On Wednesday, in the latest edition of "when regulators attack," European Union regulators raided pharmaceutical firms and generic-drug makers' operations throughout Europe.

Representatives of the E.U. raided operations of multiple large companies, including GlaxoSmithKline (NYSE: GSK), Pfizer (NYSE: PFE), and Teva Pharmaceuticals (Nasdaq: TEVA), looking for antitrust and anticompetitive actions in both the branded and generic sectors. They're looking in the wrong places.

On the hunt
Because few innovative drugs entered the marketplace from 2000 to 2004 -- sort of an arbitrary period to select -- and generic drugs were sometimes being delayed, the European Commission (regulators of the European Union) decided to launch an inquiry. Even though regulators weren't looking at specific instances of antitrust violations, they decided to unilaterally raid all these places in "a response to indications that competition in pharmaceutical markets in Europe may not be working well."

The Commission's findings will be used to better understand what is causing the delay in new drug developments and could lead to antitrust proceedings against manufacturers found to be acting in anticompetitive ways (sort of like what happened to Microsoft (Nasdaq: MSFT) with the European Union last year).

Missing the most important point
Ironically, one of the areas that most affects pharmaceutical innovation isn't even slated for review in the antitrust inquiry. The Commission won't "question the various health schemes" that countries use despite the fact that the economic signals and incentives employed by government and private payers is one of the most important ignition switches, or dampening effects, on new drug development.

If the commission is worried about fewer new pharmaceuticals being brought to market, then the first place it needs to look is at the regulatory agencies and government payors that govern the approval and payment for new and generic drugs. You don't need a Ph.D. in economics to realize that if a drugmaker isn't offered enough of a potential reward for investing the time and money that it takes to bring a new drug to market, then the drugmaker simply won't work on that drug. Government health-care payment schemes have a huge effect on pharmaceutical innovation. Scholarly articles in the health economics field (as seen here, here, and here) describe how European governments' reimbursement policies restrict competition and innovation.

Equally as bad, in some cases, countries also restrict generic drug reimbursement to such a low rate that it doesn't make it worthwhile to even bring a particular generic drug into the country. The U.K.'s profit control scheme for pharmaceuticals is just as onerous.

As with any artificially created price controls, the predictable side effect of restrictive drug reimbursement policies is that drugmakers earn less profits on the sale of their pharmaceuticals in Europe and aren't as quick to market their drugs there. Combine this with a hodgepodge of complicated and differing reimbursement rules among the countries, and it's no wonder certain compounds never take off in some European countries.

Not seeing the forest for the trees Getting back to the antitrust commission and its raids: Clearly, there have been individual cases of drugmakers possibly inhibiting competition by abusing patents. Take a look at the history of Genentech's (NYSE: DNA) Cabilly patents or Sanofi-Aventis' (NYSE: SNY) Lovenox for examples, or at drugmakers paying generic-drug makers to not launch knockoffs of their drugs. The courts have found that these things occurred in the U.S. and E.U. on more than one occasion.

An interim report on the European Commission's findings is due in the fall, with a final report out in the spring of 2009. Rather than use its time looking at possible instances of anticompetitive behavior by drugmakers (if any violations are found, they could be settled with lawsuits), it would be much smarter for the Commission to also take a closer look at the imperfect competition the buyers of pharmaceuticals (namely, large government  payors) are dealing with. After all, anticompetitive demand-side policies can be just as damaging to the functioning of markets as anticompetitive supplier actions.

As an article published last year by one European think tank puts it (opens a PDF file): "In their cost containment efforts, [drug reimbursement policies like Germany's] are ultimately decreasing indirectly the returns from investment in R&D and are reducing incentives to invest in developing future drugs."

I couldn't have said it any better. So where's the European Commission investigation into these damaging and injurious government reimbursement policies?

More Foolishness on government raids:

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Fool contributor Brian Lawler does not own shares of any company mentioned in this article. The Fool's disclosure policy is not subject to a European antitrust investigation.