The Pharmaceutical Industry and the AIDS Crisis in Developing Countries ·Describe the nature of supplying drugs to emerging markets at an affordable price without undermining their profits ·Research and analyse in depth the effectiveness of one proposed policy response to this issue. Introduction 12001 saw a flurry of events, as highlighted in the excepts of the case study, which caused an awareness by the international community of the inequality between rich and poor nations in the care and treatment of people living with HIV/AIDS.
2Epitomized by the lawsuit against the South African government, the drug companies “want desperately to be seen helping fight the global AIDS crisis? but the companies also remain unwavering in their defense of patents, even if it means suing poor nations that want to make or buy bootleg generics because they can’t afford brand-name drugs. ” The episode not only represents a “moral scandal”, but also a major economic, political and social challenge. Can the needs of the poor be met through increased access to the drugs, without necessarily hurting the profits of the drug companies?
Past Trends and New Developments 3The following table summarizes the price changes for brand and generic drugs from 2000 to 2001 (IAEN). Patents and Monopoly Power 4Prices charged by pharmaceutical companies for patented drugs are commonly several orders of magnitude higher than their marginal cost (the cost of producing an additional unit of the drug). For innovative products like antiretrovirals, private firms legitimately need to recover their high overhead costs for research and development and for fulfilling the regulatory prerequisites of market approval in high-income countries.
This attributes a “temporary monopoly power” to the patent owner and creates socially useful long-term incentives for continued R&D. 5However, actual production costs are low. The low marginal costs explain why generic drug producers, as soon as they do not have to pay royalties to patent holders, are able to offer substitutes to branded products at comparatively low prices. This was the case in Brazil where its national industry produced cheaper generic drugs and was delivered free to HIV-infected patients.
In a perfectly competitive market, in which consumers will automatically buy a substitute good if its price is lower, international drug prices would spontaneously tend to be based on such marginal cost. The demand for the brand drug will be reduced (and become more elastic) with the introduction of substitutes. 6However, the international market of branded antiretroviral products is characterized by imperfect competition i. e. a limited number of firms supplies a limited number of products.
This is an oligopolistic market, where private firms are in a position to impose prices and rates of return that may capture an “excessive rent”. As such, patent rights are often associated with compulsory licensing obligations in order to guarantee an efficient public disclosure of innovative knowledge. Under the WTO Trade-Related Aspects of Intellectual Property Rights (TRIPS), any country may allow a third party to use a patent without the owner’s consent “in cases of national emergency” or “other circumstances of extreme urgency”.
Demand & Supply 7More than 33 million people are infected with HIV worldwide, over 95% of whom live in developing countries. (Kremer) Although the absolute demand of HIV-infected patients is less, the willingness-to-pay by these affluent patients is much higher based on the perceived value of the drugs. While the drug is critical (suggesting low elasticity of demand), drug companies could not charge an unlimited price, because they could not force people with AIDS to buy the drugs. It is therefore not surprising pre-2001 for the drug companies to target the segment of market demand from high-income countries.
8In the pre-2001 context, drug companies could exercise its oligopoly power and could set a price (equivalent to $10,439 per year per patient) where ideally marginal revenue equals marginal cost to maximize profit. By setting at this price, it could largely meet the demands for the patients in high-income countries, but it also meant that the demand of the low-income countries would not be met since they were unable to afford the price. (This is also due to the relatively higher elasticity of demand in low-income countries.
) Sold in the market at a uniform price, the total revenue (price x quantity) for the drug companies is thus maximized. The surplus of revenue over marginal manufacturing costs would fund the sunk costs (of R&D and factory building) and any profits. Rationale for Lower Prices ? Price Discrimination 9However, with mounting pressures from the public to provide greater access to the drugs especially to the lower-income countries, as well as to counter the increased competition from generic drugs, the drug companies have adopted a different pricing policy.
Economic theory also emphasizes that firms in monopoly (or oligopoly) position can rationally practice price discrimination. This means that the drug companies can offer different prices for the same product according to the characteristics of each segment of the demand on markets. 10It would be the firm’s rational behaviour to offer the highest prices for customers with the lowest price elasticity of demand (and the highest willingness-to-pay), in this case, to maintain the high price for high-income countries.
On the other hand, the firm can also offer lower prices to customers in the low-income countries, which have a higher elasticity. The gain in profit from the lower prices is depicted in the shaded area in the diagram above. In fact, price discrimination between markets in different countries is a common practice, therefore price difference for the drugs between developed and developing countries is not an economic anomaly per se.
On the contrary, it could be the case that increased volume of drug sales that would be promoted by unit price decreases (from economies of scale) in developing countries with high HIV prevalence can contribute to profitability at the international level. 11Indeed, price discrimination had been practiced in the early years. One study noted that “although brand drug companies seemed to follow such a price discrimination strategy in the first years, the relationship between prices and per capita income eroded over time, with virtually no evidence of lower prices with lower incomes in 1999?
It must however be noted that countries with the highest HIV prevalence tended to have higher prices, suggesting that firms tend to adapt to situations in which the urgency of the epidemic may induce a lower elasticity of demand for ARVs to price in the segments of population with some ability to pay for these drugs” (ANRS). This observation agrees with the pre-2001 pricing policy where the drug companies specifically targeted the higher-income segment with lower elasticity of demand. Expanded Diffusion ?
Regulated Markets 12The main policy recommendation that emerged is that excessive reliance on “corporate philanthropy” and international bargaining between UN organisations and the major brand-name manufacturers will not guarantee the long term sustainability of the lower differential pricing of ARV drugs that has de facto been established in some African countries since the year 2001, and its extension to a greater number of countries and to a greater number of drugs that are needed, in addition to ARVs, for HIV-infected patients.
The buyer-size effect, that could be obtained through globalisation of purchases of HIV/AIDS drugs between several countries, will only translate into price decreases to the extent that buyers have the power to substitute between multiple suppliers.
13To achieve the recommendation recently adopted by the Global Fund to Fight AIDS, Tuberculosis and Malaria that countries should purchase quality-controlled HIV/AIDS drugs at the minimum cost, decentralised negotiations, extended market competition to all potential drug suppliers, and regulatory flexibility (in international agreements, and in national legislation) towards local production and imports of generic drugs are essential. (ANRS)
The market could reach efficient size if vaccine developers charged each nation a separate price based on the maximum amount which they were willing to pay, through a system of tiered pricing. (Kremer) 14However, pursuing this policy does not come without concerns. While parallel importing could be regulated, drug companies fear that if poor countries are allowed to buy low-priced drugs, American consumers will demand the same access or prices. The pressure to reduce prices in the domestic market will no doubt erode profits, since it is the US market where the lion’s share of their profits are derived and where they have the greatest freedom to price drugs at a premium.
However, if this occurs, the incentive to continue with R&D will be reduced, to the detriment of AIDS patients in the longer term. Moreover, in the context of imperfect competition, information asymmetries between suppliers and buyers are likely to be exacerbated. Private firms have a priori no incentive to disclose information on their real production costs as well as the lowest levels of the prices that they would rationally be ready to accept to sell.
15One way to achieve some of the same objectives as tiered pricing would be to purchase vaccines internationally for a range of poor countries at a single price and then collect co-payments from these countries that would vary with their incomes. This approach would increase access to vaccines, while ensuring that richer countries, which have greater willingness to pay for vaccines, contribute more toward covering the costs of vaccine research and development.
The embarrassment of charging many different prices to different countries would be avoided. This approach would, however, require outside funding to make up the difference between the price at which vaccines are purchased from manufacturers and the co-payments received from the poorest countries. (Kremer) 16For developing countries, a hybrid model has somewhat emerged in terms of ARV procurement, in which they introduce generic competition in parallel to negotiations with brand companies through UN.
Procurement is only half the battle, this needs to be followed up with a equitable and sound distribution channel to those in need. Conclusion 17If vaccine developers charge a single monopoly price to governments, some countries will not be able to afford to purchase the vaccine. All countries could potentially be made better off, as long as the rich countries paid no more than the monopoly price they would have paid otherwise, and the poor countries pay less than the amount at which they value the vaccine, but more than the actual production cost.
(Kremer) Price discrimination implemented in its various forms, together with appropriate interventions to counter the imperfect competition of the market, will ensure the balance between the profits of the brandname companies (vis-a-vis the role of generic companies) and the access to drugs by the AIDS patients in developing countries.
References: 1)KENNEDY, R. E. The Pharmaceutical Industry and the AIDS Crisis in Developing Countries, Harvard Business School, August 2001. [Case Study] 2)AGENCE NATIONAL DE RECHERCHES SUR LA SIDA (ANRS): Economics of AIDS and Access to HIV/ AIDS Care in Developing Countries, Issues and Challenges ?
Part One: Patents, Generic Drugs and the Market for Antiretrovirals, June 2003. [Available from http://www. iaen. org/papers/anrs. php, accessed in Jul 2006] 3)INTERNATIONAL AIDS-ECONOMICS NETWORK (IAEN): State of the Art: AIDS and Economics, July 2002. [Available from http://pdf. dec. org/pdf_docs/PNACP969. pdf, accessed in Jul 2006] 4)KREMER, M. Creating Markets for New Vaccines Part 1: Rationale, April 2001. [Available from http://papers. nber. org/papers/W7716. pdf, accessed in Jul 2006] 5)PNG, Ivan. Managerial Economics, 2nd ed. , Blackwell Publishing, 2002.