Free-Riding in Pharmaceutical Price Regulation: Theory and Evidence

We present a model of the strategic interaction among authorities regulating pharmaceutical prices in different countries and the R&D investment decisions of pharmaceutical firms. Regulators’ decisions affect consumer surplus directly, via prices, and indirectly via firms’ profits and R&D investment policies, which in turn affect patient health. The positive externality of a price increase in one country provides an incentive for other countries to free-ride, and we show how country-level characteristics affect optimal pricing decisions and equilibria. Our theoretical predictions are tested using price data for a set of 70 cancer drugs in 25 OECD countries. We find evidence of behaviour that is consistent with the free-riding hypothesis and which, in line with the theoretical predictions, differs according to country-level characteristics. Countries with comparatively large market shares tend to react to increases in other countries’ prices by lowering their own prices; in countries with comparatively small market shares, regulators’ decisions are consistent with the objective of introducing the product at as low a price as possible. We discuss the policy implications of our results for incentivising global pharmaceutical R&D and the recent proposal to move towards a joint pharmaceutical procurement process at the European level.