15 Jun 2016

(by ) Much has already been written about the potential effects of Brexit on both the British economy as well as the rest of the word, vis-à-vis effects on immigration, employment, wages, inflation, investment, growth and so forth, and by now we know that either the sky is going to fall or it will be like manna falling from the sky. Definitely one of those two. Reality however is a bit more nuanced, and what follows may be sector specific and depend on the regulations and terms that are negotiated upon exit. Post exit, will the UK be on its own in terms of trade agreements with the rest of the world, or will it, like Norway, be able to enjoy benefits of a single market by entering into European Economic Area (EEA)? Not to be gauche, how does it affect the price of my medicines here in the UK? While the Farage v. Cameron debate rages on, in this blog I give example from just one sector – pharmaceuticals – to discuss how prices of branded drugs, which include new and important therapies, may increase due to various trade agreements post Brexit.

Very briefly (and very roughly, as I don’t want to get bogged down with intricate details of price mechanisms), I start with how drug prices are currently set in the UK. The National Health Service (NHS) publishes tariffs or list prices for all approved drugs on the basis of which it reimburses pharmacists for dispensing drugs. The method of determining these prices is different for branded (which includes patented and new drugs) and generic drugs. Generic drugs are those whose patents have expired and where there are potentially many firms producing them. For these drugs, the government samples manufacture prices via wholesalers, computes an average price for each drug, and then sets a reimbursement rate based on that average value while also allowing for a dispensing fee for the pharmacist. The logic behind this so called ‘internal’ reference mechanism is that the pharmacists will always try to purchase from the cheapest generic provider and this will keep the prices low for the NHS.

However, the price of branded or on-patent drugs is not subject to internal (or external) referencing (as it is in some other European countries). The government more or less reimburses for a branded drug based on whatever price is set by the manufacturer but allows for a mark-up by the wholesalers and a dispensing fee for the pharmacist. The relevant question for our purpose is, how do the manufacturers set prices for the branded drugs and will anything change post-Brexit?

Due to an active patent on these drugs, the firm is a monopolist, and hence, a price setter. The price it charges is based on a typical patient’s willingness-to-pay (WTP) for the drug (or of her government or insurer on her behalf), which in turn may depend on income levels and other demographic differences. Thus if people in Britain and Greece have different WTPs (for example due to different income levels), then the prices will be different in each market even if the cost of producing the drug is the same. However, given the free movement of goods and a single market under the Treaty of the Functioning of the EU (TFEU), there are no import tariffs or quota restrictions within the EU. This raises two questions: (i) what prevents Greek wholesalers from buying cheaper drugs there and re-selling them to pharmacists in the UK at an intermediate price, i.e., engage in what is called “parallel” trade, and (ii) if they can engage in parallel trade, how can price differences still exist?

The answer to the first question is yes, parallel trade does take place within the EU and this is one way drug prices in the UK are kept in check, i.e., due to intra-brand competition. The answer to the second question is that drug manufacturers have developed a series of strategies to restrict parallel trade and without this competitive pressure, UK prices may be higher. For instance, firms may sell less to wholesalers with export licences or charge them higher prices, use different packaging in different countries (wholesalers then incur repackaging costs), or selectively withdraw their original drugs from some markets in favour of next generation or ‘me-too’ drugs to soften competition.

These strategies can be anticompetitive and sometimes run afoul of competition rules in the EU. For instance, when GlaxoSmithKline (GSK) charged higher prices to Spanish wholesalers with export licences and applied for an exemption to maintain dual pricing in Spain, the European Commission declined GSK’s application (though later the Commission’s decision was annulled by the Court of First Instance). In another case, AstraZeneca (AZ) tried to delay generic entry for its blockbuster anti-ulcer drug Losec by withdrawing its drug from Sweden, Finland, Denmark and Norway in the late 1990s and launching a newer patented formulation, Losec MUPS. Since the presence of a “reference drug” (i.e. the original drug on which a generic drug application is based) was required in these member states at the time, this withdrawal initially blocked both the launch of generic versions of Losec as well as competition from parallel imports of Losec from other countries. Ultimately AZ was charged with the abuse of dominant position under Article 102 of the Treaty and fined euro 53m.

The bottom line is that price differentials do exist and despite manufacturers attempts to restrict parallel trade, the practice is prevalent in the EU, thanks in part to free movement of goods within the single market. In fact the UK government encourages parallel trade as it explicitly allows the UK pharmacists to acquire and dispense the cheaper parallel imported drugs from Greece or Spain or other EU countries and lets them keep a portion of the difference between NHS reimbursement price and the import price.

Post-Brexit what is likely to happen to parallel trade? If the UK somehow negotiates to stay in the single market EEA it will have the benefit of no tariffs, parallel trade will continue and there will be competitive pressure on branded prices. So nothing changes except that the UK may have less of a say about policies adopted by the EU and may still have to live by those rules if it wants access to the single market. On the other hand, if the UK is not a member of EEA, then it cannot arbitrarily waive away customs duties against EU members as that would be a breach of the most favoured nation (MFN) clause of General Agreement on Tariffs and Trade (GATT) and would jeopardize UK’s membership in World Trade Organization. Thus, if the UK wants free trade with former EU partners it will have to adopt similar tariffs (possibly zero) against China, India and other countries as against Germany and Spain. The elaborate alternative would be to file under article 24 of GATT to set up bilateral or regional trade agreements that cover all substantial areas of trade (and not just pharmaceuticals) with former EU countries to form a new customs union with the EU to replace the customs union that it has just left!

In short, given the difficulties of these negotiations, it is likely that Brexit would result in the UK setting some import tariffs from other EU member states. That in turn may limit the amount of parallel trade (or the threat of it) between UK and the EU. Lack of parallel trade can lower the competitive pressures on branded drugs in the UK and result in an increase in prices. So, if the analysis applied here to the pharmaceutical sector is representative of what may happen to prices in other sectors as well, then Brexit may indeed be an expensive pill to swallow.

 See for instance Kanavos and Costa-Font (2005), “”, Economic Policy, 20(44), 751–798.