Pills, Patents and Profits C. P. Chandrasekhar

Heard often is a rumour that India is a country that has been cautious in liberalising its economic policy. As a consequence, it is argued, the country has been saved from the many difficulties and crises that have afflicted many other nations, developed and developing. However, for those closely following the evolution of Indian economic policy since 1991 the basis for these rumours is unclear. Liberalisation in India has indeed been slow on occasion because of the fortunately messy complexity of a democratic polity. It has also been slackened by the loss of popular support and social sanction for the country’s still dominant, “centrist” formation, the Congress.  But these have not held back the ideologues and advocates of so-called “reform”. Over the last decade, if there is a common element in policy, that has been the near continuous pursuit of liberalisation, despite the restraints that the country’s history and polity and the poverty and deprivation of its population set on the process.

The net result has been the liberalisation of policy across the board, ranging from restraints on trade and foreign investment to controls on investment, production and prices. India today is among the more liberal of developing economies, despite the presence of a plethora of toothless or ignored instruments of control. And, the process still continues.

Among the more recent instances of liberalisation being pursued even when controls have served the country well, are policies on patents, foreign investment and pricing in India’s pharmaceutical industry. It is widely accepted that regulation and control in India’s pharmaceutical sector had resulted in a situation where the country had managed to ensure access to cheap medicines for its population, with no damaging shortfalls in the domestic availability of life-saving and other crucial drugs. Besides the normal controls that had characterised India’s regime of intervention aimed at reigning in markets and directing development, there were three sets of measures that were particularly important in the pharmaceutical sector. The first was India’s decision to require leading foreign firms operating in its markets to dilute their foreign shareholding to 40 per cent of total equity. Though these transnationals dragged their feet when complying with this requirement and finally did so only by creating a wide shareholding structure that allowed the retention of foreign control, the measure did restrain their power and enhance the transparency of their operations.

Second, India’s early position on patents, that recognised process patents and not product patents, had a salutary effect on drug availability and pricing. Indian scientists and engineers had the capability not just to de-synthesize patented drugs to identify their chemical composition, but also to find alternative process routes to manufacture them. This ensured that the production of medicines with important therapeutic qualities could not be monopolised and that monopoly exploited by foreign patent holders. Drugs were not just available in adequate quantities, but at reasonable prices too. In the event, the foreign firms, rather than lose out on India’s large market chose to stay on and market their own versions, even if at prices much lower than those they commanded in markets abroad.

Finally, starting from 1963, the government through its drug price control policy, set ceilings on the prices that could be charged on different drugs. Those ceilings were cost-plus prices, accounting for costs of production and adding on a margin, with the focus of control being the “essentiality” of a bulk drug or a formulation. The control on prices formalised the government’s policy of keeping essential and life-saving drugs affordable, even while seeking to provide a “reasonable” return to producers, both foreign and domestic. India’s success in implementing these policies was helped by the large size of its market, even if a substantial share of that market was supported by the “out-of-pocket” expenditure of individual consumers, as opposed to state expenditures on provision of health services. A large market made aggregate profits significant even when profit margins were capped.

This was not to say that the powerful transnational firms did not fight back and seek ways of circumventing controls. They delayed equity dilution, they attempted to stall drug replication through alternative routes, they spent huge sums trying to win over doctors who made the consumption decisions for patients, and they used mechanisms such as “transfer pricing” to escalate costs in order to conceal and transfer profits abroad. Transfer pricing involved the sale at inflated prices (when compared with available substitutes) of intermediates and bulk drugs, by the parent company or its third-country subsidiary, to the Indian-arm of the parent. Since margins under the price control regime had to be added on to “cost”, final product prices too were inflated through this process, with those prices including profits that were concealed as costs and transferred to some segment of the global operations of transnational firms. These strategies notwithstanding, India’s regulatory regime in this sector was a great success.

Given this history, one would expect that a cautious policy of “liberalisation” would leave untouched policies with regard to the pharmaceutical industry. Why tamper with a regime that has not created problems such as shortages, has prevented exploitative pricing and has, in fact, been recognised as a resounding success? Yet, liberalisation has been pursued here too. The first casualty in such liberalisation was, of course, the patent regime.  The argument in favour was that India did not have an option. To be a member of the world’s multilateral trading regime and the World Trade Organisation, it had to sign on to the Uruguay Round agreement and the intellectual property regime it embodied. This required, among other things, the acceptance of product patents. There is, however, no evidence that India led the fight to limit the damage to developing countries on this count, or demanded suitable exceptions in an area impinging on the people’s health. The net result was that the earlier flexibility domestic manufacturers had, to look for an alternative process to replicate old and new patented drugs for the domestic market, no more exists. As a result, the danger of drug price inflation due to monopoly was now real and already visible in the case of patented drugs.

There are, however, two other ways in which the indigenous drug industry can continue to play a positive role in ensuring the availability of reasonably-priced medicines. The first is by entering the production of drugs that go off patent protection because of having crossed the period for which patent protection is valid. Domestic firms can create generic versions of these drugs that can compete with branded products to bring down prices. There are a large number of drugs, estimated to constitute a significant share of domestic drug consumption, that are slated to go off patent over the coming years. So even this limited flexibility could make a significant difference.

But here, fears are being expressed that one aspect of the liberalised policy of the government could prove an impediment. In 2000, the policy with regard to foreign direct investment (FDI) in the pharmaceutical industry was liberalised. Under the new policy, FDI in the sector was brought under the “automatic route”, and the ceiling on foreign shareholding was removed allowing for foreign ownership of up to 100 per cent. The net result has been a spate of acquisitions of leading drug firms by foreign producers. Among the recent acquisitions by transnational firms have been the takeovers of Matrix Lab by Mylan, of Dabur Pharma by Fresenius Kabi, of Ranbaxy by Daiichi Sankyo, of Shanta Biotech by Sanofi Aventis, of Orchid Chemicals by Hospira and of Piramal Healthcare by Abbott. An overwhelming proportion of recent FDI inflows into pharmaceuticals production has been in such acquisitions rather than in greenfield projects.

What this does is that it places domestic capacities and capabilities that could have served as competitors to foreign producers in foreign hands. Besides the fact that this would influence pricing, given the oligopolistic position and the global strategy of these firms, it could lead to a decline in the production of generics. Firms with patents for new formulations targeted at diseases that can also be treated by off-patent generics may choose after acquisition to hold back on the production of such generics or raise their prices to protect branded products.

The implication of this is that with the liberalisation of FDI policy, the effort to keep medicines affordable has become even more dependent on price control. It is in this context that the recently released draft National Pharmaceuticals Pricing Policy , 2011 gives cause for concern. Ever since 1994, market criteria have been introduced into the drug price control policy. As of then, commodities chosen for price control were identified on the basis of the total turnover of the drug concerned in the domestic market and the share of leading producers in that market. So it was not so much “essentiality” as defined by the nature of the disease for which the drug was relevant and the characteristics of the population predominantly afflicted by that disease that rendered it eligible for price control. Rather it was the size in value of the market for a drug and the degree to which its production and sale was concentrated that mattered. This did mean that medicines for the rich that were expensive but could be afforded by them could be included under price control, whereas some medicines important for the poor may be excluded. The dilution did push up prices in the case of quite a few drugs. However, where imposed, the ceiling price was determined by the cost of production plus a margin for post-production expenses and profit.

But now, on the grounds of expanding the drug price control list, the government is choosing to dilute price control even further. The draft policy claims to be concerned with reverting to the essentiality criterion (defined as the inclusion by experts in the National List of Essential Medicines) as opposed to the economic criterion or market share principle. In the process, drugs constituting a much higher 60 per cent of the domestic market are reportedly to be brought under price control. However, according to the All-India Drug Action network, the list of the top-selling 300 medicines prepared in October 2003 by ORG-Nielsen accounted for more than Rs.35,000 crore of sales, which amounts to almost 90 per cent of the retail market. Yet, at least 60 per cent of these top-selling 300 medicines are not in the National List of Essential Medicines (NLEM).

Moreover, on the grounds of the complexities involved in regulating the prices in such a large section of the industry, the draft policy recommends a shift away from cost-based pricing to market-based pricing. According to the latter, the ceiling price for a drug would be fixed on the basis of the Weighted Average Price (WAP) of the top three brands by value. So the price charged by leading producers when the policy comes into operation would provide the benchmark for fixing the ceiling. These prices tend to be higher than that of low-ranked competitors, because of the market power of the dominant firms. Thus, the shift from what the regulator considers “reasonable” to what the market leaders consider “appropriate” amounts to a substantial dilution of price control, with even subsequent changes in the ceiling being linked to changes in the wholesale price index for manufactures. What is more the prices of patented drugs are to be determined separately by a special committee constituted for the purpose, with no clear guidelines enunciated.

As of now the policy appears complex and its effects uncertain. But in principle what it does is to take one more step away from regulation, creating an environment in which all the gains of a well crafted and highly successful post-Independence drug policy will be lost. Liberalisation is indeed thriving in India, even in areas where it can be least justified.

(This article was originally published in the Frontline, Volume 28, Issue 24, November 19-December 02, 2011)