Government can reduce medicine prices overnight

According to media reports the newly established Medicines Pricing Committee intends to recommend a single exit price for pharmaceuticals, which is to be set as each drug leaves the factory. It also intends setting the permitted mark-ups for wholesalers, distributors and pharmacists.

While price controls are intended to make medicines more affordable, South Africans will pay dearly for the proposed government meddling with the price system. They will lose the benefit of competition in the distribution chain, pay more in taxes to cover the cost of the increased bureaucracy, and lose access to drugs that disappear from the market because manufacturers decide to cease production or supply in South Africa. Some will withdraw because they object, in principle, to being told how to run their businesses, others because of the uncertainty of being dependent on the arbitrary decisions of officials, and yet others because it makes doing business in this country unprofitable. Whatever the reason, consumers will be the losers.

A single exit price and fixed mark-ups would attempt to ensure that everyone in the drug distribution and dispensing chain gets a guaranteed cut. The financial discipline imposed by competition would be removed as well as the incentive to find better and cheaper ways of distributing and dispensing. Instead of competing for market share on the basis of quality, effectiveness, price, service, and efficiency market participants will concentrate their efforts on lobbying the Pricing Committee to increase permitted mark-ups. Eventually, as is so often the case with administered prices in a market from which competition has been removed, the single-exit-price system will lead to higher drug prices.

Government actions are not costless and the costs are ultimately borne by consumers and taxpayers. Consumers pay higher prices than they would have done in an unfettered market while taxpayers are burdened with the administrative, personnel and operational costs of bureaucracy. The burden is exacerbated by the cost of gathering and distributing the taxes to maintain the bureaucracies. Then there are the costs to firms of complying with procedures and regulations, which usually entail the hiring of additional staff and office space. Firms become less efficient because of the time and resources spent on complying with demands that contribute nothing towards production. The compliance costs are ultimately passed on to the consumer in the form of higher prices. It is then utterly perverse for government officials to hold themselves out to be the saviours of the consumer when they are adding substantially to the cost of products, including that part of the ultimate price that goes to government in the form of taxes and duties.

Fixing the exit price of a drug assumes that someone actually knows what the “right price” for a particular drug should be. However, no committee of “experts” has any means of knowing. Producers themselves have to find out by trial and error and are often compelled to charge different prices for different situations, and ironically, in South Africa that means charging private distributors more so as to be able to subsidise the public sector. There is consequently no such thing as a “fair” price. In a properly functioning, unfettered and competitive market, buyers and sellers interacting freely with each other within a framework of property rights, voluntary exchange and the rule of law, determine prices in the millions of buying and selling transactions that take place every minute of the day. In such an environment, the firm that is the manufacturer and owner of a drug is free to sell to whomever it wishes, at whatever price buyers are willing to pay.

In an interactive market environment, prices are information carriers that tell everyone, especially producers, what is and is not in demand. Government intervention in the process robs producers of vital information on which to base their production and forward planning decisions. Not surprisingly, communist countries constantly over-produced and under-produced goods because they had no way of determining demand. In desperation they copied prices from the free world but, while those proxy prices were better than nothing, they did not reflect the wishes of their own consumers. In a totally socialist world the instructions given to producers by their consumer-bosses through prices would be missing, as would borrowed proxy prices, and there would be no way for governments to allocate resources.

The Pricing Committee will obviously try to make use of proxy prices but they will face the same problem experienced by the socialist production planners. By tampering with prices they will deny pharmaceutical firms access to the freely expressed views of this country’s consumers, which would otherwise be supplied by the myriad decisions of consumers to purchase or not to purchase drugs at the prices at which they are offered to them. Firms would also be denied the crucial right to constantly adjust prices to take account of demand, or the lack of it, and their own ability to supply the demand at the price the consumer is prepared to pay. No lumbering bureaucracy can hope to emulate the complex co-ordinating function performed by freely determined prices and anyone believing they can, suffers from what the eminent economist Friedrich von Hayek described as “fatal conceit”.

If government wishes to achieve the best result for the consumer it should not intervene in the pharmaceutical manufacturing industry. It should treat pharmaceuticals in the same way it treats any other products, including normal precautions to assure safety. All government-created barriers to entry and unnecessary compliance costs should be removed, including the double-testing of drugs that have already been approved and are on sale in the world’s most advanced countries. Above all, government should not interfere in drug pricing and distribution and should rely on highly competitive firms to vie with each other for the custom of the consumer. This will provide infinitely superior outcomes to anything that government officials can hope to engineer.

Although government should not cause economic distortions by treating any particular type of industry either exceptionally well or exceptionally badly, if it is intent on intervening anyway, it has a much better option for achieving low drug prices than the one it appears to have chosen. It could declare South Africa to be a Pharmaceutical Manufacturing Free Zone. It could then exempt all pharmaceutical products from VAT and exempt the manufacturing firms from income tax, import duties on machinery and other requirements used in the process of manufacture, as well as from all unnecessary cost-increasing government regulations. Government could even go further and make the entire health care industry tax exempt. Within a short time South Africa would attract a host of additional health-care and pharmaceutical product providers instead of driving them away as current government plans are bound to do. They would be falling over each other to serve the South African public. Prices would drop sharply, overnight as a result of the tax exemptions, and in time even further due to increased competition. And, of course, the lack of a useful role for the Medicines Pricing Committee would become patently clear.

Author: Johan Biermann is an independent policy researcher. He is the author of Undermining Mineral Rights: An International Comparison, published by the Free Market Foundation in 2002. He and Eustace Davie are co-authors of the forthcoming book, South Africa’s real health care challenge, to be published by the FMF in the next few months. 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.

FMF Article of the Week\14 October 2003