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A recent ChinaFile report makes pretty bleak reading for ‘Big Pharma.’ Long regarded as the next great hope for market expansion, the mirage of China keeps receding into the middle distance.

Always there, always out of reach. This time the story centres on China forcing reductions in the price of key drugs, but previous disputes have involved the issuing of compulsory licences to produce generic versions of frontline treatments. Each time, the lure of market access for Western majors proves too compelling to turn back.

On one level the pharmaceutical industry is an emotive subject. Drugs save lives, yet they also cost money. Pharmaceutical companies make money by saving lives, but they therefore also profit from ill-health. On another level, however, the pharmaceutical industry is just like any other. Innovation and high quality research lead to new and improved products, and therefore profits with which to conduct further research.

Inevitably though, these competing commercial and healthcare priorities can produce difficult market conditions in countries where the latest drugs are highly prized, but the costs are prohibitive. The market for pharmaceuticals, therefore, more than for any other traded products, is wrapped up by the restraining language of permission and regulatory approval.

From a macro-economic perspective the most innovative pharmaceutical companies are from Europe and the US, which have decades of capital investment and research behind them, along with the best scientific and medical universities in the world providing a constant flow of specialist training for new recruits. On top of this, high levels of public funding for healthcare ensure demand is always high for even minor product improvements.

Developing countries can’t compete with these deep reservoirs of research expertise and product development, so pharmaceuticals is a key strategic sector for developed economies transitioning away from labour intensive heavy manufacturing. But, given that developing countries can’t compete, they have little incentive to agree to the patent protection and market access that is the lifeblood of pharmaceutical innovation.

Therefore the world is divided. In the West, the benefits of innovation are obvious, so patent protection is extensive and enforced. In countries unable to match the research advantages of developed economies patent protection can be disregarded in favour of ‘generic’ producers, able to reproduce the ingredients at cost, without paying for the research and testing (India is an acknowledged trendsetter).

The China Angle

China continues to be seen as an enormous potential market for Western pharmaceutical companies. They have the products, China has the people. But China also has its own pharmaceutical companies, and a government jealous of the advantages of Western companies. What this produces is endlessly difficult market conditions. China’s government has an interest in capping or reducing healthcare costs, but can’t ignore strong demand for foreign products.

A further complication is simply that only some drugs are sold ‘over the counter’, so the ‘sale point’ for the most important drugs is really through hospitals and clinicians. The way for a Western company to get its products distributed in China then, is to develop a network that both provides drugs, and educates healthcare professionals in their use and benefits. This brings companies into direct contact with local administrative and purchasing practices where the rules of interaction are not always entirely clear. GlaxoSmithKline felt the sharp end of this exposure in 2013 when its senior executives were arrested and the company was eventually fined $483 million. Furthermore, GSK had little incentive to fight their case, as the unstated punishment of being shut out of China entirely always hovered in the background (some interesting contemporary observations here). It’s still not entirely clear what they did wrong.

Now a central government initiative – taking example from India – to simply demand price reductions on key drugs, provides a further test of Big Pharma’s long term commitment to China. This comes on top of last year’s decision to put ‘generics’ and ‘branded products’ on the same price control regime, meaning branded products are simply not allowed to benefit from the premiums generated by lack of consumer trust in generics. Until now, market entry has always been a key criteria for investment in China, fuelled by the expectation that the Chinese market would eventually develop and become more normal, but it looks increasingly likely that China is going the way of India, and this is bad news for all.

The Macro Angle

Although this issue is often framed in terms of ‘just healthcare outcomes’ for developing economies, and there are few in the Western press with much sympathy for Big Pharma, the implications eat away at the entire framework of world trade. It is true that Western economies have a strong comparative advantage in pharmaceuticals, but if they are not allowed to gain from that comparative advantage it raises a question over how the benefits of more open trading relations are distributed.

Combine this with the damage done to medical research by restricting the reach of patent protection and the long term economic implications are potentially very negative, not just for Western economies, but also for China. The next pandemic will not simply cure itself after all, and with concerns rising all the time over antibiotic resistance, the stakes are not trivial.

When looked at purely from the perspective of terms of trade, China’s market for pharmaceutical products was estimated at about $115 billion for 2015, about half of which was accounted for by foreign companies with perhaps as much as 20% directly imported (Most recent figures, 2014, $19 billion according to the Ministry of Commerce). The growth in this market has already been remarkable, having risen from only $48 billion as recently as 2012, but estimated to grow as high as $315 billion by 2020. Western companies – if patents were recognised and upheld, and brands were allowed to attract a premium over less desirable generics – might be expected to claim the lion’s share of this market growth, but the shift towards an Indian market model would make this much harder to achieve.

Herein lies the problem. Obviously China wants to minimise exposure to rising health costs, but to do by directly undermining the research protections enjoyed by Big Pharma raises doubts over China’s commitment to normalised trading relations. And that – it must be understood – has wider implications.

By Douglas Bulloch

Source: Forbes