Penny Goldberg Princeton University, NBER and BREAD

Intellectual Property Rights Protection in Developing Countries: The Case of Pharmaceuticals. Marshall Lecture European Economic Association Congress, Barcelona August 27, 2009 Penny Goldberg Princeton University, NBER and BREAD

Background and Motivation • IPR protection has emerged as a principal issue in domestic competition policy. • In the international context: TRIPS & WTO (1995). • Member countries had to recognize and enforce product patents in all fields of technology, including pharmaceuticals. • Developing countries had an extension of 10 years. Had to have patent protection by 2005. • Here: Focus on pharmaceuticals because of the public policy importance of this sector. • Question: Is there a case for harmonization of patent policies across countries at different stages of development?

Why is it a highly contentious issue? One side of the argument... • Patent enforcement in developing countries will lead to higher prices. • “The idea of a better-ordered world is one in which medical discoveries will be free of patents and there will be no profiteering from life and death.” [Indira Gandhi (1982)]

Why is it a highly contentious issue?(continued) The other side of the argument... • “‘High priced medicines after change in patent laws is a misconception.” [Organization of Pharmaceutical Producers of India]. • TRIPS compliant patent laws attract foreign R&D investment in developing countries, and promote technology transfer. • Patents may provide incentives for research on developing-country specific diseases

Thesis of this talk • Existing arguments reflect the trade-off between static efficiency loss (higher prices) and potential dynamic gains (research, new products). • But: Higher prices are unlikely to materialize because of price regulation • Dynamic gains also unlikely. Developing country markets too small to change research priorities of pharmaceutical concerns. • Potentially largest effect on distribution and availability of new products in the developing world • Distribution over time (launch of new drugs) • Distribution over space (rural versus urban) • Then what is the fuss about? • Global reference pricing • Long-run concerns about exports from developing markets

Road Map • Theoretical arguments regarding IPR in developing countries • The challenges on the empirical side • What makes developing countries special? • Lessons from a Case Study: India and Quinolones (newer generation of antibiotics) • Analyze patterns in the data • Impose structure to estimate welfare effects • Do the results generalize? Some cross-country evidence • Policy implications • What has happened since new patent legislation was signed in 2005?

Theoretical Arguments Standard analysis of patents in the closed economy: • static (short-term) pricing distortions • dynamic (longer-term) innovation gains • optimal policy equates the marginal static efficiency loss to the marginal dynamic benefit (Nordhaus 1969). Complications in multi-country setting: Note: Most trade economists not in favor of TRIPS

Theoretical Arguments (continued) • Fundamental Externality: Benefits of innovation are spread beyond national boundaries. Countries differ in their capacity for innovation because of: • Skill endowment and technical know-how • relative size of domestic market • Is Patent Length Harmonization (PLH) a necessary condition for global efficiency? Global Efficiency: Regime that provides the optimal aggregate incentives for innovation throughout the world Answer: NO (Grossman and Lai [2003]) However: PLH has important implication for the distribution of welfare between developed and developing countries. • Global Reference Pricing • Further complications with differentiated products such as pharmaceuticals

On the Empirical Side … • Very few empirical studies on drugs in developing countries. • Arguments based on assumptions, rather than estimated parameters. Main limitations of this approach: • Domestic and foreign products are assumed to be perfect substitutes. Any welfare losses associated with patent enforcement stem from price increases of foreign products alone. • Substitution towards other drugs and therapeutic segments ignored. • Work on pharmaceutical markets in developed countries (plenty of papers) not pertinent to the TRIPS debate, because developing countries differ from developed countries in five critical respects:

(Some) Important Differences between Developed and Developing Countries • Per-capita health expenditures lower • No health insurance coverage • Different diseases • Storability, transportation and administration of drugs different. • People may not purchase full dosage. As a result: - long-run elasticity may be smaller than short-run elasticity - externalities

Comparing the health sector in low-income and developed economies

Shares of Major Therapeutic Segments in Retail Sales: India versus the World Market

What we have done in the context of India • Use detail product-level data from India to estimate key demand and supply parameters: own and cross-price elasticities, expenditure elasticities, marginal costs • In the period covered by our data, India did not recognize pharmaceutical product patents; hence many products available that were under patent in the U.S. • Carry out counterfactual analyses of what prices, consumer welfare, firm profits would have been had patents been in effect

The Basic Thought Experiment • Had patents been in effect, domestic products that were in violation of patents would have to be withdrawn from the market • Estimates of key demand and supply parameters can then be used to simulate the effects of product withdrawal on prices, consumer welfare and profits Limitation of Analysis: TRIPS applies only post-1995. Most of the products that will be affected are still undergoing clinical trials in the U.S. and hence not in our data Does not tell us what will actually happen, but only what would have happened if patent laws had been enforced earlier…

Case Study: Indian PharmaceuticalsQuinolone sub-segment of Systemic Anti-Bacterials • Why India? • Leading example of a low-income developing country that had not recognized patents. • Strong opposition to TRIPS. • Disease profile of Indian population mirrors that of many low-income countries. • Domestic Indian pharmaceutical industry was as of 2002 the largest producer of “generic” drugs (followed by Brazil). Market structure: many small and medium-sized domestic firms selling drugs that are patented elsewhere.

India’ s pharmaceutical sector • Indian Patents Act (1970): excluded pharmaceutical product patents, recognized process patents for a term of 7 years • Leftward tilt in policy during 1970s: drug price controls, restrictions on foreign equity shares, capacity expansion • Liberalization since early 1990s • Dramatic growth of Indian pharmaceutical industry in the last 30 years • Indian firms are major exporters • India the largest producer of formulations, by volume, and a leading bulk drug producers

Production, exports, imports and domestic sales of pharmaceutical formulations (Rs. Billions)\s (Rs. billions)formulations\s (Rs. billions) • \s

Production, exports, imports and domestic sales of bulk drugs(Rs. Billions)\s (Rs. billions)formulations\s (Rs. billions) • \s

India’ s pharmaceutical sector • Market structure also changed: • declining share of multinational subsidiaries from about 80% to 90% in 1970 to roughly 30% in 2000 • increase in number of firms in organized sector of the industry (roughly 400 firms) • mushrooming of very small-scale units

Top 20 firms by domestic retail pharmaceutical sales in India

Systemic Anti-Bacterials (Antibiotics) • Focus on the systemic anti-bacterials segment of the market, and within that on the quinolones sub-segment • Systemic anti-bacterials include all the original miracle drugs (for treatment of bacterial infections) that sparked the development of the research-based pharmaceutical industry as well as later generations of molecules • Systemic anti-bacterials accounted for about 20% of retail pharmaceutical sales in India in 2000 • Systemic anti-bacterials segment divided into several sub-segments, each representing a family of related molecules

Therapeutic Categorization All Pharmaceutical Products Cardio- vascular system Central nervous system Anti-infectives Respiratory system Others … Quinolones Cepha- losporin Penicillin Trime- thoprim Tetra- cycline Macro- lides Ampi- cillin

Why Quinolones? • Systemic anti-bacterials (i.e., antibiotics) important in a country where infections a major cause of disease. (life quality enhancing drugs, such as anti-depressants, Viagra, etc. will presumably be affected more by patents; however, less important from a public health policy perspective) • Antibiotics important in terms of revenue share in Indian market (#2 in revenues). Within antibiotics, quinolones one of the largest with 20.8 revenue share. • Quinolones belong to the latest generation of antibiotics. Drug of choice for most infections  there should be many substitutes available. • Several quinolone products still under patent protection in the U.S.

The idea behind our exercise: Imagine that patents had been enforced in India as they were enforced in the U.S. Simulate market outcome (we are not deriving the effects of actual TRIPS enforcement in 2005, since most patents had expired by then). But can get a sense of what the effects will be when important life-saving drugs are introduced in the future….

Methodological Approach • Explicitly model consumer and firm behavior. • Detailed estimation of the demand and supply structures: own-price and cross-price elasticities and bounds on marginal costs. • Counter-factual analysis: price changes, consumer welfare losses, firm profit gains/losses. • Decompose consumer welfare losses into three components:

Loss of Variety Effect - Expenditure Switching Effect + Reduced Competition Effect = Consumer Welfare Loss of TRIPS

Key: Demand Estimation Two-Stage Budgeting and AIDS: • Natural therapeutic categorization. • Flexible functional form and very general demand patterns. • Can be applied to both household-level data and market-level data. • Finite virtual prices

How we Define a “Drug” • Data is highly disaggregate: information at the SKU level • Differentiate along two dimensions: molecule and nationality. • Aggregate over dosage forms: syrup, capsule, tablet; strength: 100 mg, 500 mg; packet size: 10 tablets, 24 tablets… • Aggregate over domestic / foreign firms: Ranbaxy, Cipla; Bayer, Glaxo…

Two-stage Budgeting Approach Anti-biotics Penicillins Macrolides Ampicillin Quinolones Cepha- losporins Trimetho -prim Others Dom Cipro Dom Spar For Cipro For Oflo Dom Norflo Dom Oflo For Norflo

Some Interesting Patterns in the Data • Four main molecules. • Domestic share in each case SUBSTANTIALLY larger than share of foreign subsidiaries. • Domestic CIPRO by far the biggest (53% revenue share). • Yet, prices of domestic products higher by ca. 10% (last 2 rows of the table). • Note also: • VERY large number of domestic firms. • Foreign firms violate patent laws in India while respecting them in their own countries. • Products often introduced in India by Indian firms. Foreign firms follow years later. • General impression from these tables: Domestic drugs sell at a premium. Distribution networks and ease of access a possible explanation.

The Quinolone Sub-Segment

Main Demand Side Results (drive counterfactual simulation results and conclusions) • VERY large cross-price elasticities between domestic products with different molecules. In fact, some domestic products appear to be closer substitutes to one another, than domestic/foreign products containing the same molecule •  Domestic Products closer substitutes to one another than to foreign products with the same chemical composition. Genuine empirical result. • Possible Interpretation: Differences between domestic and foreign products in the distribution networks. The retail coverage of domestic firms (as a group) is much more comprehensive than that of multinational subsidiaries. • Quite possible therefore that local pharmacies more likely to have in stock domestic products containing different molecules than they are domestic and foreign versions of the same molecule.

In Sum: • Consumers seem to prefer domestic to foreign products (as indicated by the higher prices and higher market shares) • Domestic Products close substitutes to one another • Likely reasons for these patterns: • Delay in launch of new products by multinational patent-holders in India, possibly due to reference pricing. • Lack of well developed distribution and marketing network by multinationals. • Important policy implication: loss of variety as a result of patent protection likely to be substantial. • New drugs will be available to Indian consumers with a delay • Even after their launch, their distribution especially in rural areas may be lacking

Evidence from other countries • How general are the previous findings? • No direct evidence on consumer preferences in other countries. • However, evidence on firm/product entry from cross-country studies • Two studies particularly relevant: • Lanjouw (2005): 68 countries of all income levels and drug launches between 1982-2002 • Danzon and Epstein (2008): 15 countries and drug launches in 12 different therapeutic classes between 1992-2003.

Evidence from other countries (continued) • Main findings: • Launch timing is influenced by price regulation. If price regulation reduces prices, it contributes to launch delay. • Global reference pricing is particularly important here: Manufacturers delay launch in low-price countries to avoid undermining higher prices in other countries. Hence, referencing policies adopted in high-price countries impose welfare costs on low-price countries. • Effect of IPR is ambiguous.

Implications for Welfare • Consumer welfare losses are substantial: $400M when we remove all domestic quinolones from the market -- 65% of the sales of the entire anti-bacterial market in India in 2000. • Consumer welfare loss not that large as long as some domestic competition remains. Loss largest when all domestic products disappear from the market.  Driven by large cross-price elasticities across domestic products. • A substantial fraction of the loss is due to the loss of product variety. Again, driven by large cross-price elasticities for domestic products  Corresponds to the case where strict price regulation would keep the prices at their pre-TRIPS level. • Conclusion: Price regulation alone not sufficient in order to mitigate the loss suffered by Indian consumers.

Implications for Welfare (continued) • Prices increase between 100% to 400%. • Losses to domestic firms pale in comparison: $50M per year  May explain why domestic firms have been divided regarding TRIPS. • Moderate gains to foreign patent owners: • Without price regulation: $53M per year • With price regulation: $19.6 per year • “developing a new drug costs $802M on average”, Mednews (2001). • What is the fuss about? Global reference pricing?

Total Welfare Loss Loss of variety: compulsory licensing Substantial price increase: substitutes within segment important Consumer Welfare Loss + Firm Profit Loss Total effect bigger than sum of components Foreign Profit Increase Increase in R&D unlikely

Policy Implications • Substantial loss of consumer welfare from reduction in product variety—more than 50% of overall losses under most scenarios • Suggests possible role for compulsory licensing • Counterargument: If the value of product variety derives from coverage of distribution networks and associated ease of access, this component of consumer welfare loss may be transitory • with India recognizing patents, MNC subsidiaries may invest in expanding distribution networks • But: Incentives to undertake such investments will be small as long as the market remains small. Price controls will further reduce incentives.

On Incentives… • Sales of Bayer’s ciprofloxacin: $1.6 billion in 2000 • Profit of Bayer’s ciprofloxacin: $640 million in 2000 • Total revenue in the ENTIRE anti-bacterials segment in India: $610 million in 2000 Note: The profit calculation assumes as 40% markup, which is standard in this industry.

Summary Recent debate has focused on: - prices - R&D Our research points to another issue  distribution and marketing of EXISTING products - over time - over space (rural versus urban in particular) Big Question: Will patent enforcement change the supply side of the market? • Incentives of multinationals to invest in distribution networks and marketing in developing country markets? • Joint Ventures with domestic firms? Licensing?

So, what has happened since 2005? • Evidence is VERY preliminary • Recent work by Arora, Branstetter and Chatterjee(2008): • “Striking Increase in R&D intensity of Indian pharmaceutical firms” • In particular: • Increase in absolute R&D expenditures • Increase in R&D intensity • Increase in measures of research output • Increase in stock market valuation of Indian firms’ R&D investment.

So, what has happened since 2005? • But: • No evidence that the above developments are driven by “independent innovations” • No new products • No evidence of R&D collaboration between Indian and Western firms (with few exceptions) • Question: Where did the R&D expenditures go? • Answer: • Process and not product innovations • Sales of generic products abroad: Explosion of export activity • Contract manufacturing

So, what has happened since 2005? Big benefit of TRIPS: It opened up to Indian firms foreign markets for TRIPS-legal imitations – the generics market! At the same time Oxford Analytica reports: • Complaints that price controls undermine the growth strategy of the pharmaceutical industry. • In 2005 number of new drug products introduced to the domestic market fell by 50%. Their contribution to total sales was just 1%. • Industry confined to re-processing of international drugs patented before 1995. • Because of TRIPS, no new generic drugs. • Foreign firms are slow to introduce new products; little interest in its small scale opportunities

Conclusion • Indian firms seem to have benefited from TRIPS, but mainly through exports • Risks to Indian consumers real. • More research into the distribution of new drugs in India and other developing countries necessary. • How soon? • Do they reach poor rural areas? • Perhaps the hardest question: Welfare implications of distribution: Do we want new drugs to reach uninformed consumers?

THANK YOU!

Penny Goldberg Princeton University, NBER and BREAD