Recent commentaries on how to ensure that a large and stable supply of low-priced medicines is made available to poor countries place at the center of their solution the concept of "equity pricing."¹ The idea is that poor countries, rich countries, and pharmaceutical companies would all agree to establish a global distribution system that would ensure very low prices for essential medicines in the poorest nations (or even provide them for free). While there remains debate about how such an arrangement would work, its essential elements involve these features: a) pharmaceutical companies would voluntarily agree to provide medicines at extremely low prices in designated nations, either directly or under license, b) governments and/or non-governmental organizations would purchase medicines in bulk to distribute to the poorest citizens of these nations, c) this arrangement might be bolstered by the threat of forcing the pharmaceutical companies to license their patents to generic drug manufacturers, and, d) rigorous controls would prevent these low cost drugs from being re-exported to developed nations.

I agree fully that a distribution system that achieves stable and very low prices in poor countries is urgently needed, and that some combination of the above policies is required to accomplish this goal. However, it is of interest first to explore the extent to which the current international system provides incentives for differential pricing in favor of patients in developing nations. Appealing to economic theory, we might expect prices for identical goods in different nations to rise with the nation’s per-capita income. The logic is that patients in higher-income economies not only have greater demand per-capita for drugs but also that this demand is less elastic. In other words, as incomes rise around the world, patients become less sensitive to the prices of drugs and, as a result, pharmaceutical companies find it profitable to charge higher prices in rich countries and lower prices in poor countries. This concept is referred to as "Ramsey-pricing" in economics and it explains price differentiation in many goods and services.

The obvious question is whether pricing works this way in the real world. I have been studying international drug prices to investigate such issues. Before we turn to the data, we must note the importance of carefully defined products in international price comparisons. Medicines differ considerably between countries in concentration, dosage, and means of administration. Thus, I assembled from IMS Health information on brand-name drugs that are sold in identical formats. The data discussed here are for ex-manufacturer prices (manufacturer’s prices before any hospital or pharmacy markups or dispensing fees), which are more comparable internationally than pharmacy or hospital prices, for the year 1998. Keep in mind that these are prices of brand-name drugs, sold under license by the original manufacturers. No generic drugs or parallel-imported drugs are included in this sample. (“Parallel” or “gray market” goods are imported from another country where they were previously sold, typically at a low price.)

Here I summarize the pricing information, with prices defined per unit (e.g., pill).² There were twelve countries in the sample and up to twenty drugs in common between the United States and the other eleven. Defining the U.S. price for each drug to be 1.00, I calculated the relative price for each in every country. The average price differentials relative to the United States were ranked as follows (see figure): United States (1.00); Brazil (0.81); Mexico (0.76); Japan (0.74); Sweden (0.73); United Kingdom (0.70); Canada (0.63); South Africa (0.58); Italy (0.55); South Korea (0.54); Thailand (0.41); and India (0.08).

Two things stand out in these data. First, brand-name prices in India are far lower than those in other nations, presumably because of extensive generic competition in that market. Second, and more relevant to our analysis, there is no strong correlation between per-capita income and ex-manufacturer prices. Brazil and Mexico have the second-highest and third-highest average prices in the sample, while higher-income Canada and Italy rank seventh and ninth. On the other hand, prices in South Africa and South Korea are not much different from those in Canada and Italy.³

Pharmaceutical companies have a number of ways by which they can differentiate prices between countries, including restrictions on parallel trade. Parallel trade in brand-name drugs was not permitted among most of the above countries in 1998, with the exception of India and members of the European Union. If markets truly were segmented and the Ramsey pricing rule was operational, we would anticipate considerably more price discrimination favoring developing countries than these figures suggest. Why is this not the case?

A number of relevant hypotheses may be advanced here. First, and most obviously, countries differ in the rigor of their price controls, which may operate at the ex-manufacturer level. Italy has extensive controls, while Canada exercises a comprehensive price maintenance system under which public authorities monitor drug prices and intervene to restrict "excessive" price increases. However, price controls by themselves cannot account fully for the facts described above. Second—and related—is the fact that some developed countries exert their controls on the basis of international reference pricing, a system where prices from around the world are used to compute allowable domestic charges. Because such comparisons often include data from major developing countries, these schemes have the perverse effect of encouraging pharmaceutical companies to bargain for high prices in those countries. It is fair to say that, for extensive equity pricing to emerge in the global community, rich countries need to moderate significantly their use of poor-country prices in calculating their reference schemes, or to abandon it altogether.

Third, and most significant, the notion that prices vary with per-capita income rests on the false idea that within each country, patients with average (or lower) incomes have access to brand-name drugs. The reality is that drug companies find it more profitable to sell largely to high-income patients at relatively high prices, and to ignore the larger volume of low-income patients. Patients with higher incomes are simply more likely than poor patients to be able to afford drugs, either directly or through insurance programs. (In impoverished countries where public health budgets are chronically limited, most patients have to buy drugs out-of-pocket, which often induces them to go without.)

This hypothesis has received theoretical and empirical support in a recent study.⁴ In this model, really poor people (those whose income falls below a threshold) go without medicines so that they can pay for shelter and food. As incomes rise, however, people become more able to afford drugs and demand for them rises. In this context, assuming other things to be equal, countries with high income inequalities should observe higher prices than countries where income is more evenly distributed. Econometric analysis of this prediction is strongly borne out in an analysis of product prices across developed and developing countries. The data suggest that a one-percent rise in the measure of income inequality (Gini coefficient) tends to raise average drug prices by 0.7%, which is highly significant.

This is a novel and important result, but we should be careful in drawing policy conclusions from it. While reducing income inequality may be desirable for a number of reasons, more direct policies are appropriate for increasing poor patients’ access to medicines. First, the development of effective internal market segmentation through public and private insurance markets should increase the willingness of drug companies to offer medicines at low prices to poor patients. Second, governments in developing countries may need to increase their expenditures on pharmaceuticals considerably in order to provide access. Finally, part of the access problem relates to inadequate medical and transportation infrastructures, which need to be improved.

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Part of the research underlying this article was funded by the World Intellectual Property Organization.

Notes
1. Prominent examples include Commission on Macroeconomics and Health, Macroeconomics and Health: Investing in Health for Economic Development, (Geneva: World Health Organization), 2001; and Commission on Intellectual Property Rights, Integrating Intellectual Property Rights and Development Policy, (London: Commission on Intellectual Property Rights); 2002.

2 Full information is available in the report, "Parallel Imports in Pharmaceuticals: Implications for Competition and Prices in Developing Countries," WIPO, April 2001.

3 When comparisons are made for each drug across countries, the correlations are somewhat higher on average. But some drugs have a negative correlation between per-capita incomes and prices, while many drugs have no significant correlation. The correlation coefficients for the 20 drugs range from -0.29 to +0.82 with income measured on a purchasing-power basis.

4. See Eina V. Wong, Pharmaceutical Drug Prices in the International Market, Ph.D. dissertation, University of Colorado at Boulder, 2003.