Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry

Abstract

In this essay about international drug pricing in the global pharmaceutical market, we focus on the issue of access to medicine in developing countries. Acknowledging the essential trade-off between equity and efficiency that characterizes international drug pricing, we provide a perspective on the panorama of drug pricing and patenting policies. These policies are designed to optimize both supply and access to drugs. We examine their respective rationales, consequences and limitations. In a context of increasingly intense market interactions between developed and developing countries, the common challenge for these regulations is to safeguard incentives for the research and development industry, while accounting for lower purchasing power in developing countries.

Full text

PRICES, PATENTS AND ACCESS TO DRUGS: VIEWS ON EQUITY AND
EFFICIENCY IN THE GLOBAL PHARMACEUTICAL INDUSTRY
Quentin Cavalan, Maud Hazan, Irène Hu et Roxane Zighed
La Documentation française | « Revue française des affaires sociales »
2018/3 | pages 249 à 268
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RFAS - 2018 - N° 3 249
Prices, Patents and Access to Drugs: Views on Equity
and Efficiency in the Global Pharmaceutical Industry
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
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250 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
ABSTRACT
In this essay about international drug pricing in the global pharmaceuti-
cal market, we focus on the issue of access to medicine in developing countries.
Acknowledging the essential trade-off between equity and efciency that characte-
rizes international drug pricing, we provide a perspective on the panorama of drug
pricing and patenting policies. These policies are designed to optimize both supply
and access to drugs. We examine their respective rationales, consequences and
limitations. In a context of increasingly intense market interactions between deve-
loped and developing countries, the common challenge for these regulations is to
safeguard incentives for the research and development industry, while accounting
for lower purchasing power in developing countries.
RÉSUMÉ
Prix, brevets et accès aux médicaments: comment concilier équité et efficience
sur le marché pharmaceutique mondial?
Dans cet article consacré à la xation du prix des médicaments sur le marché
pharmaceutique mondial, nous nous intéressons à la question de l’accès aux trai-
tements dans les pays en développement. La dénition du prix des médicaments
dans un contexte international suppose la prise en compte du dilemme entre
équité et efcience. D’un côté, les pays en développement veulent pouvoir accéder
à des médicaments à prix abordables pour traiter des maladies telles que le sida,
le paludisme ou la tuberculose. De l’autre, l’industrie pharmaceutique a besoin de
protéger ses droits de propriété intellectuelle pour avoir un intérêt à investir dans
l’innovation et le développement de nouveaux médicaments. Nous posons donc la
question des politiques qui peuvent être mises en œuvre pour concilier ces deux
exigences. Nous présentons d’abord les caractéristiques du marché pharmaceu-
tique mondial et les difcultés d’accès aux traitements qu’elles entraînent pour les
pays en développement.Dans un deuxième temps, nous mettons en perspective
différentes politiques actuelles relatives à la tarication des médicaments (tarica-
tion différenciée et réglementation des prix) et aux brevets pharmaceutiques, en
décrivant les principes qui les sous-tendent ainsi que leurs effets et leurs limites.
Ces politiques sont conçues pour optimiser à la fois l’offre de médicaments et l’ac-
cès aux traitements. Dans un contexte où les interactions économiques entre pays
développés et pays en développement sont de plus en plus fortes, toute la dif-
culté pour les concepteurs de ces mesures réside dans la nécessité de ménager un
juste équilibre entre la sauvegarde des incitations à investir dans la recherche et
développement d’une part et la prise en compte de la faiblesse relative du pouvoir
d’achat dans les pays en développement d’autre part. Nous examinons enn deux
approches innovantes issues de la littérature économique et évaluons dans quelle
mesure elles permettent de concilier équité et efcience. La première, qui allie
forte protection de la propriété intellectuelle et tarication différenciée, ne permet
pas cette conciliation, notamment parce que le commerce parallèle et le référen-
cement externe restent d’actualité. La deuxième, connue sous le nom d’Advance
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RFAS - 2018 - N° 3 251
Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry
Market Commitment (AMC) ou garantie de marché, repose sur un accord passé
entre un pays en développement, un nanceur et un laboratoire et encourage la
concurrence pour l’innovation. Elle pourrait se révéler plus prometteuse même s’il
reste des obstacles à surmonter.
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252 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
Introduction1
At the 2001 Doha convention, the World Trade Organization (WHO) declared:
«We recognize that intellectual property protection is important for the deve-
lopment of new medicines. We also recognize the concerns about its effects on
prices.» (WTO, 2001)
This statement was a response to the Agreement on Trade-Related Aspects of
Intellectual Property Rights (TRIPS) that had been adopted seven years earlier. The
aim of that agreement was to set down minimal intellectual property protection
standards, notably in the eld of pharmaceuticals. However, the TRIPS agreement
raised concerns that patenting would increase pharmaceuticals’ prices and under-
mine the ability of developing countries to face pressing public health challenges.
The main purpose of the Doha convention was, therefore, to reform the protection
of the intellectual property within the eld of pharmaceuticals in order to protect
public health and promote universal access to medicines.
The history of the TRIPS agreement and its amendments highlights the com-
plexity of international drug pricing and the tension between two sometimes incom-
patible considerations. On the one hand, equity concerns, through the developing
countries’ claim to affordable access to pharmaceutical products that treat HIV/
AIDS, malaria or tuberculosis at affordable prices. On the other hand, efciency
concerns, with the pharmaceutical industry’s need to protect intellectual property
rights in order to incentivize investment in innovation and development of new
drugs. Indeed, research knowledge is a global public good, whose output can be
simultaneously used by multiple actors and whose access cannot be prevented. In
the meantime, the pharmaceutical industry has high xed costs and very low mar-
ginal costs of production. This makes it very expensive to develop a new drug, but
very cheap to copy a drug and produce it in large quantities. Therefore, individual
businesses and countries have strategic incentives to free-ride on research funded
by others. In the absence of intellectual property protection, no actor has enough
incentive to invest in the development of new pharmaceutical products, so that it
can result in an undersupply. Without a trustworthy framework to ensure returns
on research investment, research remains insufcient.
Taking this context into account, what is the optimal policy for pharmaceu-
tical production? How can policy-makers reconcile equity considerations, cha-
racterized by access to drugs for developing countries, with efciency concerns,
characterized by incentives to provide research and ensure an optimal supply of
pharmaceuticals?
This topic has been widely studied in economics, at the crossroads of seve-
ral approaches that investigate both prices and intellectual property regulation.
In this paper, we answer this question by presenting where economic research
stands today and the main approaches that have been taken on international drug
pricing and patenting. Throughout this article, we focus on the tension between
1. The authors would like to thank Lise Rochaix and Léa Toulemon (Hospinnomics) for their advice and support,
as well as Antonella Miho and Matthew Fisher for their careful proofreading.
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RFAS - 2018 - N° 3 253
Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry
equity and efciency, with a specic interest in the interaction between developing
and developed countries. Our main contribution consists in synthesizing different
approaches that have been developed on this issue in a non-exhaustive literary
review. Firstly, we will present the characteristics of the pharmaceutical market
and the access problems resulting from them. Secondly, we will analyze the per-
formance of current pricing and patenting policies to solve this equity versus ef-
ciency dilemma. Finally, we will draw on two approaches from the theoretical
economic literature to solve this dilemma.
Market characteristics and problems of access to drugs
in developing countries
The pharmaceuticals market suffers from several structural inefciencies.
Characterized by high xed costs and low marginal costs, the industry suffers
from a fundamental free-rider problem which under-incentivizes Research and
Development (R&D). Moreover, prices tend to be high, leading to social surplus
losses and access problems. In developing countries, the access problem is accom-
panied by two more concerns: quality control in drug production and the lack of
R&D for the treatment of diseases that are specic to the developing world.
In the following section, we will present a theoretical framework and statistical
evidence in order to demonstrate how characteristics of the pharmaceutical mar-
ket generate tension between equity and efciency objectives.
The global pharmaceutical market
To give a rst sense of the global pharmaceutical market and its geographic
distribution, expenditures reached USD 1,105 billion in 2016, of which the United
States (U.S.) accounted for 42%, Europe 14% and 22% among a further 21 emer-
ging pharmaceutical markets (IFPMA, 2017).2The sales shares are expanding far-
ther to the global East and South, mostly driven by China and India (IFPMA, 2017).
These trends have changed the stakes and characteristics of the global pharma-
ceutical market. Meanwhile, the 160 low and middle-income countries, as classi-
ed by the World Bank in 1995, have increased their global share of healthcare
expenditures from 26% in 1995 to 40% in 2013 (Jakovljevic and Getzen, 2016).
2. Emerging pharmaceutical countries include China, Brazil, Russia, India, Algeria, Argentina, Colombia,
Bangladesh, Indonesia, Mexico, Nigeria, Pakistan, Poland, Saudi Arabia, South Africa, Philippines, Turkey,
Romania, Chile, Kazakhstan and Vietnam (QuintilesIMS Institute, 2016).
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254 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
Patent protection and market for drugs
Several features of the pharmaceutical market imply the need for strong regu-
lations. First, as in every innovative industry, it is characterized by high xed costs.
Indeed, developing a new drug requires huge investments in R&D with potentially
no insurance that the whole process will actually yield returns. For instance, the
average cost of bringing a new drug to the market has been assessed at USD 800
million (Boldrin and Levine, 2008). Second, once a new drug has been developed,
the marginal cost of producing the drug is quite low, which makes the replication
and production of generic drugs nancially attractive. The combination of these
two characteristics creates an incentive issue to invest in pharmaceuticals drugs.
Without regulation, generic manufacturers can copy and compete with the rm
that carried out the costly investment of R&D. Anticipating this strategy, rms will
not put the nancial means on R&D since they will not be able to recover them.
This is particularly inefcient from a social point of view, especially in the phar-
maceutical industry where the social benets of research and development are
potentially extremely high for some diseases.
This point makes the case for patent protection in the pharmaceutical industry.
The U.S. Food and Drug Administration (FDA) denes a patent as the exclusive use
of an innovation for a xed period of time. Patented drugs can therefore be sold
exclusively by the patent owner, which prohibits other companies from selling the
generic version of that drug. Generic drugs, however, are dened by the FDA as
«medications created to be the same as an existing approved brand-name drug
in dosage form, safety, strength, route of administration, quality, and performance
characteristics» (2018). Generic drugs are therefore generally sold after a patent’s
time-exclusivity period expires. They are identical to the original patented product
and may only change in packaging, color or inactive ingredients (FDA, 2018). As of
today, the exclusivity period of patented drugs in France is 10 or 11 years (Agence
nationale de sécurité du médicament et des produits de santé, 2017), while in the
U.S., the FDA (2015) grants different exclusivity periods depending on the drug
classication, from six months (pediatric drugs exclusivity) to seven years (orphan
drugs exclusivity).
In granting patents, governments incentivize rms to invest in research, by
ensuring a monopoly over the sale of the drug once it is developed. The value of
a patent can be approximated by the incremental added value of the innovation
at the time the patent is secured, which is also called the patent premium. Arora
et al. (2008) actually measured the patent premium for 19 industries and found
it to be the highest for medical instruments, biotechnology, and pharmaceutical
companies, strengthening the case for the need of patent protection in the phar-
maceutical industry.
In practice, patent regulation is a bone of contention between countries. The
U.S. clearly dominates the pharmaceutical market with 10,438 patents granted in
2013, while 12,060 patents were granted to all European countries put together
(Akkari et al., 2016). On the contrary, India pushes policies which encourage gene-
ric manufacturers at the expense of patented drugs (Lanjouw, 1997).
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RFAS - 2018 - N° 3 255
Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry
The need to regulate prices
Furthermore, patents can actually induce economic inefciency. The pharma-
ceutical market is no exception to the static versus dynamic efciency dilemma.
Indeed, patents allow rms to start investing in research for drugs whose benets
will arise an average of 14 years from now (Paul et al., 2010). Therefore, patent
protection increases dynamic efciency. However, since patents grant monopoly
power to a company for a given period of time, their protection leads to static
inefciency: monopolists do not sell at marginal cost, and part of the social surplus
is lost. That dilemma could be a rationale for price regulation in the pharmaceu-
tical market. However, according to Danzon (2006), this cannot be the main ratio-
nale, because patents do not prevent the entry of all the drugs that could in effect
compete with the patented ones and also, the industry is structurally competitive.
Another justication can be found in the widespread presence of health insurance
systems in the pharmaceutical market. Indeed, because patients do not pay the
medicines out of their pocket,those systems make insured patients less sensitive to
prices, a situation that incentivizes pharmaceutical manufacturers to overcharge
their drugs. The extra cost is then borne by insurers. Actual price regulation varies
widely around the world. For instance, the U.S. does not directly regulate prices, as
exemplied by the Sovaldi USD 84,000 treatment’s scandal in 2013.3Again, at the
opposite end of the spectrum, India actually enforces a very strict price regulation,
which results in low drug prices.
Therefore, the pharmaceutical industry is characterized by the need to incenti-
vize innovation by ensuring strong intellectual property regulation. This can lead
to high drugs’prices, especially when combined with high-coverage social insu-
rance systems. In developing countries, where social insurance systems only pro-
vide weak coverage, the burden of high drug prices is primarily borne by patients.
Patent monopoly and comparatively low social insurance can consequently exa-
cerbate access problems.
Access problems in developing countries
In 2015, the Access to Medicine Foundation estimated that globally two bil-
lion people did not have access to essential medicines (WHO, 2016). In develo-
ping countries, access to drugs problems are manifold: disproportionately affected
population with weak purchasing power, remoteness, lack of medicine skills lea-
ding to inadequate treatment prescriptions, distribution disruption, drugs’ stock
shortages and so forth. Access itself can be an issue due to the lack of health ame-
nities and bad planning. Yet, here, we focus more on access difculties related to
3. In 2013, the pharmaceutical company Gilead gained federal approval for its drug Sovaldi treating hepatitis
C and set the price to USD 84,000 for a 12 weeks treatment, releasing public, private payer and government
outrage.
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256 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
prices and quality, which are more directly linked to the question of drug patenting
and drug pricing policies.
High prices
An obvious barrier of access to pharmaceutical drugs in developing countries
is the high prices that patients have to pay, especially when their country’s social
security system is weak. A new medicine’s price is high until its patent expires and
competition and/or generic products emerge. Yet, many countries cannot benet
from lower priced generics if their market delays their entry or if there is inef-
cient competition among generic producers. 
Fixing fair prices to medical drugs is a conundrum for national health sys-
tems as well as for the pharmaceutical industry. Indeed, the responsibility is often
discharged from one to the other: the mere structure of drugs prices is discussed
and subject to negotiations. According to gures presented in the International
Federation of Pharmaceutical Manufacturers & Associations (IFPMA) 2017 report,
once accounting for taxes, pharmaceutical import duties, distribution margins and
drug seller charges, the net manufacturer selling price can end up representing
less than one third of the nal price.
The stakes are even higher when considering the determination of a fair price
across countries with different income levels. Several surveys have been conduc-
ted on the ex-manufacturer prices and retail prices of essential drugs.4Among
them, Scherer and Watal (2002) showed that prices of many life-saving medicines
for HIV/AIDS were not signicantly lower in developing countries of Africa and
Latin America than in the OECD countries in the late 1990s.
R&D for neglected diseases
One concern in the global drug market is that developing countries and their
small markets might present less economic interests for the pharmaceutical
industry (Kremer, 2002). Developing countries have different disease environments
due to geographic and social factors. More than one billion people in developing
countries are facing diseases that are often qualied as «neglected diseases »,
including dengue, leprosy, mycetoma, or yaws, and that are less economically pro-
table than treating cancer or neurological conditions (Pécoul et al., 1999), which
are affecting wider markets, in both developed and developing countries.
Moreover, the problem of high xed R&D costs and low marginal costs of pro-
duction, which can result in undersupply, is worsened by the characteristics of the
market in developing countries: small size of the market due to low purchasing
4. Drugs’ manufacturers sell their products to wholesalers at the « ex-manufacturer price ». Subsequently,
wholesalers apply a markup before selling these products to pharmacies, which also charge a markup or phar-
macy margin. Value-added tax (VAT) can also be claimed. The sum of all these components constitutes the retail
price.
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RFAS - 2018 - N° 3 257
Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry
power or low marginal willingness to pay because of credit constraint, large cost of
adhering to quality standards, large investments without high expected prot for
R&D on tropical disease, and lack of intellectual property protection lowering the
potential revenue from product sales (Kremer, 2002).
Quality issues
Apart from the undersupply issue, when access to medicines is possible, the
quality of the product can also be an issue. This is a two-fold problem. On one
hand, many developing countries are more likely to lack technical, nancial or
human resources required to comply with good manufacturing practices, and are
more exposed to the competition of illegal markets. The lack of intellectual pro-
perty rights in some developing countries led to patented-drugs being copied, wit-
hout guarantee of quality. Piracy or «drug dumping » of counterfeit medicines
being easier in informal markets which are often larger in developing countries.
The WHO (2017) has introduced three distinctions for drugs representing quality
issues: (1) substandard medical products which are authorized medical products
that fail to meet either their quality standards or their specications, or both;
(2) unregistered/unlicensed medical products that have not undergone evaluation
and/or approval by the National Medicines Regulatory Authority (NMRA) for the
market in which they are marketed, distributed or used, and that are subject to
permitted conditions under national or regional regulation and legislation; (3) fal-
sied medical products that deliberately/fraudulently misrepresent their identity,
composition or source. WHO estimates that 10,5% of medical products in low-
and middle-income countries are eithersubstandard or falsied (2017).Therefore,
if patents and resulting high prices constitute a barrier to access in developing
countries, this is not the only one, and the problem of supply and quality are also
to be kept in mind.
Impact of current policies on availability and prices
In the light of the aforementioned drug market characteristics, different poli-
cies exist to mitigate large R&D expenses and subsequent accessibility issues.
What are their rationales and how do they perform, regarding both efciency and
equity criteria?
Existing pricing policies need to be investigated before moving to patent pro-
tection policies. In each case, we assess these policies and theoretical and empiri-
cal perspectives in order to highlight their main advantages and limitations.
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258 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
Pricing policies
In order to solve the accessibility issue induced by high prices, two main poli-
cies exist: differential pricing implemented by the rm itself or price regulation
implemented by governments or other regulatory authorities.
Rationales and limitations of differential pricing
Differential pricing has been broadly discussed as a preferred option given the
structure of the market, which allows pharmaceutical manufacturers to imple-
ment price discrimination across markets. Price discrimination refers to a prot-
maximizing producer selling the same product to different consumers at different
prices depending on their willingness and ability to pay. It implies that the produ-
cer (1) has enough market power to control prices, (2) can identify consumers’ wil-
lingness-to-pay and (3) can prevent resale from low-priced markets to high-priced
markets. In this context, an intuitive option that solves the accessibility issue is to
set a higher price in low demand-elasticity markets. Yet, in practice, demand-elas-
ticity is hard to accurately estimate. Third-degree price discrimination therefore
consists in setting different prices depending on consumers’ observable wealth. It
follows that a positive correlation should then be observed between drug prices
and countries’ income.5
This regulation system appears to be a win-win strategy: producers maxi-
mize their prots by adapting their prices to consumers’ willingness-to-pay and
consumers can afford products that were out of their reach and so, increase their
welfare. The theoretical case for differential pricing has been recently growing
as a result of economic and demographic growth in some low- or middle-income
countries, which increases the potential market size of these countries (Yadav,
2010). Other aspects that played a role in such evolution include the higher reco-
gnition of manufacturers’ social responsibilities in ensuring universal access to
medicines and increasing competition from generic manufacturers in emerging
markets (Yadav, 2010).
However, beyond its theoretical appeal, differential pricing remains a limited
strategy to improve access to medicines. Indeed, in his literature review, Yadav
(2010) gives an assessment of the implementation of differential pricing and
stressesthat differential pricing has been mainly restricted to vaccines, contra-
ceptives, and antiretroviral drugs. Moreover, he underlines the lack of signicant
correlation between the price of medicines and a country’s income. Recent empi-
rical studies (Scherer and Watal, 2002; Maskus and Ganslandt, 2002; Hellerstein
et al., 2004; Lai and Yadav, 2007; Waning et al., 2009) even nd evidence for an
inverse correlation, i.e. poor countries paying higher prices. Possible explanations
for low implementation levels relate to the poor knowledge of demand and supply
5. Still, one has to bear in mind that this price differential could also be related to the role of the health insu-
rance reimbursement system in most developed countries.
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Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry
structures and to the risk of eroding margins in higher income markets due to
external referencing. External referencing refers to the use of the price of a phar-
maceutical product in several countries to derive a benchmark or reference price
for the purpose of setting or negotiating the price of the product in a given country
(WHO, 2013). Eventually, as highlighted by Yadav (2010), for affordability levels
lower than the marginal cost of manufacturing, differential pricing is not enough
to ensure access, and donors’ subsidies or government support are still required.
Parallel trade: A limit to differential pricing implementation
Apart from limited implementation, another efciency drawback of differential
pricing is linked to its difculty to prevent parallel trade in the context of tra-
ding economies. Maskus (2001) dened parallel trade as parallel imports of goods
produced genuinely under intellectual property right (IPR) protection, placed into
circulation in one market, and then imported into a second market without the
authorization of the IPR owner. The only difference between exported goods and
original products is that their packaging may differ and exported goods may not
carry the manufacturer’s warranty. Parallel trade is a common practice in the
European pharmaceutical market resulting from the free movement of goods
ensured by the 1957 Treaty of Rome. In 2008, the shortages of epileptic drugs in
Greece due to massive importation into the United Kingdom is a case in point of
how parallel trade can undermine differential pricing and be problematic along
several aspects (Morgan, 2008). However, parallel trade is also authorized under
certain conditions in several developed countries such as Japan or Australia and
in developing countries such as Thailand, Argentina and South Africa.6
First, one needs to understand why parallel trade undermines differential pri-
cing. The short-term process is quite straightforward: when a drug is massively
bought in country A where it is cheaper in order to be exported to country B, this
can result either in shortages or in an increase in price in country A. However, in
country B, the price will go down as the parallel trader is selling it at a lower price.
Eventually, prices should converge across countries. Second, in the medium term,
the seller can anticipate that there will be parallel trade and tries to avoid competi-
tion on his market shares induced by parallel trading. Therefore, he will set similar
prices across countries in order to prevent parallel trade, which should strengthen
this price convergence and further undermine differential pricing.
An abundant empirical and theoretical literature studies the impact of paral-
lel trade on price convergence, drug supply and welfare. Many authors empiri-
cally and theoretically conrm the price convergence resulting from parallel trade
(Ganslandt and Maskus, 2004 for empirical and theoretical evidence; Jelovac and
Bordoy, 2005 for theoretical evidence). Another approach highlights the negative
impact of parallel trade on drugs supply, as Danzon and Epstein (2012).Finally,
a third approach tries to estimate the impact on welfare and nds mitigated
6. See Maskus (2001) for a review of the legal treatment of parallel import in pharmaceuticals.
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260 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
results. Jelovac and Bordoy (2005) use a model of industrial organization in which
countries differ either in their health needs or in their schemes of health insurance
reimbursement. They conclude that parallel trade will have a positive impact on
total welfare if countries only differ in their health needs, but a negative impact if
they only differ in their copayment schemes7 or in both dimensions.
Rationales and limitations of price regulation
According to the OECD denition (2002), price regulation refers to the policy of
setting prices (minimum and/or maximum) by a government agency, legal statute
or regulatory authority. For example, price control can consist in internal bench-
marking (comparing drugs from the same drug class) or external benchmarking
(comparing with prices from other countries). Rémuzat et al.(2014) underline
that external reference pricing (ERP) is applied in all of the 28 countries of the
European Union except the United Kingdom and Sweden. Likewise, Canada uses
the median price in a reference group of seven countries to determine the price of
a new drug (Patented Medicine Prices Review Board, 2017).Yet, comparing drug
prices between countries is difcult because products are not identical. It is neces-
sary to take into account their origins, whether they are generic or over-the-coun-
ter products, and whether they are retail prices or manufacturer prices that might
be subsidized. For this reason, Danzon and Furukawa (2003) built a composite
price index measuring price per dose by molecule indication, which enables one
to overcome the fact that products are different in presentation, strength, and pack
size.
Recent empirical studies nd evidence of a negative impact of price regulation
on investments in R&D, on the probability of launching a new product and on
launch delays. Very strikingly, Golec and Vernon (2006) estimate the costs of price
regulation in the European Union between 1985 and 2004 to USD 5 billion in
foregone R&D spending, 1,680 fewer research jobs, and 46 foregone new medi-
cines. Furthermore, price regulation has been shown to entail lower supply of
pharmaceuticals, for both developed and developing countries. Kyle (2007) empi-
rically highlights the lower probability of launching a new product in countries
with price controls but also in other markets (spillovers effects), which results
from three channels: (1) companies delay launch into price-controlled countries,
(2) companies are less likely to introduce their products in additional markets after
entering a country with price control, and (3) drugs that were invented by rms
headquartered in countries with price control reach fewer markets than drugs that
were invented by rms without price control. Danzon and Epstein (2012) com-
plement the analysis of Kyle (2007) by identifying three mechanisms resulting in
higher launch delay: (1) lower expected prots for the manufacturers, (2) strategic
delays in order to inuence the nal price, (3) bureaucratic delays resulting from
7. A manufacturer can charge higher prices when the co-payment rate is lower, taking advantage of a lower
price elasticity of demand. This can result in a reallocation of drug consumption from individuals with more
drug needs to individuals with relatively less drug needs.
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RFAS - 2018 - N° 3 261
Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry
regulatory processes. Finally, external reference pricing can have negative spillo-
vers effects (and resulting welfare losses) on launch delays in other countries in the
case of lower price reference countries (Danzon and Epstein, 2012).
Patent protection
As discussed before, the international market for drugs is also characterized
by strong patent protection. In this following part, we present the theoretical fra-
mework and evidence about the impact of patent protection on availability and
prices of drugs.
Theoretical impact of patent protection on availability and prices of
drugs
The theoretical effects of patent protection are threefold. First, patent protec-
tion is expected to have an impact on the level of R&D. Indeed, the prospect of high
prots, given the monopoly power maintained while the patent owner exclusively
sells the drug, incentivizes companies to invest in R&D. Second, patent protection
is expected to have an impact on the probability and delays of launch of new
products in a given market. This is also due to the higher incentive to launch
new products under the prospect of monopoly power and higher expected prots.
Third, patent protection is expected to have an impact on prices. Indeed, a patent
creates a monopoly as no substitute for the patented drug can be sold at a lower
price. Therefore, the producer can set a price that is higher than the marginal cost
and generate higher prots because other rms cannot compete. This results in a
wealth transfer from consumers to the monopolist and consequently in a welfare
loss for the consumers.
Accordingly, the main theoretical issue is that in a static approach, weake-
ning intellectual property should increase access to drugs in developing countries
thanks to access to cheaper generics. However, in a dynamic approach, this could
be detrimental to both developing and developed countries, as it reduces incen-
tives to invest in R&D and eventually results in the lower overall supply of drugs.
Empirical evaluation of the impact of patent protection on availability
and prices of drugs
Empirical evidence generally nds positive impact of patenting on R&D. Arora
et al. (2008) analyze the effect of patenting by modeling the link between R&D
effort and the decision to patent, accounting for the fact that strong patent regula-
tion is at the same time benecial for the rm due to higher prots under mono-
poly power, and detrimental because the rm cannot use the knowledge produced
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262 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
by the R&D of other rms. Calibrating the model with U.S. survey data, they still
nd that patents stimulate R&D across all manufacturing industries, including the
pharmaceutical one. Kyle and McGahan (2011) also study the impact of paten-
ting in the context of the 1 994 Agreement on Trade-Related Aspects of Intellectual
Property Rights (TRIPS). They nd that in general, R&D effort is positively asso-
ciated with the protection of intellectual property.Evenson and Kanwar (2001)
nd similar results and conclude that intellectual property rights unambiguously
constitute incentives for spurring innovation. Moreover, as Grabowski (2002)
underlines, this question has also been extensively addressed from a management
point of view, as in Manseld (1986), by using declarative data from rms. Such
surveys highlight the signicance of patent protection for the development of inno-
vations in the pharmaceutical industry.
The agreement on trade-related aspects of intellectual property right (TRIPS)
is a legal agreement signed by all WTO members in 1 994. It aims at harmonizing
and, more specically, guaranteeing some minimum standards in terms of intel-
lectual property rights at the international level. This agreement not only focuses
on pharmaceutical drugs, but relates to any form of intellectual property regula-
tion: patents, copyrights, trademark etc. However, its more controversial aspects
deal with the harmonization of the pharmaceutical drugs patent system, which is
accused of preventing access to essential medicines in developing countries. Those
concerns led, after new rounds of negotiations, to the adoption in 2001 by the
WTO of the Doha Declaration which, in substance, states that public health should
come before intellectual property rights. More recently, in 2015, TRIPS was again
made more exible when the WTO agreed to give the least developed countries
a supplementary delay (2033) to reach TRIPS’s objectives in terms of intellectual
property regulation.
However, empirical evidence is more mixed when considering the impact of
patenting launching delays and the probability of launch. By analyzing the timing
of launch of 642 new drugs over the 1983-2002 period in 76 countries, Cockburn
et al. (2016) show that more extensive patent protection decreases delays of launch
in new markets. Yet, by conducting a cross-country analysis on how patent protec-
tion affects the probability and speed of drug launches, Lanjouw (2005) nds that,
in she short term, for developing countries, higher levels of protection encourage
entry of innovative products. This is particularly true for countries where local
technical capacity is higher and where multinationals may therefore hesitate to
enter the market due to increased potential competition. Nevertheless, this domes-
tic capacity could be an alternative source of entry and in the long term, the author
argues that patent protection can have a negative impact on this local capacity. In
the end, a developing country offering high patent protection could thereby lose
the benets of entry by the multinationals and have a lower probability for the
launch of new products due to the weakening of the domestic capacity.
Finally, empirical evidence demonstrates the positive impact of patents on
prices. In an attempt to simulate the impact of patenting in India under the TRIPS
agreement and the move from a competitive to a monopolistic market, Watal
(2000) shows that prices are likely to increase and welfare to decrease due to
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RFAS - 2018 - N° 3 263
Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry
moving to the monopoly structure. However, this work is done in a static approach,
which means that Watal does not account for the fact that an increase of patent
protection could also result in increased local capacity if it incentivizes domestic
rms to invest more in R&D and to develop new products.
The joint effect of higher prices, higher R&D and either higher or lower
launching delays and probability of launch is difcult to estimate. Few studies
try to jointly estimate the impact of patent protection on multiple outcomes (R&D,
launch probability, prices and welfare). Following the TRIPS agreement, Kyle and
Qian (2014) try to estimate the effects of patent protection on prices, launch proba-
bility and sold quantity in both developed and developing countries. They nd that
strengthened patent protection has a positive effect on prices and sold quantities
but that this effect is smaller for developing countries than for OECD countries.
Patent protection does provide incentives to develop pharmaceutical drugs, yet it
also leads to higher prices. However, when focusing on patented drugs, they show
that the patent premium is on average lower after than before the TRIPS reform.
This evidence minimizes the potential detrimental effect of TRIPS – through higher
prices – for developing countries. The authors are also tackling another crucial
point: whether TRIPS had an effect on the pharmaceutical drug markets for notable
serious and harmful diseases. Their estimation shows that the launch probability
of drugs is higher under stronger patent protection, but that the effect declines
with the disease burden. This result argues in favor of drugs being patented to
answer specic needs, but that TRIPS weakened this relationship between the pro-
bability of dispensing a drug and the level of disease burden. This study seems to
show that strengthened patent protection, through TRIPS, did not have disastrous
effects in terms of drugs accessibility in developing countries. However, one of its
notable limitations is not being able to account for the resistance from develo-
ping countries, which could be a signicant confounding factor. Strengthened price
control or an increase in the use of compulsory licenses can offset the true effects
of patent protection. On one hand, taking this confounding factor into account, it
could be that the positive result regarding access to drugs on patent price premium
is not driven by TRIPS, but by an increase in government control over prices after
TRIPS. On the other hand, the mitigating effects of TRIPS on the launch probability
of drugs targeted at high burden diseases could be due to reduced economic inte-
rests for industries following price control or compulsory license use.
Therefore, even though empirical evidence unambiguously shows that patent
protection is benecial to research and development, empirical evidence is more
mixed as to whether patent protection has a positive impact on availability of
drugs, especially for developing countries due to ambiguous effect on delays of
launch, probability of launch, and to increased prices.
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264 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
Reconciling equity and efficiency
Beyond the implementation of different existing policies and their pros and
cons, how can equity and efciency criteria be reconciled? Two of the main stra-
tegies discussed in the literature include the approach presented by Danzon
and Towse (2003) and the advance market commitment approach presented by
Kremer (2002).
Differential pricing and patent protection
To reiterate a point made earlier in this article, the main problem when consi-
dering international pricing of drugs and patenting is that static efciency and
dynamic efciency do not necessarily go hand in hand. Static efciency requires
that prices of drugs are reasonable so that people can afford them. In this context,
high prices are problematic. However, dynamic efciency requires that rms pro-
duce and launch new drugs, which is positively correlated with patent protection
but also results in higher prices. Therefore, how can we reconcile access to drugs,
patent protection and R&D?
Following what has previously been described in this paper and an article
by Danzon and Towse (2003) entitled «Differential Pricing for Pharmaceuticals:
Reconciling Access, R&D and Patents», an optimal market should be characte-
rized by: (1) strong intellectual property protection so as to guarantee dynamic
efciency on one hand, and (2) differential pricing so as to guarantee static ef-
ciency on the other hand. The idea underlying this set up is that strong intellectual
property protection ensures incentives to innovate and optimal supply, whereas
differential pricing ensures that different markets with different characteristics
can pay a reasonable price.
Prerequisites for the implementation of such policy include that market seg-
mentation can be achieved and therefore that parallel trade or external referen-
cing are prohibited. At the moment, this market segmentation prerequisite is not
met, mainly due to the existence of external referencing as well as parallel trade.
This is despite the fact that numerous papers on price regulation and parallel
trade have proved external referencing and parallel trade it to be inefcient.
Design and challenges for advance market commitments
The innovation contest constitutes another alternative to reconcile equity and
efciency. At the beginning of the 2000s, Kremer (2002) promoted the idea of
Advance Market Commitment (AMC) to overcome pricing limitations in neglected
disease areas (e.g. malaria, tuberculosis, HIV). AMC involves long-term agreements
between poor countries, sponsors and vaccine developers. First, a country willing
to purchase a vaccine sets its affordable price per unit. Sponsors then top it up to
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RFAS - 2018 - N° 3 265
Prices, Patents and Access to Drugs: Views on Equity and Efficiency in the Global Pharmaceutical Industry
a higher price, at which they commit to purchase a xed number of vaccines. Once
these are purchased at the higher subsidized price, manufacturers are constrained
to sell further treatments at a lower affordable price in the long term. This allows
for expected market returns to neglected disease treatment to equalize with other
pharmaceutical products. Furthermore, it is sustainable for sponsors to the extent
that no cost is incurred until the vaccine is successfully developed.
Although a range of theoretical studies discusses the theoretical pros and cons
of AMC (Towse and Kettler, 2005; Berndt et al., 2005; Ridley et al., 2006), it is still
early to draw conclusions on the efciency of the rst AMC pilot announced in
2007 by GAVI Alliance, WHO and UNICEF for pneumococcal vaccines. A prelimi-
nary analysis by Snyder et al. (2011) suggests that the rollout of AMC vaccines has
been rapid, but their data prevents them from disentangling the possible impact
of AMC from that of the level of resources involved. Among the main challenges
in implementing AMC is the difculty to specify optimal product features and its
estimated cost of production as well as the lack of information, which is furthered
by information asymmetry between manufacturers and public-sector funders. In
a longer-term perspective, AMC design should also question the conditions for a
sustainable and affordable supply after the commitment is over. This could be rea-
ched through a set of appropriate incentives for manufacturers of both rst and
second-generation vaccines.
Conclusion
In this review, we have tried to understand how to deal with the efciency and
equity issues raised by international drug pricing. The proposal made by Danzon
and Towse (2003) to reconcile equity and efciency – which consists in strong
intellectual property rights, differential pricing and the absence of parallel trade or
external referencing – seems attractive. Unfortunately, in practice, each dimension
of this proposal is problematic. Indeed, parallel trade is not always possible to pre-
vent, especially in free trade areas such as the EU market. Moreover, the authors
advocate for strong patent protection to reach optimality. Yet, imposing patent pro-
tection has costs in developing countries, not only in terms of higher prices, but
also because the entire industry, which focused on generic manufacturing, has to
adjust to the new market conditions. Thus, patent protection has become a bone
of contention at the international level as reected in the negotiation surroun-
dings the TRIPS agreement and the post-TRIPS Doha Declaration. Regardless of
the conclusions of those debates, without a clarication on the pharmaceutical
lobbies’ ability to inuence politics and research, economists’ insights might not
be heard.8In the meantime, proposals to reach both efciency and equity that do
not necessarily advocate strong patent protection as a prerequisite deserve parti-
cular attention. In this perspective, carrying on with the analysis of the ability of
the innovation contest to reach those goals is essential.
8. For an analysis of the role of pharmaceutical industry in U.S. patent policy, see for instance Scherer (2007).
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266 2018 - N° 3 - RFAS
Quentin Cavalan, Maud Hazan, Irène Hu and Roxane Zighed
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