The Pharmaceutical Industry And The Aids Crisis In Developing Countries

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

1 2001 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.

2 Epitomized 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

3 The following table summarizes the price changes for brand and generic drugs from 2000 to 2001 (IAEN).

Patents and Monopoly Power

4 Prices 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.

5 However, 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.

6 However, 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

7 More 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.

8 In 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

9 However, 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.

10 It 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