Government involvement in the pharmaceutical market has traditionally been far more extensive than in markets for most other goods. Not only the extent of government intervention matters, but also the form. Governments can inform, regulate, mandate, finance and provide [85]. As many governments consider changing the relative roles of the public and private sectors, it is worth reviewing the underlying reasons for different government interventions. Economic theory provides a useful framework.

Economic reasoning suggests that in “perfect markets” willing buyers and sellers should be left to transact their business without government interference as the market will lead to an optimal solution. However, the necessary conditions for a perfect market are rarely fully met and pharmaceutical markets are likely to be plagued by market failure. The main forms of market failure in pharmaceutical markets are considered below, together with possible government responses.

Informational imbalance

For commodities such as cabbages and candies, producers, sellers and consumers are all equally aware of the quality of the product and its value for money. However, if one party to a transaction knows more than the other about product quality this creates space for markets to fail. In the pharmaceutical sector information about quality, safety, efficacy, value for money and the specific appropriateness of individual drugs often varies between the parties involved.

The extent of market failure

Informational imbalance (or asymmetries) probably constitutes the most serious form of market failure in the pharmaceutical sector. As in the health care sector generally, the consumer (or patient) often knows less than the prescriber or dispenser. However, there are also substantial informational differences between other actors in the sector.

Several types of informational problems occur:

• Drug efficacy: Most actors will be less well informed than the manufacturer about the efficacy of the drug. This is a problem in virtually all contexts. Prescribers and consumers must depend (at least partially) on the manufacturer for information about the effects of the drug.

• Drug quality: There may be substantial questions about the quality and safety of the drug. This is a critical issue in countries with weak regulatory authorities where unsafe drugs are often marketed.

• Appropriateness of the drug: Patients tend to know less than the prescriber about the appropriateness to their needs of specific drugs.

Consequences and responses

Informational imbalance between the prescriber/dispenser and the patient allows the prescriber/dispenser to give misleading advice in order to increase profits. Lack of knowledge about a particular product on the part of the prescriber may be reflected in irrational prescription patterns. Some manufacturers may manipulate this lack of information by providing distorting information so as to enhance their own sales and profitability.

Government has a range of tools with which to respond to these problems. These tools include quality regulation, regulation of promotional practices (preventing practices which provide inaccurate or biased information), provision of information and training (to both consumers and prescribers), strengthening of professional ethics to prevent prescribing for profit, and licensing and registration of virtually all actors in the sector. Professional associations and drug manufacturers' associations may also take measures, such as voluntary codes of practice, to prevent the worst consequences of information differences.

Failure of competition

When there are many buyers or sellers of a commodity the actions of any single actor do not affect anyone else. However, if there are few buyers or sellers then these few may be able to exercise market power. In the case of sellers this is called monopoly power, in the case of buyers it is known as monopsony power. Market power enables sellers to charge higher prices than they would in a situation of perfect competition.

The extent of market failure

Unlike the overall health care sector, the pharmaceutical sector suffers substantial problems related to the failure of competition. High initial investment costs mean that average production costs reduce only when a large quantity of a drug is produced. However, with international trade, it is rarely the case that a true monopoly of this sort exists. Instead market power is created through:

- patent protection, which exists in order to encourage research and development;

- brand loyalty created through marketing which generates market power even after patents expire;

- market segmentation, especially by therapeutic subclass;

- gaining control over key inputs, thus preventing other firms from competing effectively;

- implicit collusion between firms through, for example, price-fixing.

An alternative perspective suggests that, due to the special characteristics of drugs, competition takes undesirable forms. In particular, because of the life-saving nature of many drugs and the fact that patients do not pay for them directly in many countries, there is unlikely to be substantial price competition but rather competition in product quality, innovation and brand awareness.

Consequences and responses

The most obvious consequence of the failure of competition is higher prices than would be expected in a competitive market. The two main responses are to create more competition in the market and to regulate prices or profits. Both of these responses are evident in the pharmaceutical market. Governments have tried to create more competition through the regulation of promotional practices and through generic substitution policies. Price controls are also common.

Externalities

Health services such as immunization and the treatment of contagious tuberculosis or sexually-transmitted diseases have benefits for people who consume the services, but they also have external benefits (termed 'externalities' by economists) to other people.

The extent of market failure

Externalities are widely prevalent in the health and pharmaceutical sectors. They occur with treatment for all communicable diseases or in the provision of vaccines against such diseases.

Consequences and responses

If consumption of services with externalities is left to the market, then the level of immunization or treatment will be less than what is desirable from a social perspective. Public health will suffer and both individual and collective health costs may rise.

Subsidizing the services with externalities is the standard response to this problem. By reducing the price for at least some consumers, the government can increase consumption of a drug and hence boost demand. It is not necessarily the case that goods with externalities need to be provided free of charge. The appropriate level of subsidy will depend on how far the level of (unsubsidized) consumption falls short of the optimal level.

Equity

Equity, strictly speaking, is not a form of market failure. There is no assumption in economics that perfect markets will lead to equitable situations. But equity is a central policy objective of many governments. Governments often target the poor and the underserved, although in practice they may not succeed in this goal.

Equity is also an important objective for some private not-for-profit organizations. In sub-Saharan Africa, mission facilities have historically been located in remote rural areas in order to serve the very poor [44].

Private for-profit organizations generally do not have equity as an objective. Their profit-oriented nature may even directly conflict with financial and geographical equity.

Access to pharmaceuticals in the private for-profit sector is granted on the basis of willingness to pay. Those unable to afford drugs will be denied access to them. Moreover private for-profit providers locate where willingness to pay is greatest, which tends to be in urban areas. Poorer rural areas will remain underserved.

Yet the poor in many countries rely on private for-profit drug sellers and pharmacists. Why is this so?

• Drugs may appear less expensive in the private sector: Private sector drug sellers may be more willing to sell drugs in small and affordable quantities although people will not be cured without taking a full course of treatment and may even suffer adverse effects (such as increased drug resistance).

• There is limited access to public sector drugs: Although in principle the public sector is in a good position to ensure equitable access to drugs, in practice political pressure and other threats to government effectiveness result in inequity. A large share of drug budgets may be allocated to urban referral hospitals rather than to rural dispensaries, for instance. Sometimes referred to as the “inverse care law”, the result may be that those with greater needs receive less care [17].

• People will find money to pay for private sector drugs if there is no access in the public sector: This often means borrowing money, which may have adverse long-term effects on the welfare of the household.

Equitable access to essential drugs can be achieved only by government subsidy of the drug costs of the poor. Government may choose to provide these drugs itself, or alternatively there are a number of means (such as vouchers or reimbursement systems) whereby subsidies can be targeted at the poor who seek drugs from private outlets.

Government may also consider ways to make the private for-profit sector more geographically equitable, such as by offering incentives or subsidies to locate in more remote areas. Such incentives have a cost. This cost needs to be compared to that of the government extending its own services and providing drugs directly.