ABSTRACT

This chapter argues that differential pricing can reconcile patents, which are essential incentives for innovation, with affordability of on-patent drugs in developing countries. The theory of Ramsey pricing provides a rigorous basis for differential pricing, based on cross-national differences in price elasticities, as an efficient way to pay for the global joint costs of pharmaceutical R&D. Such differential pricing would also be consistent with standard norms of equity, assuming that demand elasticities are inversely related to income.

To achieve appropriate and sustainable price differences does not require a regulatory system to establish and enforce differentials. Rather, equitable differentials could emerge as a result of market forces if appropriate institutional structures were in place. In particular, achieving such differentials will require either that higher-income countries forego trying to “import” low drug prices from low-income countries, through parallel trade and external referencing, or that such practices become less feasible. The most promising approach that would prevent both parallel trade and external referencing is for purchasers on behalf of developing countries to negotiate contracts with drug manufacturers that include confidential rebates. With confidential rebates, final transactions prices to purchasers can differ across markets while manufacturers sell to distributors at uniform prices, thus eliminating opportunities for parallel trade and external referencing.

The option of compulsory licensing of patented products to generic manufacturers may be important if generics truly have lower production costs or originators charge prices above marginal cost, despite market separation.