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Drug prices post-Brexit – an expensive pill to swallow?

If the UK votes to leave the European Union, would it still be able to enjoy benefits of a single market by being in the European Economic Area (EEA)? Or would it be on its own in the world? The outcome of that uncertain situation could have a big impact on one sector that is of crucial importance to millions of people – pharmaceuticals.

Here’s 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 that’s patents have expired and where there are potentially many firms producing them. For these drugs, the government samples manufacturing 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.

Generic drugs. Shutterstock

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 would anything change post-Brexit?

The British and Greek examples

Due to an active patent on such drugs, the manufacturer is a monopolist, and hence, a price setter. The price it charges is based on a typical patient’s (or of their government or insurer’s) willingness to pay for the drug, which in turn may depend on income levels and other demographic differences. So if people in Britain and Greece have a different willingness to pay (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, there are no import tariffs or quota restrictions within the EU. This raises two questions: what prevents Greek wholesalers from buying cheaper drugs there and re-selling them to pharmacists in the UK at an intermediate price – in other words, engage in what is called “parallel” trade; and 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 – due to intra-brand competition. And to answer the second, 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 follow-on drugs to soften competition.

These strategies can be anti-competitive and sometimes run foul 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 Court of First Instance ruling).

In another case, AstraZeneca 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” – 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 AstraZeneca was charged with abusing a dominant position under the treaty and fined €53m.

Big fine. Shutterstock

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 the free movement of goods within the single market. In fact, the UK government encourages parallel trade as it explicitly allows pharmacists in the country 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.

So what happens next?

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 clause of the General Agreement on Tariffs and Trade and would jeopardise the UK’s membership of the World Trade Organisation. So 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 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 one that it had 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. And 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 health sectors, too, then Brexit may indeed be an expensive pill to swallow.

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