Submission on the Regulations Relating to a Transparent Pricing System for Medicines and Scheduled Substances

26 July 2012
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This document explains fundamental problems with price controls and then examines some international experience of controlling the price of medicines, and the impact these regulations will have in South Africa if implemented.

Drug price regulations, as with any form of price control, will not and cannot protect consumers or ensure lower drug prices. Governments have for over 40 centuries attempted to control prices and in every case the regulations have interfered with the normal market process, have reduced competition and ultimately have harmed the consumer. Consumers are most effectively protected by open competition which gives the maximum power to consumers to punish or reward firms based on their performance.

Government micro management of medicine distribution, wholesaling and retailing, and the imposition of price control on these sectors of the industry can be expected to have similarly negative effects and unexpected consequences. The most serious of these is likely to be the probability that small and outlying outlets, such as those in rural areas, will be most severely affected.

Comparing drug prices around the world is notoriously complex and is often not even useful. Different regulatory regimes and purchasing power means that drug prices differ across countries for a number of reasons and direct comparisons do not necessarily provide evidence of greater or less consumer welfare in a given country. South Africa has always been able to secure amongst the lowest drug prices internationally for both the private and public sectors without imposing price controls.

One of government’s motivations for requiring a single exit price for medicines is to ensure that “South Africans have access to affordable, good quality medicine”. We quote studies showing that, to the extent that comparisons are possible, South Africa’s private sector patients do not pay excessively high prices for medicines and the State purchases medicines at extremely low prices, which is confirmed both by the study we quote and the fact that a single exit price of 50% below list price would still be above the price it pays. We come to the latter conclusion due to the fact that the State is to be excluded from the operation of the single pricing system. South Africa would therefore appear to be generally well served by its medicine suppliers and drastic government intervention such as the institution of price controls seems to be unwarranted.

South Africa is not alone in wanting to control or regulate the price of medicines and most advanced economies implement some form of price regulation. However, these regulations result in a wide range of negative consequences for patients. Numerous international studies have shown that drug price regulations result in long delays in drug registration if the drugs are registered at all. While price controls may bring some benefits to consumers in the short term through lower drug prices, the medium and long term costs in reduced research and development and fewer innovative drugs are considerable.

Apart from the negative economic and healthcare effects of these drug regulations, we have serious concerns about the way in which these regulations have been formulated. By granting discretionary powers to unelected officials these regulations violate the principles of “good law”. We are of the view that the regulations are ultra vires as Section 22G of the Medicines and Related Substance Act 1965 (No. 101 of 1965) does not give the minister or the pricing committee the powers to prescribe the price of medicines. In any event, such far-reaching powers without specified objectives and criteria in accordance with the Guidance Principle (as required by the Constitution) are unconstitutional.

In our view the regulations necessary to give effect to Section 22G of the Act should be confined to regulating “the introduction of a transparent pricing system” and “an appropriate dispensing fee” and “prescribing the method of publication of a single exit price”. Seeking to prescribe maximum prices for medicines therefore goes beyond the powers created by the Act itself. The wording of the Act indicates government’s intention to compel pharmaceutical companies to abandon the complicated discounts they grant to distributors and wholesalers of their products and there is no evidence of any intention whatsoever to institute price control on medicines. Although we consider discounts to be an accepted and acceptable marketing mechanism, the Act sets out to prevent pharmaceutical manufacturers from utilising them, and the application of Section 22G(3)(a) appears to do that perfectly adequately without the necessity for elaborate regulations that alter the intention that is clearly expressed in the Act, and in addition, will have highly disruptive consequences for health-care and the economy in general. There is therefore also no necessity for the Department of Health to act unconstitutionally by exceeding its powers in the formulation of the regulations required for purposes of implementing Section 22G.

1. Introduction

The government has committed itself to reducing the cost of medicines and healthcare to patients in an attempt to improve welfare and the health of the nation. As part of its plans, the Government Gazette of 16 January 2004 carried draft Regulations Relating to a Transparent Pricing System for Medicines and Scheduled Substances in terms of Section 22G of the Medicines and Related Substances Act 1965 (Act No 101 of 1965).

While the government may have good intentions in wanting to increase access to medicines and good quality healthcare, its proposals will have many unintended consequences that will in effect reduce access to medicines and compromise South Africa’s healthcare system.

This document explains the fundamental problems with price controls and then examines some international experience from controlling the price of medicines. We then go on to explore some of the expected impacts from the regulations in South Africa. Lastly we raise some concerns that we have about the way in which these regulations have been formulated and whether they conform with the definitions of good law.

We urge the pricing committee to give careful consideration to our comments. Improving South Africa’s healthcare system is a crucially important goal and yet the way in which these draft regulations undermine that goal requires an almost complete overhaul of these regulations.

The Free Market Foundation is a registered Non-Profit organisation that promotes the open society philosophy, the rule of law, and free market policies based on sound economic principles. It works for an economic and business environment that will facilitate the achievement of high economic growth in Southern Africa.

High economic growth is regarded as the key to increasing incomes and living standards and reducing poverty and all the evidence now shows that an economic environment characterised by economic freedom is superior to any other in achieving that objective. Not only does economic freedom result in the highest per capita incomes but it also improves all the other measures of human development, such as higher life expectancy, better literacy rates, improved sanitation, increased water sources and many other desirable social outcomes.

Price controls reduce the efficiency of any industry upon which they are imposed but also ultimately harm their intended beneficiaries. In the longer term, consumers and especially the poor in South Africa will be made worse off by the imposition of price controls and not better off. It is our grave concern for the consequences of the regulations that has impelled us to make this submission.

2. The effect of price controls

The most fundamental problem with price controls, be they for medicines or for any other product, is that they interfere with the normal pricing mechanism and the signals that prices send to buyers and sellers. If consumers appear willing to buy more of a product, then manufacturers will have an incentive to produce more of that good and more manufacturers will enter the market. Because of competition for consumer demand, manufacturers are likely to research the product so as to improve it and provide greater choice for consumers. As prices rise, due to increased consumer demand, we expect supply to increase as the dynamic market adjusts to satisfy the demand. The determination of market prices through continual changes in demand and supply is therefore the basic building block of economics.

Price controls distort that pricing mechanism and interrupt the dynamic demand and supply process. Consumer tastes and needs change continuously and as demand for a particular product rises or falls, so the price rises and falls, sending signals to manufacturers to adjust the supply of the product in a never-ending trend towards an equilibrium price. Government-set prices are usually arrived at after a negotiated political process, but once set, that fixed price cannot adjust to account for the ongoing changes in demand for the product. If a price is set too high by government, the supply of that product will exceed demand. For instance, European governments set the price of many agricultural products above the price that would be achieved through a normal market process. This means that European farmers produce far too much milk, maize and pork to the detriment of consumers in their role as taxpayers.

If government sets the price of a good below the equilibrium price level, consumers are signalled to consume more of the product than manufacturers would normally produce at that price. With increased demand and without any incentive to increase supply, shortages arise which in turn reduce consumer choice and lead to welfare losses. Because not enough of the good is sold, a deadweight loss arises because income is lost to the producer and the consumer is left without the good he or she desires.

2.1 Historical attempts to control prices
Governments have attempted to control prices for a variety of goods and services for almost 40 centuries. From the Babylonian King Hammurabi to US Presidents Nixon and Carter, the desire to meet the needs of certain interest groups by imposing price controls by fiat has been irresistible. Yet in every case, price controls have ended up harming the consumer and imposing significant costs on the entire economy.

2.2 Implications for micro retailers and poor consumers
Price controls are normally promoted and devised under the guise of assisting the poor and alleviating poverty. Yet in almost every case it is the poor that suffer most from price controls. In South Africa and most other countries, it is the rich that have access to the high volume, low mark-up retailers that can offer cheaper goods in large urban areas. The poor generally shop in low-volume, high mark-up establishments in the townships simply because they are conveniently located. Price controls tend to penalise the low volume establishments that serve the poor, therefore forcing them to travel to urban centres, incurring costs and inconvenience in order to shop. Price controls are essentially patronising as they assume that poor consumers (on whose behalf the controls are devised) are unable or too ignorant to make valid choices for themselves.

In addition to penalising small volume retailers and businesses and harming poor consumers, price controls act as barriers to entry. In many cases price controls are tolerated or even welcomed by large established businesses because it keeps competition out of the industry. If prices are regulated downwards to a level where the high volume, low mark-up retailer can still remain in business, no other kind of business will be able to compete. Not only does this harm emerging businesses, but it reduces consumer choice and therefore welfare.

2.3 Price controls during apartheid
Given its interventionist and controlling nature, it is not surprising that the apartheid government was particularly fond of price controls. Almost all goods and services were highly regulated during the apartheid years and most of the controls harmed consumers. It is not even clear that the price controls favoured by successive apartheid governments ensured lower prices. For instance after the price controls on soft drinks were removed, prices fell. The first democratically elected government of South Africa increased economic freedom and served the interest of consumers by removing the web of price controls and economic restrictions. To reverse this trend by reinstating price controls would be a damaging and backward move for the country and most importantly for consumers, both rich and poor.

2.4 Price controls always have negative consequences
By interfering in the normal market process, price controls discourage normal price competition and stifle innovation, research and development. Without any normal price signals, manufacturers cannot respond to the needs of consumers and are therefore often unwilling or unable to improve their product and to compete effectively in order to meet the needs of consumers.

It may be argued that healthcare and medicines are somehow different to other goods and that therefore price controls are justified. The market for medicines and healthcare however are subject to the same laws of economics as any other good or service. In fact given the importance of good healthcare for human well-being and the highly damaging effects of price controls it is imperative that price controls are NOT imposed on medicines. Indeed food is more important for human survival and welfare than medicines and the government quite correctly removed the many price controls on agricultural products precisely because of the damaging effects on the economy and on consumers. For many centuries governments around the world have tried to impose price restrictions on food and this has almost always led to reduced supply of food and ultimately famine. The price controls on medicines will have exactly the same impact and in the long run will harm patients and increase the suffering of some of the most vulnerable and needy South Africans.

3. International experience of Drug Price Controls

South Africa is not alone in wanting to control or regulate the price of medicines. Almost every advanced economy, with the notable exception of the United States, imposes some sort of control over drug prices.

A range of measures have been used by various governments to control drug prices and restrict the amount spent directly on medicines. In most cases these controls are exerted over drugs sold to the public sector for national health systems. Governments can either regulate the drug prices directly (which occurs in France and Italy) or indirectly (as happens in Germany and Japan) by restricting the amount that can be reimbursed via a social security system. Countries can also choose to limit the profitability of companies as is done in the United Kingdom.

The existence of these price and profit controls around the globe may appear to legitimise to some extent the drug pricing proposals in South Africa. However, comparing drug prices in different countries is highly complex, and claims that drug prices are lower in countries that control prices are misleading and often inaccurate. In addition to the inconsistencies in comparing drug prices, a number of unintended consequences arise when governments interfere in the market for medicines. All such relevant issues should inform the decisions of the medicine pricing committee.

3.1 Comparing drug prices

Recent media attention in South Africa on the issue of drug pricing has claimed that South Africa has amongst the highest prices in the world. Yet international comparisons of drug pricing are notoriously complex. Drug price comparisons can vary widely depending on which drugs are included in the study and on whether weights are used to account for the different volumes of medicines consumed. Studies performed during the 1990s by Patricia Danzon, among others, at the University of Pennsylvania show that drug prices in the United States (where there are few price controls) vary widely with drug prices in other countries where there are strict price controls. Depending on how the prices are measured, she found that U.S. prices can be lower than prices elsewhere.

Apart from the different regulatory regimes and disposable income in different countries (which will affect the price at which a company markets any product let alone medicines) the composition of a country’s formulary will affect the average price of medicines. For instance, the use of generic drugs, which are often sold at a fraction of the price of branded or patented drugs, can greatly influence the cost of drugs to consumers. Some countries, most notably France and Italy, do not have an active generic drugs market. The US on the other hand has a large generics market that drives down the price of medicines very rapidly once drugs are off patent. The competition between generic drug producers drives down drug prices over time and therefore studies that fail to account for the generics market will not give an accurate picture of overall drug prices. The fact that branded and patented medicines are subject to price controls in France and Italy means that the market for generics is limited as price-sensitive consumers that would otherwise purchase generics will simply continue to buy the branded drugs. In effect the price regulations in France keep the prices of off-patent medicines artificially high while US consumers benefit from the vigorous competition in the generics market.

South Africa has had two distinct markets for medicines and other controlled substances; the private sector and the state sector. Around 7 million South Africans are members of medical aid schemes and another 13.5 million have access of some description to healthcare in the private sector. The state sector is thought to provide healthcare services to a potential 33 million South Africans through the various state health facilities. As many people use both private and public health services, especially those that purchase traditional and other natural medicines but use public hospitals when they need surgery or specialised treatments, there is a considerable overlap. There are also many people that hardly ever use medication or other health services, so determining the respective health-care contributions of the public and private sectors is very difficult. Any discussion of drug prices in South Africa should take into account the price discrimination that has traditionally occurred, with drug manufacturers selling drugs at relatively high prices to the private sector and at greatly discounted prices to the state sector. The fact that manufacturers have been able to price-discriminate has meant that overall, drug prices in South Africa are amongst the lowest in the world.

Table 1 below gives a country comparison with South Africa of drug prices in the private sector. Among the countries studied, South Africa has either the lowest or second lowest drug prices. The highest prices according to this particular study were consistently found in the United States.

Table 1 Cross-Country Medicine Price Comparison (Private Sector)

1995 1998 2001
Pairwise Comparison N Price Ratio N Price Ratio N Price Ratio
SA/USASA/UKSA/GermanySA/DenmarkSA/NetherlandsSA/AustraliaSA/Brazil 2021151922-- 1.00: 1.571.00: 0.751.00: 1.591.00: 1.001.00: 1.16-- 21221113212114 1.00: 4.581.00: 1.161.00: 1.061.00: 1.121.00: 1.141.00: 0.831.00: 1.17 27272020272616 1.00: 3.201.00: 1.401.00: 1.191.00: 1.241.00: 1.291.00: 0.791.00: 1.15
Notes: (i) The comparisons are done for comparable markets defined as such due to similar levels of income, relatively liberal price controls particularly on new product introductions, and the importance intellectual property plays.; (ii) Besides the pricing discussion in the text, compared is the cost of a basket of important sellers extracted from the top 50 (for 1995) and 80 (for 1998 and 2001) products by value in SA relative to other comparable markets, using IMS ex-factory list prices data as it applies to ethical drugs dispensed through pharmacies. The list prices were in the currencies of each country. Prices were compared in Rands at the applicable official exchange rate as it applies for the years.; (iii) N = number of comparable products.; (iv) ‘-’ indicates no data available.

It is important to note that South Africa, which has a slightly lower per capita GDP than Brazil, has lower drug prices in the private sector. This is despite the fact that Brazil has weaker IPR protection and greater scope to issue compulsory licences and override drug patents. Weakening IPR may not lead to cheaper drug prices if it does not encourage generic competition. In addition, weaker IPR may frustrate the ability of the brand name medicine producer to price-discriminate.

The Minister of Health issued a statement on 15 January 2004 to coincide with the release of the proposed regulations on transparent pricing claiming that the regulations are ‘a major development in our effort to ensure that South Africans have access to affordable, good quality medicine .’ Yet the public health sector, which is supposed to serve the poor, has access to among the cheapest medicines in the world.

Through the Co-ordinating Committee for Medical Procurement (COMED) tendering system for drugs, the government has been able to ensure that medicines for the state sector are around 35% lower than the World Health Organisation’s (WHO) International Drug Price Indicator Guide (IDPIG). The IDPIG is compiled from actual international tender prices for the supply of generic drugs to agencies and vendors in poor and middle income countries. Table 2 below details the COMED expenditure based on 8 of 9 tenders considered for 71 commonly used products. The tender prices available to the public sector ensured a saving of almost R280million compared to the IDPIG prices.

TABLE 2 Total Expenditure on 71 Common Products (based on quantity estimates) 2000
Total for 8 of 9 Tenders Considered Expenditure
TOTAL for COMED Tenders at Comed Prices R 526 870 968
TOTAL for COMED Tenders at International IDPIG Tender Prices R 806 003 082
DIFFERENCE R 279 132 114 or 35% saving
Source George Djolov, 2004

3.2 The effects of drug price regulations

As we have explained in the previous section, not only are international comparisons of drug prices highly complex and often misleading, it is not clear that countries that impose price controls necessarily have lower prices. South Africa has been able to secure among the lowest drug prices internationally for both the private and public sectors without imposing price controls. While drug price controls may not necessarily ensure lower overall healthcare costs, the available evidence suggests that they result in a number of unintended consequences. Most notably the presence of drug price controls tends to reduce investment in research and development, delays drug registrations, and can lead to shortages in supplies and illegal trade in medicines.

3.2.1 Reduced drug access

Patricia Danzon of the University of Pennsylvania has analysed the effects of price regulations on the registrations of new drugs in various countries. Her research shows that due to the dangers of parallel importation from countries that have regulations that ensure low drug prices, medicine manufacturers prefer to delay or cancel the launch of a particular product in price-control countries.

Danzon found that between 1994 and 1998 there were 85 new chemical entities (NCE) launched in the UK and US. Out of a maximum possible registration of 2,125 registrations of these NCEs in 25 countries, only 55% (1,167 were actually registered) . The research showed that those countries with lower expected prices or smaller expected market size experience longer time lags and delays in new drug registrations.

Danzon’s research is supported by evidence from Canada, which suggests that drugs that are widely available in the United States are simply not registered and are therefore unavailable in Canada. It is widely reported that US border states regularly treat Canadian citizens that are unable to access treatment at home .

In some cases, the delays in registering new medicines, due to the price controls, benefit domestic drug producers. As John Calfee explains:

Advanced nations with pervasive pharmaceutical price controls, such as Japan, have for decades denied innovative drugs to their citizens even as domestic pharmaceutical firms prosper by pursuing low-risk research on products of marginal value .

Apart from the regulated drug prices, which deter the registration of new drugs, the lengthy process undertaken by bureaucracies to determine ‘appropriate’ drug prices adds to the delays in gaining access to drugs. For instance, in some European countries, such as Belgium, patients can wait for more than 2 years longer to access a medicine that is already available in the UK and Germany . These delays do not only harm patients by denying them important medical treatment, but add to the costs of the manufacturing firms that are prevented from selling their new products. This in turn puts pressure on the companies to recover their lost revenue elsewhere, further distorting medicine prices. In recent years, the volatile foreign exchange rate has affected medicine prices, mostly pushing them up. Manufacturers and importers are likely to be negatively affected by the proposal to only allow an annual increase in drug prices as they will be unable to respond effectively to changes in the exchange rate. This acts as a further disincentive to the marketing of drugs in South Africa.

Allowing patients to access the latest innovative medicines is vitally important. While generic medicines play a crucially important role in any healthcare system, the value of new and innovative medicines and medical technology cannot be overstated. For instance, research has revealed that one new HIV/AIDS drug prevents around 6 000 deaths in the following year and ultimately prevents 34 000 deaths . While it is true that newer drugs tend to cost more than older, off-patent drugs, (by an average of 24 percent) the former can reduce the number of productive work days lost by 21.3 percent . Newer drugs can also reduce the length of time a patient has to spend in hospital. Given that hospital care (which includes the cost of medical staff, equipment, food, linen etc.) is often very costly, any financial benefit from using older, off patent drugs can be extinguished by the cost of extra days spent in hospital.

3.2.2 Reduced research and development

Perhaps one of the most important and damaging long term effects of drug price regulations is the impact they have on research and development. This impact is also one of the most 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.

Perhaps the most telling evidence of the impact of price controls on research and development is the movement of research from Europe, which has a variety of price controls, to the US, which has few price controls. Between 1988 and 1998, the US share of production of best selling drugs increased from 19 to 33 and in 1998 the US produced 8 of the 10 top-selling drugs. Some European companies, such as GSK and Novartis, have moved much of their research and development capacity to the US .

While price controls may bring some benefits to consumers in the short term through lower drug prices, the long term costs in reduced research and development and fewer innovative drugs are considerable.

Bain & Company, an international management consultancy, conducted research into the effects of drug price controls in Germany .

Germany introduced reference-based drug pricing in 1989 with the aim of reducing drug expenditure. Bain’s research revealed that the price regulations reduced the German government’s spending on drugs by $19 billion in 2002. These savings however need to be balanced against the economic costs of poorer health outcomes resulting from the fact that German patients did not have access to the latest innovative therapies. In addition, reduced research and development in Germany, a reduction in jobs and investment, and lower corporate taxes to government cost the economy around $22billion. The result is that the drug price regulations, rather than saving the country money, cost it around $3billion .

3.2.3 Market distortions and the black market

Apart from the increased overall costs of healthcare, reduced availability of drugs and reduced research and development, drug price regulations in many countries have exacerbated the parallel trade in drugs and the black market for medicines. Artificially low drug prices in one country provide incentives for entrepreneurs to export those drugs (perhaps illegally) to countries that have higher drug prices. This can reduce income of the drug manufacturer by reducing its ability to price discriminate. It can also lead to poorer health outcomes as the manufacturer has reduced control over the product sold in the higher priced market. With products such as medicines it is often crucially important for the manufacturer to control the supply chain, ensure that the product is safely transported, and that it complies with the various regulations governing its use.

Due to the economic distortions created by drug price controls, patients frequently do not have access to adequate healthcare. In the United Kingdom, rationing of healthcare services due to price controls has created shortages which more often than not affect the poorer sections of society. The wealthy North East Thames region near London has 27 percent more doctors and dentists, 15 percent more hospital beds and 12 percent higher health spending per capita than the rural Trent area in North East England . Price controls have not resulted in greater equality in access to healthcare in the UK. The rationing of healthcare services has meant that the pattern of healthcare consumption has changed little since 1948 when the highest social class consumed 40% more services than the lowest social class .

4. Anticipated Effects of Proposed Drug Price Regulations

Based on the international experience of drug price regulations and the structure of the local industry, distributors and pharmacies, we expect a wide range of unintended negative consequences from the proposed drug price regulations.

4.1 Delayed drug registrations and reduced access to innovative drugs
The evidence suggests that drug price regulations, even in wealthy economies such as Japan, increase the delay in registering new drugs. Manufacturers have greater incentives to register their medicines and comply with the increasingly onerous regulatory requirements in countries where they have greater freedom to price their products without bureaucratic intervention. The registration process in South Africa already delays the registration of drugs, imposing considerable costs on drug companies. The drug price regulations, most particularly Regulations 5 to 10, are likely to increase the delays of drug registration and/or stop manufacturers from registering the drugs at all. The healthcare outcomes are likely to be severe and will reduce patient welfare as well as the ability of physicians to care for their patients.

4.2 Reduced drug access
Apart from the delays in registering drugs and the reduced overall availability of innovative new medicines, the drug price regulations will force many pharmacies into bankruptcy and ensure that the distribution of drugs to rural and remote areas will be financially unviable. Regulations 11 to 15 will reduce the income stream and profit margins for pharmacies, wholesalers and distributors to such an extent that it will become impossible to carry a wide range of medicines. Many of these companies will be forced to diversify their businesses by selling cosmetics and other products and reduce their involvement in
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