Regulating drug prices is a recipe for disaster

The South African government is introducing a new methodology for regulating the prices of patented medicines. The regulations have serious long-term implications for access to new drugs. The government is mistakenly assuming that bureaucratic central planners are better than competitive free markets at setting prices at levels that will produce the best balance of supply and demand. Unfortunately, this state intervention in drug pricing will distort market dynamics and reduce incentives to bring new drugs to market in South Africa over time. In the future this could lead to shortages of new medicines in South Africa and that will have disastrous implications for public health in the long-run.

According to a letter sent by the government to pharmaceutical makers, the new regulations will use an international “benchmark” to set the legally allowable prices of new drugs. The benchmark will be based on the lowest price observed in a group of countries arbitrarily selected by the government. This group of countries includes Australia, New Zealand, Canada, Spain and South Africa.

Yet, the drug prices in the selected countries are not reflective of market prices. This is because drug prices in the group of countries that will be used to benchmark South African prices are also regulated by governments, and are not determined by supply and demand conditions.

For instance, Canada’s national government also uses international “benchmarks” to set drug prices. New drug prices in Canada are limited to the median of the prices for the same drugs in France, Germany, Italy, Sweden, Switzerland, U.K. and the USA. Canada’s national and ten provincial government-operated drug plans also further regulate drug pricing by restricting many drugs from eligibility for public reimbursement on the basis of cost. In fact, only 44% of all new drugs approved as safe and effective by Health Canada in 2004 were eligible for public reimbursement under provincial drug insurance programmes as of the end of 2007.

This means that if the lowest price observed among the group of countries used to benchmark South African prices happens to be Canada, this price will not be reflective of a fair market price that would optimise supply and demand because it is based on prices that are arbitrarily regulated directly by the national government, and indirectly by the provincial governments of Canada.

The distortionary effect on South African drug prices will also be compounded, since the regulated Canadian prices are in turn benchmarked against a group of countries which (with the exception of the USA) also arbitrarily regulate drug prices, and which in turn benchmark their prices against other countries that regulate the price of patented drugs, and so on, and so on.

This will create a downward spiral in which drug prices are continually reduced to levels that are far below where they would be if they were determined by normal market forces of supply and demand. Over time, as prices are reduced to unrealistic levels, it will become less feasible to make a business case to bring new drugs to markets like South Africa where prices are set too low.

This is what has happened in Canada. In 2006 Bristol-Myers Squibb made a justifiable decision not to sell Erbitux, its new drug for colorectal cancer, in Canada. The company wouldn’t sell the drug here because Canada’s price-control agency demanded an unreasonably low price for it, hence probably destroying the business case for introducing the drug to our market.

The Erbitux decision illustrated that enough misguided pharmaceutical policies can eventually make the business environment for pharmaceutical makers so inhospitable that the reason for serving the market disappears altogether.

To make matters worse, heavy-handed interference in drug markets by Canadian governments provides no overall cost-savings for consumers compared to the free-market approach of the USA. Total per capita prescription drug expenditures make up roughly the same percentage of income in both countries.

As a percentage of income before taxes, per capita spending on prescription drugs was 1.5 percent of per capita gross domestic product (GDP) in Canada compared to 1.7 percent in the USA. As a percentage of after-tax income, per capita spending on prescriptions in Canada was 2.5 percent of personal disposable income (PDI) compared to only 2.3 percent for Americans.

On top of this, Americans have access to more new drugs than Canadians, and the USA attracts proportionally more investment from the pharmaceutical industry. Add it all up and there are no advantages at all from Canada’s central planning approach to prescription drug prices. The lesson is clear: South African governments should act in the interest of taxpayers and patients, and adopt more market-based approaches to drug pricing.

Author: Brett J. Skinner is Director of Bio-Pharma, Health and Insurance Policy at the Fraser Institute and a PhD candidate at the University of Western Ontario in Canada. 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.

For more information please contact:
Eustace Davie, Director
Tel: 011 884 0270, Fax: 011 884 5672, Email:

HPU Feature Article / -3 October 2008

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