The pharmaceutical market

With respect to the relations between agents in health markets, significant information asymmetries between physicians and patients produce market failures, which ultimately determine the concrete demand for services and procedures. Roles are disarticulated, creating a complex system of misaligned interests: the agent rendering payment - that is, the taxpayer through the state - does not make decisions; the consumer (patient) does not bear the cost of the service; and the decision-making agent (the physician) neither pays nor consumes.¹⁰

This lack of alignment causes patients to exert pressure such that their “felt need” is addressed, which does not always coincide with a “normative need,” generally defined by experts.²¹ Furthermore, along with the benefits obtained by physicians who charge by service provided, or who simply seek to improve their image in the eyes of the patient by attending to their felt need, physicians and patients form an alliance against the state in its role as insurer-payer, who faces significant difficulties in controlling the volume of spending derived from millions of micro-level diagnostic and therapeutic decisions.

A consequence of this is the well-known alliance against the payer. Physicians want to incorporate more technology - even though medications and procedures may be extremely costly - and patients aim to transform their felt needs into “met needs.” This leads to what has become known as the medicalization of discomfort -in some cases it has even been called disease mongering - which refers to professional and industrial actors inflating the demand for pharmaceuticals, equipment, or nutritional supplements in order to treat mild conditions, alongside advertising campaigns that attempt to medicalize any and all discomfort. Furthermore, the allure of sophisticated technology increases the utilization of expensive (though less effective) styles of clinical practice because they are seen as innovative.¹⁰

The issue at hand is how to determine when the treatment of a disease should be covered with taxpayer money without taking into consideration its social value (for example, having the latest technology in a small local hospital). Gómez and Repullo¹⁸ propose a typology of health needs and their articulation of different levels of protection. This typology is summarized in Table 2, which outlines different healthcare settings and specifies the minimum content of the right to health protection. It also attempts to characterize health needs by proposing a hierarchy of levels of need according to the type of harm involved (individual, social, or economic), connecting them to a minimum level of essential coverage.

The highest level of coverage is reinforced protection, which comprises needs that involve serious threats to individual life, social protection from the spread of disease, and economic harm associated with the inability to pay for treatment. Custodial protection also refers to an unalienable level of protection, wherein the Legislature must demonstrate the absence of need in order for coverage to be withdrawn. In a similar but opposite manner, in the case of selective protection - the weakest level of protection - lawmakers must demonstrate proof of need.¹⁰

This hierarchy would distinguish between a newly released high-priced biopharmaceutical that does not offer improved effectiveness and another group of drugs whose use is justified, or one that is not directed to a health need that falls under the category of either reinforced or custodial protection.

Relatively uncommon or rare diseases can lead to premature death or to high morbidity, but due to their low incidence the pharmaceutical industry may have had little incentive to develop drugs to treat them. Drug production requires administrative support, which to date has primarily taken the form of research funding, simplified approval processes, and market exclusivity.

These high costs generate a tension between the sustainability of the system and notions of social justice, considerations that necessarily go beyond strictly economic analyses. Many medical decisions are made from a utilitarian point of view, but this does not guarantee that socially just criteria are taken into account. Furthermore, the health market is a prismatic space composed of multiple submarkets corresponding to different specialties. Hsiao²² identifies five markets in the health sector that interact with each other, as shown in Figure 3.

Source: Own elaboration based on Hsiao²².

Figure 3 Markets of the health sector. 

As a supplier in the input factor market, the pharmaceutical industry is more tightly regulated than other productive sectors because it is a strategic market with a range of specialties. Its importance stems from two aspects: first, it represents a major cost to the system; and second, along with other inputs, the effectiveness of its products determines the capacity and the efficiency of the system as a whole. If the pharmaceutical industry makes progress toward developing new medications that provide quicker and more effective cures, it will alleviate the rest of the system. The pharmaceutical product market has direct repercussions on the sustainability of the system in three ways: the volume of purchases in the system as a whole, the prices of these purchases, and the health benefits associated with new active substances, which improve health and ease the demand on healthcare infrastructure.

From a demand perspective, inefficiencies can be derived from the following: a) the provider, the payer, and the consumer are all different agents, which may lead to misaligned interests, as previously mentioned. b) Asymmetrical information can produce relations of agency. Consumers do not possess the knowledge to determine if expert indications are appropriate. This is one weakness related to drug copayments; since the consumer is not in charge of the decision, their demand is rigid in relation to the price of a prescribed drug. As a consequence, copayments only have an effect on certain income groups, to the point that certain individuals with a normative need may be unable to access the medication they require. Some authors²³ have studied the effects of what is known as “supplier-induced demand.” c) The inelastic demand for prescription drugs. d) Price fixing occurs through negotiations that do not entirely respond to market allocation, although the state does not fully behave as a monopsony. e) Disease mongering and the medicalization of discomfort and of generally mild conditions is encouraged by the pharmaceutical industry and accepted by experts who seek to attend to felt needs. In order to avoid overprescription, price-volume agreements might be effective, in which a price is fixed for a determined sales volume, and the price goes down if sales exceed this volume.¹⁰

From a supply perspective, the most significant costs in drug production are those related to research and commercialization, given that the cost of producing the chemical compounds themselves is relatively low. It is difficult to precisely determine the production costs of pharmaceuticals, as it is not always possible to distinguish between necessary and unnecessary costs or attribute them to a single product, as several authors have noted.^24,25,26) Patents are granted in order to remove deterrents associated with externalities; however, precisely determining the magnitude of these costs is no simple task. The company holds a monopoly as long as the patent is in effect, permitting a higher price to be charged than would be the case with market competition; nevertheless, prices do not respond to the monopoly equilibrium point, given the administrative negotiation process. Moreover, the conflict between professionals and the pharmaceutical industry is especially relevant with respect to the incorporation of costly and ineffective drugs. Incorporating new parameters such as the drug effectiveness in order to set prices could prove useful in this regard.

Pharmaceutical patents

Patents are instruments that grant exclusivity rights to the laboratory that develops a drug, barring competitors from producing the patented drug for a period of 20 years.²⁷ In legal terms, patents are applied as a protection to the proprietary rights of the companies and individuals that develop new technology. From an economic standpoint, they seek to resolve externalities that lead to market failures when property rights are not clearly defined.

In the pharmaceutical sector, issues of equity must be considered alongside regulatory concerns seeking to optimize the distribution of costs and benefits. This is due to the fact that the application of patents and licenses - particularly in developing contexts, but also in richer nations - causes drug prices to be prohibitively expensive for some and generally unbearable in terms of system sustainability.

Parra Cervantes²⁸ classifies patents for active substances into six categories:

Regarding their characteristics, process patents are relatively weak protection mechanisms, as minor changes to procedures can provide a loophole. In developed countries there has been a historical tendency toward the progressive strengthening of the protections offered by patents, along with the evolution of the product patent. In Spain, for example, becoming a member of the European Community drove the 1986 patent law toward monopoly, with the introduction of product patents.

On July 8, 2009 the European Commission published the Executive Summary of the Pharmaceutical Sector Inquiry Report,²⁹⁾ which called attention to abuses regarding competition in the pharmaceutical industry. In particular, it examined the misuse of patents for the purpose of impeding competition and maintaining monopoly prices. The report shed light on the market concentration taking place in the pharmaceutical sector, alongside the paradox of more patents and less innovation, as a reaction to the entry of generic drugs to the market. That is, pharmaceutical companies increase the number of patents based on minor modifications to a single product in order to avoid the entry of generics.²⁹⁾ European economic thought is built upon the idea that competition is beneficial to society, and as such companies that attain a significant market share are closely monitored. In actuality, striking a balance between promoting corporate growth and limiting market power proves complex. Therefore, Article 102 of the Treaty on the Functioning of the European Union³⁰ punishes the abuse of economic power, which is defined as the abuse of a dominant position within a particular market.

In this sense, two contentious practices emerge in the context of European antitrust law in the pharmaceutical sector. On the one hand, a practice is considered prohibited when it meets three material assumptions: 1) that a dominant position exists; 2) that it is abused; or 3) that it affects trade between Member States.²⁷ On the other hand, strategies to delay the entry of generic drugs, such as obtaining secondary patents - which may be granted based on different dosage forms, production methods, or specific pharmaceutical formulations - are employed when a patent is sought for a minor modification to a profitable drug, even when no new replacement product exists. These techniques are known as blanketing when referring to procedure patents, flooding when multiple patents are taken out for the same product, and fencing when certain lines of investigation regarding a particular product are blocked. They produce three main outcomes:

Source: Own elaboration based on Correa³¹.

Figure 4 New chemical entities with pharmaceutical application. Period 1994-2010. 

Regulation of pharmaceutical patents

The discovery of new drugs that cure or alleviate the effects of disease is no simple matter. Pharmaceutical companies invest large amounts of resources and carry out numerous clinical trials until they are successful in finding a new active substance. In order to provide an incentive in the search for new drugs that will improve the health and wellbeing of society, patents are granted for 20-year periods.

The history of patent law can be traced back to the middle of the 19^th century, and has developed in a similar fashion in different countries. Some relevant milestones include:

The agreement confers exclusive rights to the owner (TRIPS Article 28), but also provides for some exceptions - such as the so-called “Bolar” provision - assuming that they do not unreasonably conflict with the normal exploitation of the patent (TRIPS Article 30) or compulsory licensing (TRIPS Article 31). For example, this would allow manufacturers of generics to use these products without the patent owner’s authorization in order to produce generic versions of the drug that can be marketed as soon as the patent expires.

In the case of Canada - Patent Protection of Pharmaceutical Products, in their March 17, 2000 report, the Special Panel made one of the few official statements regarding the scope of Articles 30 and 31 of the TRIPS agreement.³⁴ As the admitted exceptions were ambiguous, the African Group and other World Trade Organization countries demanded clarification and proposed a special TRIPS Council meeting on the issue. The underlying concern had to do either with the spread of HIV/AIDS on the African continent or the controversy in Brazil surrounding its 1996 Intellectual Property Law, among other possibilities.

Community provisions

Currently, Directive 2001/83/EC³⁹ of the European Parliament regulates this process. The process is initiated with local authorities and a marketing authorization is requested for the drug in question. In order to obtain authorization, the soliciting party must present clinical results (Article 8), a detailed bibliography documenting the medicinal efficacy of the drug wherever possible (Article 10.1.ii), and show that the drug is not essentially similar to other medicinal products that have been authorized (Article 10.1.iii).

Marketing authorization is valid for five years and is renewable for five-year periods (Article 24). There exists a mechanism governed by Regulation 469/2009⁴⁰ of the European Parliament, which states that patent owners can extend the duration for a maximum of five years (Article 13). The rationale for this stems from the fact that a significant amount of time elapses from the moment in which a patent is obtained until marketing authorization is granted. Known as Supplementary Protection Certificates (SPCs), this mechanism was created to offset that loss of time that the product can be on the market.

In Spain, the Industrial Property Statute (Estatuto de Propiedad Industrial, or EPI) had prohibited the patenting of “pharmaceutical or medicinal formulas” (Article 48.2 EPI), but the 1986 Law on Patents lifted that prohibition, although its entry into force was postponed until October 7, 1992 (First Transitional Provision).

Such legislative shifts must be understood in the context of Spain’s process of integration into the European Community. Spain pledged to accede to the European Patent Convention (EPC) in accordance with Protocol Number 8 of the Act of Accession to the Treaty. In fact, the Law on Patents reproduces the cited provision verbatim from the EPC.

In order to update this legal framework, new legislation was passed - Law 24/2015⁴² - although it did not go into effect until April 1, 2017. The objectives outlined in the legislation include an interest in improving innovation, adapting marketing procedures, and strengthening the security of the concession system. The new law provides three forms of protection for the pharmaceutical industry: 1) it gives a clearer definition of what is understood as a patentable invention; 2) it regulates utility models; and 3) it explicitly includes Supplementary Protection Certificates.

The National Trade Association of the Pharmaceutical Industry estimates that investment in R&D totaled €1,147,497 in 2017. Industry spokespersons have traditionally held that without enhanced protection of intellectual property, the pharmaceutical sector would be forced to reconsider its levels of investment in R&D.

New models for the protection of research discoveries

The sustainability of the health system depends on healthcare coverage - which refers to both the range of services and benefits that society receives - and cost-efficiency in covering health needs. The pharmaceutical market, therefore, is central to the sustainability of the system. Historically, patents have been employed to resolve the issue of research. However, the development of a more protective legal framework through patenting has created other problems; for example, industry actors have adapted to these circumstances and have endeavored - often successfully - to extend the duration of existing patents and avoid the entry of generic drugs, with reduced outcomes in terms of innovation and new active substances.

This problem is far from encountering a solution. The question of what type of relationship should exist between the industry and healthcare authorities therefore remains open, and can be addressed through three issues. First, how to choose the most appropriate mechanism to correct for the positive externalities produced by research, such that the costs involved in developing new drugs can be covered while still providing incentives to generate new products. Second, regarding financing decisions related to the development of new drugs, which ones should be financed, and to what degree. And third, in order to control pharmaceutical spending, healthcare authorities have incorporated measures such as reference prices, negative drug lists, or support for generic drugs.

Denying that the pharmaceutical industry is a key player in the discovery and innovation of new drugs would be just as mistaken as denying the industry’s underlying profit motive. Therefore, the regulations of healthcare authorities are the only instruments that can effectively address failures in efficiency and equity in a market where the resolution of positive externalities can generate significant equity issues. Rather, public intervention must be designed as a “win-win” situation, where all involved parties satisfy their expectations or at the very least minimize their dissatisfaction. Moreover, the experience of the past 30 years has shown that a new paradigm is needed.

Entirely eliminating patent monopolies is unrealistic, as the industry maintains that they are a top priority, although some researchers question whether or not they are a prerequisite for technological and industrial development in the pharmaceutical sector. Furthermore, the elimination of mechanisms protecting industrial property would be debatable in the context of market economies of developed societies. Therefore, health policy should explore methods of introducing mechanisms to encourage research and innovation that guarantee economic success of the industry. Previous attempts to create ideal circumstances for the discovery of new drugs that would increment the health capital of society have had only one effect: the growth in profitability obtained by pharmaceutical companies without showing any signs of significant achievements in scientific advancement.

Until now, proposals to encourage the marketing of new drugs have centered on five strategies:

These new models and proposals assume the existence of oligopolies in which balance is sought between industry profits and healthcare needs. However, the Covid-19 pandemic has demanded a distinct premise: international collaboration and shared research. The discovery of an individual scientist from anywhere in the world can become known to the international scientific community on the very same day, but fragmented clinical trials do not take advantage of magnitudes of scale, as knowledge is multiplied exponentially when it is shared. In the words of WHO Director-General Tedros Adhanom:

The first vaccine trial has begun, just 60 days after the genetic sequence of the virus was shared […] This is an incredible achievement. We commend the researchers around the world who have come together to systemically evaluate experimental therapeutics, but multiple small trials with different methodologies may not give us the clear, strong evidence we need about which treatments help to save lives.⁴⁹

A difficulty arises with the allocation of property rights that correspond to each involved party, but if the model for international cooperation regarding research findings related to the pandemic is effective, it should contribute a formula that can be extrapolated to other pathologies, as it may be able to grant profitability to some research costs, especially with respect to diseases whose prevalence is low.

According to Marovac,⁵⁰⁾ preclinical studies, animal toxicology studies, and regulatory review committees can last from three to five years, while Phase I trials can last from two to five years. Phase II trials - which can take from two to five years - are carried out with small cohorts in order to identify adverse reactions and to determine the minimum and maximum tolerable dose; one-third of molecules do not pass this stage. Phase III, which can last from two to four years, multiplies the number of patients involved in the trials by a factor of ten, and once again about one-third of drugs is rejected.⁵¹ Cutting down on the amount of time in Phases II and III is essential for reducing costs. Approval and registration with regulatory agencies can go on for anywhere from one to 25 years.

In 1960, the development of a drug took about 8.1 years. The steady lengthening of these time frames has been accompanied by improved controls, but it has also implied increased costs. Currently, the time it takes for a new molecule to become an approved drug is on average 12 to 15 years and requires a total investment of around 600 million dollars. Diverse professionals participate in this process, including organic chemists, molecular biologists, toxicologists, physicians, pharmacologists, biomedical professionals, and computer scientists. One out of every ten molecules is developed, and only one out of every 5,000 drugs that makes it to clinical trials will end up having a therapeutic use.⁵⁰

Taking the global population as the target population for clinical trials would constitute a time-saving measure. Large numbers benefit everyone - both patients and the industry - and therefore the fundamental problem is reaching a level of compensation that corresponds with the real effort put forward by each researcher. However, spontaneous strategic alliances can bring about a number a difficulties, such as the loss of autonomy in decision making, the effort needed for coordination, the need to align interests, and increased organizational complexity. Technology sharing can be useful for a project, but that same technology may be used by competitors on other projects, creating difficulties with unifying diverse corporate cultures.

Lastly, improved synchronization between local agencies - such as the Food and Drug Administration (FDA), the European Medicines Agency (EMA) or the Japanese Ministry of Health - would reduce the amount of time needed for drugs to reach the market, which would in turn lower costs.

An analysis of the pharmaceutical companies with a presence in Spain reveals evidence of a relationship between the development of new products and the formation of strategic alliances.⁵² In this regard, a major study looked at new products already on the market as well as those in clinical trials and analyzed their probabilities of reaching the market using the methodology proposed by Kellog and Charnes.⁵² Nevertheless, this study did not reach the same conclusions with respect to the relationship between the number of patents and the development of new products and strategic alliances. This could be due to the fact that active substances are patented in the initial stages of biopharmaceutical research, but many do not constitute an innovation.

It is clear that not all alliances present the same results and many involve risks, but nonetheless the work of healthcare authorities should attempt to improve collaboration models. Circumstances such as these necessitate the proactive participation of the public sector, armed with a number of formulas ranging from concrete alliances to pharmaceutical consortia. Companies will benefit from a clear definition of property rights, savings on clinical trials, and all of the other benefits associated with economies of scale, in addition to public sector support for research efforts. Drawbacks include the moral risk of possible disloyal behavior on the part of a partner and greater controls placed on research spending. Moreover, patent protection would be subject to the existing legal order, although public participation opens up possibilities for price reduction in developing countries.