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International Journal of Health Economics and Management

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21.12.2016 | Research Article

Drug innovation, price controls, and parallel trade

verfasst von: Giorgio Matteucci, Pierfrancesco Reverberi

Erschienen in: International Journal of Health Economics and Management | Ausgabe 2/2017

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Abstract

We study the long-run welfare effects of parallel trade (PT) in pharmaceuticals. We develop a two-country model of PT with endogenous quality, where the pharmaceutical firm negotiates the price of the drug with the government in the foreign country. We show that, even though the foreign government does not consider global R&D costs, (the threat of) PT improves the quality of the drug as long as the foreign consumers’ valuation of quality is high enough. We find that the firm’s short-run profit may be higher when PT is allowed. Nonetheless, this is neither necessary nor sufficient for improving drug quality in the long run. We also show that improving drug quality is a sufficient condition for PT to increase global welfare. Finally, we show that, when PT is allowed, drug quality may be higher with than without price controls.

Nur mit Berechtigung zugänglich

The EU has adopted a regime of regional exhaustion of IPR, where IPR are ended upon first sale in the region, but are not exhausted outside. The US has opted for a regime of national exhaustion, where IPR hold for imported products. Developing countries often support international exhaustion, which means complete trade liberalization.

According to EFPIA (2016), the EU pharmaceutical industry spends 14.4% of net sales on R&D. Pharmaceutical PT in the EU is estimated to amount to € 5589 million at ex-factory prices (EFPIA 2016), with market shares above 50% for some key patented drugs (Kanavos and Costa-Font 2005).

We model a generalized Nash bargaining process where parties have different bargaining power (see Pecorino 2002). In the extreme cases, all the bargaining power is on the manufacturer’s side, or on the government’s side.

Therefore, we exclude the case of ‘full commitment’ where the foreign government negotiates the price before the R&D investment stage, and thus considers the effect of the negotiated price on the global investment in R&D.

We exclude the case where the foreign government can use compulsory licensing after R&D investment is sunk (‘no commitment’), by which it would compel the firm to serve the foreign country even without fair remuneration (for a formal analysis, see Stavropoulou and Valletti 2015). In some cases, the World Trade Organization (WTO) authorizes governments to make exceptions to IPR protection and enforce compulsory licensing. To our knowledge, this option has rarely been used in developing countries, whereas it has not been used at all in the EU.

In a different setting, Matteucci and Reverberi (2005) study how public service obligations on pharmaceutical distributors may allow national governments to manipulate parallel exports to improve local welfare. They also do not consider R&D investment.

In the EU pharmaceutical industry, parallel traders are usually authorized wholesalers and distributors. Consistent with empirical evidence, we have developed an alternative model specification where PT arises in wholesale markets (as in Matteucci and Reverberi 2014, who however do not consider price controls). This vertical distribution model of PT exhibits an equilibrium with parallel imports and different retail prices across countries. Nonetheless, the main qualitative results replicate those of the simpler model developed in this paper (further details are available from the authors upon request).

For convenience, we use primes to denote derivatives of functions with respect to (hereafter, wrt) x.

For a given quality, the benefits of a drug may vary within the population of patients in terms of efficiency, tolerance and side effects (see Bardey et al. 2010). In our model, \(v_j \left( x \right) \) measures the gross benefit to each patient of a drug of quality x (due to the ‘average efficiency’ of the drug), whereas z captures the impact of the dispersion of individual tolerance and side effects among patients. We borrow the demand structure from Katz and Shapiro (1985) and several others. Qualitative results hold for more general demand structures as long as changes in product quality imply parallel shifts in demand curves.

A national health plan may (partially) reimburse consumers for their purchases of selected drugs. For simplicity, we assume that consumers pay the full price of the drug. In “Conclusion and policy implications” section, we discuss the welfare effects of reimbursement policies when PT is allowed (for a formal analysis, see Jelovac and Bordoy 2005, who however do not consider R&D investment). We also consider the patient and the physician as a single agent (the consumer). We can thus abstract from moral hazard in drug consumption.

Assumption 1 is overly restrictive. Indeed, for both markets to be served under both regimes it suffices that \(\underline{\theta } =\sqrt{2}-1<1/2\). Assumption 1 simplifies the analysis without affecting the main results.

This is because \(\frac{\partial p_2^n}{\partial \alpha }<0\) and \(\frac{\partial D_1^i}{\partial \alpha }=\frac{\partial D_1^i }{\partial p^i}\frac{\partial p^i}{\partial \alpha }>0\), since \(\frac{\partial D_1^i}{\partial p^i}<0\) and \(\frac{\partial p^i }{\partial \alpha }<0\) (\(p_1^n\) and \(D_1^n\) do not depend on \(\alpha \)).

Pecorino (2002) assumes that, except for a scaling factor, demand is the same in the two countries. Hence, in his model the demand dispersion plays no role. Lemma 1 shows that one should consider both the demand dispersion and the government’s bargaining power for determining the effect of PT on the manufacturer’s profit.

We also find that, if G’s bargaining power increases then the difference \(W^{i}-W^{n}\) also increases, namely, \(\frac{\partial \left( {W^{i}-W^{n}} \right) }{\partial \alpha }>0\) holds (for brevity we omit the proof, which can be obtained from the authors upon request).

In “Examples” section, we provide two examples where we introduce specific functional forms for the demand parameters \(a_j \equiv a_j \left( x \right) , j=1,2\), and the R&D investment cost \(C\left( x \right) \). Therefore, we can write condition (8) as an explicit function of the exogenous parameters of the model. The same reasoning can be applied to conditions (9) and (11).

When consumers have preferences for quality à la Mussa and Rosen (1978), the demand dispersion is independent of quality. This is the case, for instance, in Bennato and Valletti (2014). Since in their model the firm’s short-run profit is lower in regime i than in regime n, then quality is also lower under (the threat of) PT.

More formally, Assumption 1 ensures that \(x^{i}\) is lower than the socially optimal quality level in regime n, that is, the welfare function in regime n is increasing at \(x^{i}\) (see “Appendix 4”).

For brevity, we omit the proof, which can be obtained from the authors on request.

Condition \(1/3<\theta \left( x \right) <1\) ensures that both markets are served in the absence of price regulation. Thus, for comparison purposes we still refer to Assumption 1.

In this example, the necessary condition for quality to be higher with than without the price control in country 2 under regime i, that is, \({\theta }'<0\) (see “The impact of price regulation” section) is not fulfilled. Therefore, \(x^{i}<\tilde{x}^{i}\) always holds.

Since the expression of \(x^{i}\) is quite complicated, we provide here a numerical approximation.

Consistent with the prevailing view, we have also found that banning PT reduces welfare ex post. A ban on PT both causes a misallocation of output across countries and reduces total output wrt the case where PT is allowed.

For instance, in the recent ‘Policy package for medical innovation, in line with fiscal and economic policy’, Japan affirms the need to consider reward for innovation in reimbursement prices (see the report by the Ministry of Health Labour and Welfare, For the future of medical innovation, August 2015; retrieved from: http://pari.u-tokyo.ac.jp/eng/event/smp150818_takeda_en.pdf).

For a recent critical review of pricing and reimbursement policies for innovative drugs in Europe, see the report by the World Health Organization (WHO), Access to new medicines in Europe, March 2015; retrieved from: http://apps.who.int/medicinedocs/documents/s21793en/s21793en.pdf.

The demand dispersion and the government’s bargaining power are usually taken as independent parameters, but the bargaining power might increase as the demand dispersion is smaller (i.e. the foreign country is stronger).

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EFPIA—European Federation of Pharmaceutical Industries and Associations. (2016).The pharmaceutical industry in figures. http://www.efpia.eu.

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Titel: Drug innovation, price controls, and parallel trade
verfasst von: Giorgio Matteucci
Pierfrancesco Reverberi
Publikationsdatum: 21.12.2016
Verlag: Springer US
Erschienen in: International Journal of Health Economics and Management / Ausgabe 2/2017
Print ISSN: 2199-9023
Elektronische ISSN: 2199-9031
DOI: https://doi.org/10.1007/s10754-016-9205-5

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