Resident Fellow Roger Bate
To be sure, thanks to current threats to restrict free pricing from the new Democratic Congress there are substantial jitters in the industry. But perhaps even more worrying for the long term are the patent wars currently taking place in Asia. The future for efficient pricing may be weakening, not strengthening.
Back in 2005 things looked much rosier for the innovator drugs industry. A Republican-controlled Congress refused to allow medicines sold under price controls to be imported from Canada. And internationally, the TRIPS agreement of the World Trade Organization, signed in 1994, came into effect for developing nations. TRIPS (an acronym for the Trade Related Aspects of Intellectual Property Rights) ensures uniform patenting standards for all signatory countries. The aim of TRIPS was to encourage innovation in countries which had previously only copied western drugs, but also allow them to break patents in health emergencies, especially for treating HIV AIDS if price negotiations failed.
Much fanfare heralded the arrival of new patent legislation in 2005 in India. The research-based industry seemed to be negotiating sensibly on pricing with mid-income, TRIPS compliant countries like Brazil and Argentina.
From an innovation standpoint, this was good news. Drugs cost a vast amount to bring to market (Tufts University puts the number at nearly $1 billion dollars) because of the research and development costs and hugely expensive clinical trials. Once approved, however, production costs are often trivial. Patents provide security that the innovator will be able to recoup R&D costs before other companies can copy their drugs. Wider TRIPS adoption provided increased security and hence incentive for innovators and enabled them to price their drugs more efficiently, with costs recoverable globally and not just in the US, Japan and the EU.
Economic theory suggests that if patents are protected and it is illegal for products to be re-imported from one country to another, then it makes good economic sense for companies to tier their pricing--that is, to charge lower prices to people who don't have the means to pay what Europeans or Americans can.
Consider antiretroviral therapies for HIV. They cost hundreds of millions of dollars to develop, and Western companies must recoup the cost or leave the business. A daily dose of such drugs may cost 60 cents to produce at the margin; and, after distribution costs and wholesaler and retailer markups and tariffs, the price might rise to about 95 cents before the medicine can reach a patient. Such drugs may sell for $15 to $20 per daily dose in the West, providing a good return to the company; however, in an African clinic, the price can be set at $1, allowing a small bit of profit, not just for the drug company but more importantly for the local firms along the supply chain. Even at $1, Western companies and their African cohorts have an incentive to keep copious supplies flowing--a better spur than direct charity. What about patients who can't afford $1 a day? That's where donors come in, giving sick people money for the purchase.
In 2005, exciting developments in price tiering started to occur in wealthier non-Western countries. Middle-income nations like Brazil, Argentina, China, and India are seen as the most attractive large markets of the future. Companies taking this approach include Abbott, Gilead, and Merck. Those firms then compete on price--which is set by market forces of supply and demand at far lower levels than in Europe and the United States--and everyone gains. Pricing for many ARVs in these countries ranged from about $3 per day to $5.50 per day, providing a far smaller profit than in the West but far more than in Africa, and significant enough to provide revenue to further research efforts in the field.
But the promising start has hit some snags. Latin American countries under pressure to lower healthcare costs pressured firms to lower prices more than was probably efficient. Then the Indian Government inserted an amendment into its patent law that denies patents to companies from drugs derived from “previous knowledge”--a definition so arbitrary and capable of such broad interpretation that it encourages litigation and discourages the very innovation the new Act was supposed to spur. The amendment is so perverse that even some of the copycat companies, notably Ranbaxy Laboratories, have opposed it publicly.
Perhaps worse is what is happening in Thailand. The bloodless coup in September 2006 led to a change in leadership style and approach. The Thai leaders have broken patents and issued compulsory licenses not only for ARVs but are in the process of doing so for drugs to combat numerous other types of conditions. This tactic has been used in Brazil and Argentina for ARVs to force western drug companies to lower their prices. But up until now, no country has done so for chronic conditions, such as hypertension. Furthermore, it was always known to be a negotiating tactic--a blunt one, to be sure, but a tactic nonetheless. And western firms just lowered their prices slightly while still making something of a profit. But Thailand may actually break numerous patents and is being encouraged by anti-patent pressure groups, notably Oxfam and Doctors Without Borders.
This would be a setback for innovation in the region, as other countries may look to follow suit, notably Indonesia and Malaysia. China is the largest producer of counterfeit drugs as well as genuine copies and its myriad producers will see market opportunities if TRIPS unfolds. Any further patent abuse will undermine the delicate but efficient pricing intentions of western firms.
Press releases and public statements show that innovator companies have put further investment on hold in Thailand, and as their prices in western markets come under attack it seems likely that they could even pull out of markets with long run potential but that are short-term drains. This will not only harm Thailand but other countries in the region since corporations will naturally be skittish of further regional investment.
Asian countries are increasingly important in international drug markets, even though Western firms still rely for the bulk of their profits on Western markets. The possibility of profit from the vastness of Asia could bolster their research efforts once again; but more actions against innovators in other places could further accelerate industry decline.
Roger Bate is a resident fellow at AEI.