When a good idea – controlling medicine prices – goes bad

COMMENT

Health Minister Aaron Motsoaledi recently announced a maximum increase of 7.5% in the single exit price of medicines.

The exit price manages the price at which retailers can sell the product. It guarantees that the poor are not ripped off by Big Pharma looking to make a quick buck, which seems like a good idea.

But a managed exit price has some interesting consequences, one of which materialised when the idea was first implemented.

A few years ago there was a manufacturer in South Africa of the popular painkiller, paracetamol. This is a chemical present in many dry (tablet) and wet (such as cough mixture) medicines.

Unlike other manufacturers, though, South Africa’s paracetamol manufacturer did not make its product from scratch. Instead, it used an intermediate form of the product known as para-aminophenol.

Paracetamol is usually manufactured in a four-stage process. Para-aminophenol is the output of the third stage. It is not a product that is used commercially at this stage and so, to obtain it, the local paracetamol manufacturer had to convince foreign suppliers to halt their processes and syphon off para-aminophenol to send to South Africa. This was not efficient.

But South Africa’s production of paracetamol was protected by a large anti-dumping duty — imposed by the government to prevent imports it says are priced below fair market value — in addition to a normal 5% customs duty. The anti-dumping duty ranged from 58c/kg to R25.73/kg. Medicine manufacturers either bought paracetamol from the one local producer or imported it and paid large duty fees.

Conversely, the finished goods or medicines these pharmaceutical manufacturers produced attracted no such duty fees.

Government is a large buyer of these finished goods for the state hospital network and a supply tender is a big deal.

This demand combined with the expensive import duty on paracetamol made it attractive to manufacture these products closer to paracetamol producers, which are mainly in India and China.

The health department’s mandatory single exit price adds to this attractiveness; it limits the profit margins pharmaceutical manufacturers can achieve and so there is pressure to retain the company’s margins by looking for ways to cut input or manufacturing costs, beyond what would normally prevail in other industries.

Inevitably, the lack of duties on finished goods, the single exit price and black economic empowerment rules made it more attractive to import finished goods than to produce medicines locally.

Before long, one of South Africa’s dry plants relocated to India. It was close to the paracetamol producers and the move gave it duty-free access to the South African market.

In 2013, the only local paracetamol manufacturer closed its doors, presumably because importing the finished goods became too attractive for pharmaceutical firms and the company lost its client base.

So now, South Africa has lost one upstream manufacturer and at least one downstream manufacturer.

This is one of the unintended consequences of the single exit price and it demonstrates the dangers of imposing duties upstream — take note, steel industry.

Ironically, the 5% duty on paracetamol is still in place, even with no industry to protect. All it requires is an application for its removal and this cost burden could be removed from beneficial medications.

Donald MacKay is a director of XA International Trade Advisors and Stratalyze

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