If it’s deemed essential, just make it all here.
Here is a quick look at some drugs the World Health Organization deems essential and China’s market. Although President Trump did not say the US essential medicine list would mirror that of the WHO, we think the FDA will use that as its guidepost.
Source: CRS with 2019 year-end data from the US International Trade Commission's DataWeb
Rules of origin for pharmaceuticals and other products are important and must be clear because hospitals, doctors, pharmaceutical companies, and everybody in the supply chain needs clarity to develop policies and invest in production in the US with clear expectations.
Recently, the Veterans Administration placed an order for a hepatitis-B medication called Entacavir. It is a WHO essential medication. New Jersey-based Acertis Health won the contract, but when Customs and Border Protection (CBP) said that the India-made APIs would not be substantially changed in final production by Acertis, the VA canceled the order because the drug would have been defined as being of Indian origin. For the CPB, there was nothing Acertis would have done in its labs to significantly alter the material from India, therefore it was an Indian product and the VA could not issue a government contract for Indian medication.
Acertis sued, asserting their lab work did indeed alter the nature of the imported chemicals. They won. (The contract had already gone to their competitor, Golden State Medical Supply.)
In a February 10, 2020 decision, a Federal Circuit court affirmed a Court of Federal Claims decision sustaining a protest that challenged the US Department of Veterans Affairs' interpretation of what constitutes a "US-made end product" under the Federal Acquisition Regulation (FAR) provisions implementing under the TAA. The Federal Circuit ended up rejecting the VA's contention that the CBP's Country of Origin determination was "binding" on the VA, leaving the VA no discretion. The court agreed with the Federal Claims court ruling, finding that the "procuring agency" is "responsible for determining whether an offered product qualifies as a US-made end product.”
The courts decided that the tablets were not a "product of India”, explaining that it was significantly altered from its original input. According to the higher court, "it is clear from the TAA that the product is the final product that is procured – the pill itself– rather than the ingredients of the pill.”
So far, the U.S. government has not opted to take the VA case to the Supreme Court. But this case highlights the fact that the TAA and BAA are not sufficiently clear and are not sufficient to drive the reshoring of production.
In another unrelated case, a Swiss pharmaceutical company making Toprol-X, which is made from metoprolol succinate imported from Asia, could not declare its drug as Made in Switzerland because the API was again deemed by CBP as not sufficiently altered to be a new product.
There is enough ambiguity to make pharmacological inputs a confusing part of any domestic strategy for critical drug supply. Of all countries supplying API, we do not think a country listed by the Director of National Intelligence as the U.S.’s biggest threat (China) to be considered a reliable, core supplier.
In addition to health security and national security considerations, a re-shoring program for pharmaceuticals would make a strong contribution to the US economy. A CPA published in March said that a program of reshoring the production of approximately half of US pharmaceutical imports would add 800,000 jobs and $200 billion to the US economy. Pharmaceutical manufacturing jobs pay about 40 percent more than the average US job, so these would be good-paying jobs in a growth industry.
Current Bills Addressing Essential Medicine
Congress is putting some thought into this. The CARES Act helps get the ball moving from a data perspective. And some new bills in both the House and Senate address the issue of origin from a reshoring perspective. Here are some that were highlighted in an April 6, 2020 Congressional Research Service report titled COVID-19: China Medical Supply Chains and Broader Trade Issues.
- P.L. 116-136, The Coronavirus Aid, Relief, and Economic Security (CARES) Act includes several provisions that expand drug shortage reporting requirements to include APIs and medical devices. The bill also requires certain drug manufacturers to draw up risk management plans and requires the FDA to maintain a public list of medical devices that are determined to be in shortage. Additionally, the bill directs the National Academies of Science, Engineering, and Medicine to conduct a study of pharmaceutical supply chain security.
- H.R. 5982, The Safe Medicine Act would direct Health and Human Services to assess vulnerabilities in the U.S. pharmaceutical supply chain by issuing a report that examines U.S. dependence on China for critical APIs and gaps in domestic pharmaceutical manufacturing capabilities.
- H.R. 4710, The Pharmaceutical Independence Long-Term Readiness Act would direct the Department of Defense to include a section in each national defense strategy that outlines steps to address gaps in the U.S. pharmaceutical manufacturing base and strengthen pharmaceutical supply chains with single points of failure.
- S. 3538 Strengthening America's Supply Chain and National Security Act would require companies to report on the sources of their APIs and would tighten laws encouraging the U.S. Department of Veteran Affairs to buy American pharmaceuticals. The bill calls for federal financing guarantees to U.S. medical supply companies with production in the United States. Its goal is to “set forth recommendations to ensure that by 2025 no pharmaceutical products purchased for beneficiaries of health care from the Department of Defense or any associated program are made in part or in whole in a covered country.” That targets API, too.
- S. 3537 Protecting Our Pharma Supply Chain From China Act would require the FDA to establish a registry to track APIs and institute a country-of-origin label for imported drugs. The bill would provide economic incentives for producing pharmaceuticals and medical equipment in the United States. The bill also would prohibit federal agencies and health facilities from purchasing APIs and other pharmaceutical products manufactured in China without an FDA waiver certifying that China is the sole source.
- S. 3343, The Medical Supply Chain Security Act calls for enhanced security of the medical supply chain and enhanced FDA authority to request information about the sources of drugs. There’s a companion bill in the House: H.R. 6049; introduced in the House of Representatives on March 2, 2020, but still those who like the status quo are making sure there is little to no movement on these bills.
Another way to go about this in the near-term, other than the EO, is to increase tariffs on medical supplies and pharmaceuticals. Companies must be incentivized to invest here. But to invest here, they must also have a large enough market to get to scale. Tariffs protect against foreign cheating or price predation designed to hobble our domestic industry as it expands domestically.
The U.S. has relaxed definitions of what qualifies as a U.S. product with imported content, masking the extent to which domestically-produced products – in this case, essential medicines -- may still rely heavily on inputs from overseas, the April 6threport by CRS states.
Vulnerabilities regarding the raw materials used to make medications are not well recorded in trade and industry data. They are even harder to track when materials are shipped from China and processed in a third market such as India.
Moreover, information on pharmaceutical company production processes and stockpiles are private. Companies do not have to report on reserves. They are only required to report when they have a shortfall, which does not leave enough time, particularly in a public health emergency.
CRS report authors led by Karen Sutter wrote that the president had options to dig deeper into pharmaceutical companies’ private supply chains.
Under the International Investment Survey Act of 1976, the President has wide authority over the collection of corporate activity abroad for statistical and analytic purposes. The Act also gives the President the authority to request mandatory surveys of companies under specific deadlines with the ability to invoke civil and criminal penalties for noncompliance. To address these issues, Congress could consider whether to request the President to invoke his authority over the US government’s collection of data on corporate activity abroad. These corporate surveys could obtain specific supply chain information about the status of API, essential medications, distribution, and export policy facing US companies. Such insights could further “inform legislation that Congress has already passed, or is considering, with regard to overseas supply chains,” CRS report authors wrote.
We need mandates for essential medicines that last longer than a presidential Executive Order. That means we need to change the law. Some of the above bills will do exactly that.
For existing trade rules discussed here in the BAA and TAA, there should be a more specific stipulation than that some arbitrary percentage of the value is added in the US. We need to replace “substantial transformation” rules with rules that require every essential component of the product, as well as the final product itself, be made in the US.
We should exclude the WTO GPA agreement from applying to goods deemed critical to US national security. Why are we giving contracts to Portugal if it’s a job creator back home? Is Portugal, or any other European nation, doing the same under their WTO GPA exemptions?
Much of the criticism targeting the White House’s “failure” to make “buy American” a priority is due to these Acts that do not come close to mandating, let alone requiring government purchase orders to be domesticated.
The good news is we have bipartisan agreements in Congress to turn essential medical needs into a security issue. Reshoring essential medication is a job creator, and surely a job keeper in the high paying STEM fields.
We have learned in this pandemic that unless we make certain things here– whether it’s hospital gowns or therapeutic drugs used to fight SARS-2 – we will be left scrambling. In a pandemic, we lose lives. Even in normal times, we lose jobs to countries that do not play by our rules, such as those countries that are seeking market share dominance or strategic advantage over the US. Congress has seen the public supports action on healthcare self-sufficiency. Congress also has support for job-creating policies that keep Americans employed in high paying jobs. We think these bills above should be voted on before the pandemic is over and they are cast aside until the next public health crisis.