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PRINTED FROM the OXFORD RESEARCH ENCYCLOPEDIA, ECONOMICS AND FINANCE (oxfordre.com/economics). (c) Oxford University Press USA, 2020. All Rights Reserved. Personal use only; commercial use is strictly prohibited (for details see Privacy Policy and Legal Notice).

date: 13 July 2020

Summary and Keywords

Pharmaceutical expenditure accounts for approximately 20% of healthcare expenditure across the Organisation for Economic Cooperation and Development (OECD) countries. Pharmaceutical products are regulated in all major global markets primarily to ensure product quality but also to regulate the reimbursed prices of insurance companies and central purchasing authorities that dominate this sector. Price regulation is justified as patent protection, which acts as an incentive to invest in R&D given the difficulties in appropriating the returns to such activity, creates monopoly rights to suppliers. Price regulation does itself reduce the ability of producers’ to recapture the substantial R&D investment costs incurred. Traditional price regulation through Ramsey pricing and yardstick competition is not efficient given the distortionary impact of insurance holdings, which are extensive in this sector and the inherent uncertainties that characterize Research and Development (R&D) activity. A range of other pricing regulations aimed at establishing pharmaceutical reimbursement that covers both dynamic efficiency (tied to R&D incentives) and static efficiency (tied to reducing monopoly rents) have been suggested. These range from cost-plus pricing, to internal and external reference pricing, rate-of-return pricing and, most recently value-based (essential health benefit maximization) pricing. Reimbursed prices reflecting value based pricing are, in some countries, associated with clinical treatment guidelines and cost-effectiveness analysis. Some countries are also requiring or allowing post-launch price regulation thorough a range of patient access agreements based on predefined population health targets and/or financial incentives. There is no simple, single solution to the determination of dynamic and static efficiency in this sector given the uncertainty associated with innovation, the large monopoly interests in the area, the distortionary impact of health insurance and the informational asymmetries that exist across providers and purchasers.

Keywords: pharmaceuticals, pricing and reimbursement regulation, R&D incentives, patents, monopoly power, health economics

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