China Investment: A comment on China’s latest reforms to drug pricing – marketization

Many observers feel that in any free economy, a product’s supply and price should be determined by the market.

China has made massive improvement in this respect. The National Development and Reform Commission (NDRC) and 8 medical associations have collectively issued a motion to reform drug pricing in China. In Chinese history, this is the largest scale drug pricing reform to take place. How do we interpret the issues associated with drug pricing liberalizing and reform?

Pricing is probably the most attractive phenomenon in economics. Price reform is also something we are very concerned about currently for a while as part of market reform in China. We see many areas in China undergoing price reform, including the current focus on drugs.

Many simplistically think of price reform as marketization, i.e. to let the market determine pricing. Hence, many think the government should exit in entirety. This is a wrong thinking.

In some of the talks that I conducted previously, I have been a proponent of a set of thoughts, namely what should the government’s role be. This thought can be summarized by the words of Chinese Premier Li Keqiang. On 13 May 2013, in a TV conference, Li pointed out that under market economy, the evolvement of government’s responsibility has to distinguish the boundary between the government and the market. This is marketization reform. It is not the government exiting the market to allow complete free price movement. Rather, it’s to determine clearly the duties of government and market respectively. This is good reform.

Why is that so? The ultimate objective should be the interest of people as top priority. This means, paying the lowest price for necessities. This will make a good reform.

Should the wet markets selling vegetables undergo price reform? You might feel that since wet markets affect people’s lives due to vegetable pricing, that should be more liberalized. Will more free market competition result in vegetable pricing become lower?

No. Let’s think. Where are the markets built? Mostly in residential areas. This means high rental. And there are also costs to entry into the business. There are also considerations of water and electricity and many other factors. Will vegetable pricing be low? No. At such instances, we will need to draw a clear boundary between government and the market. The government should intervene. On 28 April 2011, Beijing’s vice mayor raised a good point, i.e., to adopt the points of view from the public’s benefits. Government should buy or invest in wet markets to prevent risks or over marketization. How? This method is similar to the Hong Kong context. That is to let the Beijing government buy or invest in 90 wet markets. And to only collect some token of rental, water and electricity fees based on costs. And thereafter, the government should increase such subsidies to double the number of such markets.

Let’s look at some statistics. Particularly, let’s look at the wet markets the government invested in and compare with nearby supermarkets.  

RMB	Government-linked	supermarkets
vegetable	0.9	2
Green radish	0.98	2
White radish	0.78	1.5
cabbage	0.58	0.8
potato	1.08	2
carrot	1.38	5

 

Let’s look at carrot. A catty of carrot in government-owned wet markets costs 1.38 yuan. Privately-run supermarkets costs 5 yuan. The remaining items are also obviously cheaper compared to nearly supermarkets. Now, we can realize what reform is. These peasants are buying vegetables. If they can get the lowest prices for such necessities, that would be a good reform. Currently in China, there are many reforms including oil, electricity, gas, drugs and water.

Let’s discuss oil price. Let’s look at the reform that the government exited in entirety from.

The government should entirely exit from the oil industry. On 18 Nov 2014, Xinhua News reported that final oil product price reform successfully broke through the previous rigid price mechanism. Price will be entirely determined by the market. We just witnessed consecutive drops in pricing.

My views on this report: pricing for up, mid and downstream, for oil should be entirely determined by the market. The government need not participate. This should be the boundary of the market and government. For instance, let’s look at upstream. On 27 Aug 2014, the energy department approved the first private enterprise in China, Xinjiang Guanghui Oil Company to freely import oil. However, they are only allowed 200 thousand tons per year. This is a test point. I think it’s a good test point. I feel this test point should amplify. Upstream should allow more private enterprise to freely import oil.

Mid-stream refers to oil process. The process factories in China has capacity to treat 150 million tons per year. Shandong province represent 70% of such capacity. Due to private enterprises not being allowed to import oil, China has over-capacity. 70% facilities are vacant. Should we then open up midstream to allow local oil refinery to compete with “3 buckets of oil” (China Aviation Oil, Sinopec, CNOOC).

Downstream. Some of us drive cars. Look around at the various petrol kiosks in China. Most of CAO related. They are the mainstream. I propose downstream to be freely operated by private enterprise to compete fairly with the big petrol kiosks.

Another reform: Electricity and gas. What is the boundary of government and market for this sector? That should be the government controlling midstream. Upstream should be subject to free market. Downstream should also liberalize. Midstream refers to network. Government should only control network. How then do we calculate price? How do we charge fees via network? Fees should be collected by network. But via the electricity and power reform announced on 4 Nov 2014 using Shenzhen as a test bed method to collect payment. That means, the government should deduce a price determination method using international practice and accounting standard. The network itself should not be allowed to determine price.

What about Gas and LNG? Same. Currently upstream is not opened to free market. Private enterprise cannot freely import LNG. Downstream should allow users to freely choose LNG Company. What about midstream pipe network? It should be similar to the above scenario of electricity and power.  Let the government deduce a price determination method using international practice and accounting standard. The network itself should not be allowed to determine price.

Another reform, which is the key of this piece: drug reform. This is the most complex reform. I have expressed my views previously to investors. Today I will use Premier Li’s message during China State Council’s meeting on 15 Nov 2014 to interpret. He named three objectives, namely: drug pricing must drop; service must improve; medical insurance must maintain.

1^st. Drug price must drop. How? I propose the following. In 2010, when China determined drug price management method, they only mentioned patented drugs and imitation drugs. Patented drugs are expensive. That is a given due to high R&D costs. But another type of drugs from overseas whose patents have expired? These are original drugs. Such original drugs have no more patents. The price is still 10 times the local imitation drugs. In the top 3 hospitals in China, supposedly 65% drugs are patented or original drugs. Should this not reform?

2^nd. Service must improve. How? Simply said: Reduce patients, increase doctors. Service will surely improve. But how? A bypass system must be created. How? I have 2 suggestions. Firstly, to those high income earners with no medical insurance, China could set up a special channel in hospital with high charges. They could then use these fees to subsidize the masses. Secondly, encourage doctors to be like in HK: every week, use 30% of their time to engage in private practice, either as locums or open their own clinics. Hospital can tax from their additional income. Result? China could then stream some of the patients to private clinics, especially high income earners.

3^rd. Medical insurance must maintain. We want drug prices to drop while service improve. Take note: service improvement would be largely due to high income people paying higher fees. The masses need not bear the burden of increased cost. Medical insurance would then be in a better position to maintain

Hence, drug price reform should be implemented according to Premier Li’s message.  As for the boundary between government and market? The government must determine an implementable policy in this respect. Then allow hospitals to implement these 3 objectives.

Ultimate objective: to allow the masses to pay the lowest fees for important necessities including drugs.

 

John Wong PhD, CA