[1124] Of moderating the FTA-related drug prices increase

It is March and the deadline to forge a free trade agreement between Malaysia and the United States is looming closer. Here, I want to share a solution that could lay a middle ground between the supporters and the opponents of the FTA as far as drug prices are concerned.

Firstly, it is good to recognize why the prices of drugs could go up if the free trade agreement is signed. The increase is exclusively due to stronger intellectual copyrights law and not due to the principles of free trade. Though a majority of us, including me, does not know the exact detail of the FTA, there is enough information flying out in the public to be sure of that. With stronger copyrights law, cheap generic drugs would not be allowed to be sold as widely as it is available at the moment, in favor of patented drugs. Makers of patented drugs would be able to enjoy higher sales for longer period without the risk of competing with cheaper generic drugs.

While I generally support freer trade, I do sympathize for individuals that would be adversely affected by higher drug prices. Nevertheless, it is imperative for us to respect private property and directly, incentive for innovation. Between the two factors, a dilemma. The dilemma must be solved if the Malaysia-US FTA is to become acceptable to as many Malaysian as possible.

Here is what I propose to solve the dilemma: there is a role for the government. The Malaysian government could buy drugs from pharmaceutical companies and then resell it to the public through public health infrastructure at cost.

I know, I know. Anybody that is familiar with this blog would not expect me to propose a statist solution. Before you bang in the head however, please read on.

The program that I am thinking of might be distantly similar to what is practiced in Australia while stopping short at down right subsidy. The Malaysian government could buy drugs through auction and I am thinking reversed modified Dutch auction.

I am unsure if reversed Dutch auction is a common economic term for the kind of auction I have in mind but a Dutch auction works like this: there are a seller and many buyers. For simplicity and clarity reason, I shall call the seller as the auctioneer while the buyers as bidders. The auctioneer begins the auction by placing a high ask price. The price will be lowered by the auctioneer if there is no buyer. The auctioneer will continue to lower the price until there is a willing buyer. A variation of this auction was practiced during the initial public offering of Google back in 2004.

A reversed modified Dutch auction, as I call it, is a scenario which there are a buyer and many sellers. The buyer is the auctioneer while the sellers are the bidders. In a sense, reversed Dutch auction is the opposite of Dutch auction in the way monopoly is the opposite of monopsony.

Within Malaysian context, the Malaysian government is the auctioneer while various pharmaceutical companies of patented drugs are the bidders. The government starts by placing a low ask price in the free market. If there is no willing seller at such a low price, the government will increase its offer price and will continue to do so until there is a willing seller. The government could continue to do so until all of its demands are met. An example might help illustrate what I am trying to get at. Say the Malaysia government is demanding 1000 tons of drugs. At the same time, there are five sellers which I shall call A, B, C, D E and F.

Company A is able to supply 300 tons at RM1.00 per kg.

Company B is able to supply 300 tons at RM1.50 per kg.

Company C is able to supply 200 tons at RM2.00 per kg.

Company D is able to supply 100 tons at RM2.50 per kg.

Company E is able to supply 100 tons at RM3.00 per kg.

Company F is able to supply 100 tons at RM3.50 per kg.

The first 300 tons will be fulfilled by Company A and the government will pay RM1.00 per kg for drugs. This leaves 700 tons of unfulfilled demand. Realizing that nobody is willing to see any drug at RM1.00 anymore, the government raises it ask price and eventually will hit RM1.50 per kg. At that moment, Company B will step in and supply the government will 300 tons of drugs at such price. This leaves 400 tons of unfulfilled demand. The process will continue until the demand is exhausted. In this particular scenario, the government will pay at RM3.00 per kg at most; the government will not buy from Company F.

While prices could still increase vis-à-vis prices without the FTA, the increase would not be as much as that without this model with the FTA. If the drug prices are not low enough, perhaps the government could add in some sort of subsidy into the equation by selling the drugs bought at a loss. I however would only agree to such arrangement if other subsidies see some sort of quid pro quo reduction. Yes, I am looking at the Malaysian fuel subsidy. Essentially, the fuel subsidy reduction would finance the new drug subsidy, making this system neutral.

Whether or not we subsidize the drugs in the end, I do think this arrangement could solve the dilemma.

One major problem with this model is the possibility of the sellers colluding with each other to jack the price up. Nevertheless, such problem is not unique to or the exclusive weakness of this system. Therefore, I do not think it deserves to be addressed here. A discussion on collusion would take away the focus of this entry.

Another way to approach the problem is by having the government purchases the drugs in huge quantity, get bulk discount and resell the drugs at cost, possibly, exactly like the Australian model. Or, on top of that, with subsidy, with method explained earlier.

I am unsure which method would provide cheaper drugs but the latter certainly have less red tape to worry about.