Government hospitals and clinics are experiencing severe shortages of essential medicines, according to media reports last week. Government officials claim that the shortage of drugs in South Africa and worldwide are caused by profit-run pharmaceutical companies that do not base the distribution of medicine on patient need.
They overlook the fact that the business of pharmaceutical companies is to manufacture medicines, which they supply to government. It is the responsibility of government to distribute or have those medicines distributed to government health facilities. Pharmaceutical companies develop and manufacture drugs because of the profit motive. They are not charities and patients’ needs are served by virtue of the profit motive.
Warehousing and distribution of drugs and other medical supplies would be carried out much more efficiently if government were to rely on for-profit specialist private companies to do the work rather than attempt to carry out the operation themselves. They would deliver the supplies more efficiently and at lower cost. Such companies compete with each other on the basis of efficiency and price and government could employ several of them, carrying out warehousing and delivery in different parts of the country. There is, however, a proviso. If the performance of a private contractor is not up to standard over a protracted period, whoever has done the hiring has chosen the wrong contractor, has not ensured that the contract is properly written, has not built in penalties (including cancellation provisions), or is not doing sufficiently frequent and proper performance checks. The fingers that are frequently pointed at private contractors regarding poor performance point straight back at whoever is doing the hiring.
As a result of the competition for profit, pharmaceutical companies have initiated research and developed vaccines, antibiotics and a plethora of other medications that have increased life expectancies throughout the world, helping humanity to enjoy longer, happier, and more productive lives. If companies are prohibited from making a profit, they would not make the enormous investments required to bring drugs to market to serve patients’ needs.
The view that drug companies should not make a profit discounts the great amount of effort made by individuals in drug companies from the scientists, to the marketers, receptionists and cleaning staff, and every other citizen who invests capital in the company. The success of the company in meeting patients’ needs can be measured by the profit it makes. The profit it makes enables everyone involved to support their families and contribute to the fiscus through the taxes they pay. But, undoubtedly, those who benefit most, are the patients who need the medicines that company produces.
A common misconception is that healthcare, somehow, differs from other products. That government is justified in limiting profits by introducing price controls.But the market for medicines, medical care, and other health-related products are subject to the same laws of economics as any other good or service. Food is more important for human survival and welfare than medicines, yet government removed price controls on agricultural products once they recognised their damaging effect on the economy and the harm caused to consumers.
History, and basic economics, has repeatedly demonstrated that price controls result in shortages – why then do government officials act surprised when their ill-considered but well-intentioned policies deliver the exact consequences predicted by basic economic theory? Price controls, especially those that are fixed for protracted periods of time, are squeezing the profit margins of local pharmaceutical manufacturers to unsustainable levels because they prevent them from increasing prices when unavoidable input costs rise. But, instead of abolishing price controls, the government is seeking to introduce new regulations that will allow it to apply different rules to local and international manufacturers – clearly discriminatory and probably in violation of World Trade Organization rules.
Perhaps one of the most important and damaging long-term effects of drug price regulations is the impact they have on research and development (R&D). This impact is also somewhat difficult to measure and is often unseen because government and consumers are not aware of the lost innovation that would have taken place in the absence of price controls.
John Vernon of the University of Pennsylvania has estimated the impact of price controls on R&D. Using data from the 15 largest pharmaceutical manufacturing firms in the world, Vernon estimates several models of the determinants of R&D over the course of a decade. The results confirm that drug price regulation diminishes the incentives to invest in R&D. Moreover, the magnitude of the correlation is substantial, suggesting that R&D investment is highly sensitive to the degree of drug price regulation. The model predicts that investment in R&D could decline by up to 47 percent as a result of price controls.
Given the unintended, but unavoidable, consequences associated with price controls, is it not time for the South African government to reconsider this intervention? Why, instead of placing an inordinate amount of pressure on overstretched public sector officials to try and predict which way the exchange rate will move or where inflation is headed, do government officials not introduce policies that increase competition in the pharmaceutical sector?
As far as the claim by government officials that there is a “worldwide shortage of drugs”, to the best of my knowledge, the only places where this occurs is in countries that apply the same discredited policies of drug price controls – there is no shortage of medicines in market-orientated economies.But perhaps all of this is just a smoke screen to revive the South African government’s aspirations to introduce and expand the role of the state-run pharmaceutical company, Ketlaphela.
Like price controls, the economic consequences of local production by a state-owned pharmaceutical company are entirely predictable. South Africa’s other state-owned enterprises provide ample evidence to boot. Like them, and unlike privately owned companies that cannot rely on taxpayer bailouts, a state-owned pharmaceutical company will have no economic incentive to operate efficiently or profitably and will become a drain on the economy. More importantly, the state-owned company will create uncertainty among investors and “squeeze out” a number of highly efficient, innovative and generic manufacturers of drugs that already meet international quality standards and already operate in South Africa. Ultimately, patients’ needs will be even less accommodated and they will suffer. Let us hope the government will not wait until then before it calls the private sector in to rescue the situation.
Author: Jasson Urbach is an Economist and 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 FMF.