HPU
Respect the Constitution and apply economics in the pricing of medicines
Author: Eustace Davie Date: 17 April 2007

While closed pharmacies, and especially community pharmacies, are the first visible casualties of government intervention in healthcare pricing, costly consequences of other healthcare regulations are no less harmful to the long-term interests of patients.

The underlying motivation of the Department of Health (DOH) in instituting price controls on medicines is probably based on a belief that the same quantity and quality of medication will be provided at lower cost under a price control regime as would be available to patients in an open, competitive market with no price controls. Such a belief has no economic foundation.

In their book, <I>Free to Choose</I>, Milton and Rose Friedman described why price controls have negative consequences. ‘Economists may not know much. But we know one thing very well: how to produce surpluses and shortages. Do you want a surplus? Have the government legislate a <I>minimum</i> price that is above the price that would otherwise prevail’, they wrote. ‘Do you want a <I>shortage</I>? Have the government legislate a <I>maximum</I> price that is below the price that would otherwise prevail.’ The DOH’s legislated <I>maximum</I> medicine prices will have the consequences predicted by the Friedmans: they will create medicine <I>shortages</I> and deprive patients of services that would otherwise be available to them.

Reports on medicine pricing generally fail to mention that the controlled prices apply only to the private sector. A 2000 report showed that through the Co-ordinating Committee for Medical Procurement (COMED) tendering system for drugs, the government was able to ensure that medicines for the state sector were purchased at around 35% less than the World Health Organisation’s (WHO) International Drug Price Indicator Guide (IDPIG).

Government purchases medicines from pharmaceutical companies in SA at prices that are among the lowest in the world. These medicines are then supplied to the poor through government hospitals and clinics at no or a minimal charge. The contention that the price controls are necessary to reduce the prices of medicines for the poor is therefore not completely accurate. While pharmaceutical companies and other medicine sellers are bound by law to charge everyone else a single exit price (SEP) set by government, the DOH is exempt and buys by tender at huge discounts.

Prior to the institution of the price controlled SEP, pharmaceutical companies were able to offset the effects of the low prices received on sales to government against higher prices on their sales to the private sector. In other words, wealthier private patients subsidised the medicines of the poor. The price controls are likely to result in a convergence of the prices to the state and private purchasers and in time lead to the opposite of what the DOH says it wishes to achieve.

Everyone in the healthcare industry is dismayed by government’s long delay in announcing new regulated medicine prices. The healthcare industry is operating in a state of uncertainty, unable to plan or budget properly, which is detrimental to the conduct of business and the interests of patients.

In our submission on 15 April 2004, the FMF appealed to the DOH to reconsider its decision to institute price controls on medicines, and drew attention to various difficulties other countries experience with such controls: “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 two 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 also 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 lost revenue elsewhere, further distorting medicine prices.”

Price setting by government is unavoidably arbitrary, will always have unintended consequences, and cannot be carried out without causing some form of harm. Benchmark pricing attempts to determine ‘acceptable’ medicine prices, deriving them from average prices for the same products in other countries. While this mechanism may appear to have economic legitimacy, it causes distortions because it is incapable of capturing or simulating all the factors that determine competitive market prices.

Purchasing power parity (PPP) prices that attempt to take into account the incomes of purchasers in the respective countries reflect the attempts of pharmaceutical companies to recover the greater part of the fixed cost incurred in producing drugs on an ability-to-pay basis, which means that the highest prices are paid by patients in wealthier countries. However, exchange rate changes and fluctuations in costs of production, which are incapable of being accurately forecast, can create large distortions if locked into a SEP that is fixed for any length of time.

Patient welfare will be best served by a freely competing, innovative and entrepreneurial private healthcare industry functioning in a statutory environment characterised by respect for private property rights and the proper application of the rule of law, which is a founding principle of our Constitution. Section 33, which stipulates that ‘everyone has the right to administration that is lawful, reasonable and procedurally fair’, must also be applied. The DOH needs to bear in mind these constitutional principles of our democracy if it is to avoid regular challenges in the Constitutional Court.

Respect for the Constitution in all health care matters, including the pricing of medicines, will not only result in a better all-round statutory dispensation for healthcare providers, it will also provide the best outcomes for patients. Application of economic principles in making health care policy decisions will provide even better outcomes: abandon the medicines pricing regulations.

<b><u>Author:</b></u> Eustace Davie is the director of the Health Policy Unit (a division of the Free Market Foundation). This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Free Market Foundation.

<I>FMF Feature Article/ 17 April 2007</I>