Government should not fix medicine prices

Government’s decision to get involved in the pricing of medicines has ramifications that go far beyond the provision of health-care. Setting maximum prices for goods has caused misery and death over the ages and could do so again. There are many historical instances in which such controls have escalated into full-scale authoritarian government management of economies, leading to poverty, famine and the fall of civilisations.

An American soldier was shot dead last year while guarding a queue of angry Iraqis waiting in line to buy price-controlled petrol at a government-owned filling station. Had there been competing private petrol stations and no government-set maximum price the tragedy would not have occurred. Prices would have adjusted to a level at which supplies met demand without causing queues of frustrated customers.

Similar queues formed when the American government tried to keep petrol prices artificially low during the 1970s. As soon as the price controls were removed and the price was allowed to increase to its real market level, the queues disappeared. The artificially low price encouraged higher consumption and reduced supply. Logic, or the laws of economics if you will, tell us that was inevitable.

In giving evidence to the Department of Health’s Pricing Committee on the pricing of medicines, the directors of the FMF predicted, based on the laws of economics, that price controls on medicines would cause similar shortages. There would be a tendency for consumption to increase and supply to diminish, which was obviously not what the Health Department’s regulations were attempting to achieve. Startlingly, a member of the committee told us that there is no such thing as ‘the laws of economics, there is only theory’. FMF Executive Director, Leon Louw, then quietly suggested that the law of economics incorporated in the statement that ‘there ain’t no such thing as a free lunch’ (commonly known as TANSTAAFL) is indisputable.

That the Department of Health and its pricing committee may have the best of intentions will not reduce the potential harm their proposed regulations will cause. Attempts to change or ‘improve’ outcomes by intervening in the economy for political reasons will almost without fail have negative consequences. The reason is that ‘the economy’ or ‘the market’ consists of the sum of the activities of the entire population, all attempting to maximise their welfare. In using a mechanism such as price control, government tries to prevent consumers from freely exercising their choices, and simultaneously, to take over the functions normally performed by supply and demand in the market-place. This is what the Pharaohs of ancient Egypt did when they instituted price controls on wheat, ostensibly to prevent a famine. In doing so, they disrupted production and supply and induced a famine that eventually ended their reign.

Similarly, the Roman emperor Diocletian instituted stringent price controls in an effort to correct the consequences of earlier price controls on wheat and other goods dating back to the fourth century B.C., a situation he exacerbated by debasing the currency. He imposed the death penalty on anyone contravening the controls or withholding goods from the market. One historian described the result: ‘the people brought provisions no more to market, since they could not get a reasonable price for them, and this increased the dearth so much that … the law itself was set aside." Diocletian paid a price for attempting to buck the laws of economics – he was forced from the throne after just four years.

When Paul Stewart, the Chief Executive of Boehringer-Ingelheim declared during the FMF panel discussion on the proposed medicine pricing regulations that his company had recently invested R600 million in South Africa but would invest no more if the pricing regulations were implemented in their published form, he was merely stating the economic reality that would face his company. He did not say that his company would withdraw from South Africa: he said it would cease investment. To describe his declaration as a threat consisted of inaccurate reporting and a misuse of language. The real threat lies in the regulations and not in the reactions of the pharmaceutical companies.

The laws of economics predict that having 50% sliced off their listed selling prices will make doing business in South Africa extremely unattractive to pharmaceutical companies, if not totally impossible. What makes matters even worse is that the regulations intend to disrupt the medicine distribution channels: distributors, wholesalers and pharmacists are to have their profitability severely harmed if not destroyed. The whole supply chain, from manufacturer to corner pharmacy, hospital, clinic, supermarket and spaza shop will be affected. Some will disappear and others will have to find other products to sell. Pharmaceutical companies will have to curtail or stop investment and will in time perhaps do as the Roman merchants did, fold their tents and go away to countries more friendly towards producers, in this case of life-saving medicines.

The Department of Health may respond that it is merely doing the same as other countries by instituting price controls on medicines. That may be so but our consumers will also pay the same price: the unavailability of the most modern medicines. Europe is discovering that it is losing pharmaceutical research to the U.S. precisely because it has price controls. So instituting price controls is not a winning formula in the country competitive stakes.

More importantly, price controls on medicines could lead to unnecessary deaths in South Africa, not because a frustrated consumer pulls out a gun and shoots a soldier guarding the price-controlled product, but because a vital medicine is not available due to the disruption of the supply-chain. Prices freely formed in a market that has no regulatory barriers to entry or disincentives to production and distribution are essential signals that guide suppliers as to what is in greatest demand and where they must concentrate their productive effort. Remove those essential signals by fixing prices by regulation and the entire information process is destroyed.

The proposed medicine pricing regulations will undoubtedly have negative consequences for health-care in South Africa. Patients, and especially those in rural areas, will be denied access to medicines because the costs of supplying them will exceed the controlled prices. Some medicines will no longer be manufactured in South Africa or imported. The costs of compliance, as well as that of implementing and policing the system will be immense and regulation will be piled upon regulation in futile efforts to make it work. A negative message will be sent out to the world’s investors, suggesting that South Africa is not a good place in which to do business. As a developing country with massive unemployment, South Africa needs all the investment it can get, so we need to start treating investors like businesses treat their customers – be nice to them.

Author: Eustace Davie is a director of the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Free Market Foundation.

FMF Feature Article /6 April 2004

Correction and apology: This article originally stated that a member of the pricing committee declared that there is no such thing as laws of economics, "there is only politics" - the article should have read "there is only theory".

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