The Aidsm Crisis, Differential Pricing of Drugs, and the Trips Agreement : Two Proposals

The AIDS Crisis, Differential Pricing of Drugs, and the TRIPS Agreement

Two Proposals

Arvind SUBRAMANIAN*

I. INTRODUCTION

In response to a spate of articles in the popular press criticizing the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) for impeding Afiica’s access to essential drugs, the Director-General of the World Trade Organization defended the Agreement. Mr Moore’s defence rested in large part on arguing that TRIPS allows for differential pricing, which in his view would allow poor countries to secure reasonable access to drugs. Thus, no changes in TRIPS are considered necessary to cope with the current AIDS crisis in Afiica.

But differential pricing is a catch-all term encompassing many different situations. This article elaborates on differential pricing and explains how it should be applied to two sets of countries: the poorest countries in Ati-ica, currently ravaged by the AIDS crisis; and middle-income countries that are also vulnerable to public health crises like AIDS but are arguably in a different situation from the poorest countries. The conclusions are twofold

(i) achieving meaningfid differential pricing, namely pricing that will afford reasonable access to essential drugs in the context of the current AIDS crisis, will require changes in the TRIPS Agreement;

(ii) achieving fair differential pricing in the case of middle-income countries requires elaboration of the notion of “reasonable compensation” when compulsory licences are issued by these countries.

11. DIFFERENTIAL PRICING

In the context of the international pharmaceutical market, differential pricing simply refers to a situation whereby different prices prevail in different markets for the same drug. Suppose there are two markets-rich country and poor country-with

* The author is with the International Monetary Fund, Washington, D.C. The views expressed here are those of the author and do not represent those of the International Monetary

Fund or its Executive Board. He would like to thank Aaditya Mattoo, Je6ey Sachs and Cmten Fink for useful discussions.

324 THE JOURNAL OF WORLD INTELLECTUAL PROPERTY

strong patent protection in the rich market. Differential pricing can then arise from three &fferent patent regimes in the poor country market.

Situation A: Strong Patent Protection in the Poor Country Market

Under this configuration, prices in the two markets will be different as long as parallel imports are not allowed. Prices will then be higher (lower) in the market with the lower (higher) elasticity. It is important to note that typically, prices will be higher in the rich country markets. If parallel imports are allowed, prices will tend to rise in the poor country market. Hence, poorer countries should want to prevent (or rather want their richer trading partners to prevent) parallel imports. Indeed, if trading partners did not prevent lower-priced parallel imports from entering their markets, the poor country would want to prevent the exports of the same products (“parallel exports”), to prevent domestic prices fiom rising towards levels in the rich country.

If the analysis were extended to three markets-rich, middle-income, and poor country marketssome interesting and perhaps more realistic policy conclusions follow. One of these is the possibihty that the medium-income market would prefer uniform pricing (i.e. parallel imports) to price &scrimination, especially if there is another poorer market where the monopoly price that is charged is lower than in the me&um-income market. This explains, for example, South Africa opting for a regime of parallel imports, hoping to find lower cost sources for drugs. Drugs could also be obtained from advanced countries that have enforced price controls, resulting in prices that are lower than the free market price in the middle-income countries. In general, however, most poor countries would want to simultaneously allow parallel imports and &sallow parallel exports.

The TRIPS Agreement is neutral with regard to parallel imports. But should the poor country seek to prevent parallel exports, the TRIPS Agreement and the WTO would arguably not allow it. The country could, of course, use WTO-consistent export taxes to restrict such exports rather than relying on quantitative restrictions.

Situation B: No Patent Regime in the Poor Market

Essentially, this is the pre-TRIPs situation. Prices in the poor market will be determined by competitive or near-competitive conditions of supply. It follows that there will once again be differential pricing, with prices in the poor market much lower than in the rich market. Further, prices in the poor market will be lower than under Situation A.

Situation C: Compulsory Licensing in the Poor Market

In this case, prices in the poor market will be somewhere in between prices in

AIDS, DRUG PRICING AND TRIPS 325

Situations A and B. The exact level will depend in large part on the number of compulsory licensees and, crucially, by the compensation to be paid to the patentee. Of course, the lower the compensation, the lower will be the prices in the poor country market. The TRIPS Agreement is extremely vague on the minimum compensation that will need to be paid, and this is an issue that will probably only be resolved in the dispute settlement process.

Clearly, &om the pharmaceutical companies’ perspective, Situations B and C will be anathema as they will dilute the patent protection, and hence the profits, that they enjoy. What is interesting is that they increasingly seek to avoid differential pricingas in Situation A-in favour of more uniform monopoly pricing. That is, despite the fact that Situation A yields maximum profits, they would rather avoid large differentials in prices across markets because of the pressure &om taxpayers and consumers in their own markets who see the price differential as being unfiir to them. Also, in some countries, especially where there is public sector provision and/or financing of drugs, there is a practice of reference pricing whereby prices are linked to the cheapest price in comparison countries.

Thus, the WTO’S advocacy, and the pharmaceutical companies embrace, of differential pricing is strictly confined to Situation A. The poor country faces a monopoly price, albeit one that is lower than the alternative monopoly price. As such, this cannot by any means be considered affordable access, especially not for f f ican countries in the grip of a human catastrophe.

111. AFRICA’S NEEDS

To facilitate better access (that is, better than that envisaged under Situation A), differential pricing clearly will have to aim at Situation C . The option of revoking patent protection altogether (Situation B) is a non-starter and should not be considered. As will be explained below, this radical option is not only unrealistic in terms of its acceptability to pharmaceutical companies and their governments, more importantly it will be ineffective. This leaves compulsory licensing as the only realistic option. But for Afkica, this option is more difficult to exercise. Let us see why.

Under the TRIPS Agreement, developing countries could invoke the public healthhterest exception in the TRIPS Agreement to grant compulsory licences for the domestic production of the relevant drugs, as indeed South Afiica has provided for in its law (the law is currently being challenged in South f i c a ’ s courts as being too permissive and hence inconsistent with the TRIPS Agreement). The problem is that, whereas this is a feasible option for large, technologically advanced, developing countries that can easily produce the patented drug, this may be less feasible for the smaller African countries, which would have to import the drugs.


Thus, African countries will have to issue compulsory licences for importing the drug. But where would they find these drugs at reasonable prices (i.e. at lower than monopoly prices) if the rest of the world is TRIPS-compliant? There are two possibilities:

-

-

&om those countries that are outside the TRIPS Agreement;

from those WTO countries in which a similar compulsory licensing exception has been invoked.

As the membership of the WTO is becoming universal, the first possibility is increasingly ruled out (even China will soon join the WTO).

The key point here is that African countries cannot import &om other WTO countries unless the latter also have invoked a similar compulsory licensing exception. In other words, a country such as India or Brazil cannot issue compulsory licences to its firms just to export AIDS drugs to African countries. Article 31(f) of the TRIPS Agreement rules out this possibility because it requires compulsory licensing to serve “predominantly” the local market (i.e. in the country where the licence is issued). Because intellectual property laws are territorial, the right to import does not become a right to export unless laws in the country where production for export takes place authorize such production.

The consequences of this restriction are not theoretical. Take the recent case of the Indian company, CIPLA, that offered to sell AIDS drugs to Kenya at US$ 650 per dose. This offer was legal in In&a because the drugs in question were not covered by the TRIPS Agreement. They were inventions made prior to 1994, which is the cut-off date for protection around the world. But in a year or two, when new AIDS drugs are covered by the TRIPS Agreement, the Indian company d not be able to make such an offer. To do so, they will have to obtain a compulsory licence to service the In&an market; once such a licence is obtained, they can then export some of their total production (much less than 50 percent given Article 31 (4 of the TRIPS Agreement) to Ahca.1

If providing affordable access to Afiica is indeed a serious imperative, even this possibility that is left open under the TRIPS Agreement is a very slim one. For example, a country like Zimbabwe can obtain drugs under competitive condition only if other countries have successfdly cleared the hurdles for compulsory licensing. These include:

the potential compulsory licensees must have attempted to obtain a voluntary licence &om the patentee on reasonable commercial terms and been rehsed within a reasonable period of time;

-

1 As long as the number of AIDS sufferers in Africa exceeds those in the countries which could potentially be sources of supply for cheap drugs, Article 31(0 of TRIPS will always be restrictive.


- the patentee should be paid reasonable compensation for the compulsory licence; and

decisions by a government to grant compulsory licences must be subject to judicial review.

-

Even if these hurdles could be cleared, the delays involved could be enormous and militate against swift responses to what is a serious crisis. What is needed is a legal situation that clearly allows and legitimizes third-country governments to grant compulsory licences for export so that firms such as CIPLA in India can sell AIDS drugs to Afiican countries in crisis. This would require a change in TRIPS rules.

It is important to note that a change in the legal situation is necessary but may still not be sufficient, if extra-legal pressures are exerted to prevent realizing the outcomes that the legal changes aim at. For example, if an Indian company is willing to sell AIDS drugs to African countries at close to marginal cost, it is easy to imagme both the company and/or the Indian government coming under pressure, say (under some kind of implicit or explicit threat) fiom the United States, not to grant compulsory licences for export. If India or the Indian pharmaceutical company succumbs (as happened recently to CIPLA when it offered to sell drugs to Ghana), the loser will be the AIDS victim in Mrica.2

The need for legal clarity cannot be over-emphasized as recent experience indicates. South Africa’s parallel import regime came under severe pressure &om the United States and its pharmaceutical companies, despite the fict that parallel imports are so clearly permitted by WTO rules. In the end, of course, the United States relented, but only after substantial countervailing pressure was exerted by non-governmental organizations (NGos). Of course, the WTO rule helped, but it was not enough in itself to stave off pressure.

Some have argued that the TRIPS Agreement requires no changes because it allows countries to grant broad-sweeping exceptions to IP laws in the event of an emergency, as indeed the AIDS crisis could be argued to be. But for the reasons spelt out above, this exception will not help f f ican countries because, even if they suspended their IP laws, they would still have to obtain the AIDS drugs from partner countries. These partner countries cannot invoke similar emergency exceptions unless the emergency is a domestic one; that is, India cannot suspend its IP laws because of an AIDS crisis in Afiica.

To be sure, any change in IP rules should not become or be seen as a licence for widespread infringement of patent rights. Appropriate safeguards can be designed to prevent this. First, third-country production of drugs under “compulsory licences” for export can be restricted both to countries in real need and to multilaterally certified (by

2 The co-operation of the international community in facibtating supply by the Indnn company may need to go even &her. For example, drugs manufactured in third countries will need to obtain regulatory approval either in the country of production (under compulsory licence) or &om other countries or the WHO.


the World Health Organization (WHO)) instances of public health problems. Second, patent holders should be provided reasonable compensation for third-party use of the patent which could be specified in advance to avoid legal uncertainty. And finally, countries should be assigned the responsibility of preventing drugs produced under compulsory licences fiom leaking into other markets, and undermining legitimate patent production.3

Thus the proposal to change TRIPS rules would run along the following lines. In the event of a WHO-certified public health crisis in a least-developed country, governments in other countries should be fiee to grant compulsory licences to their pharmaceutical companies to export the necessary drugs to the country/countries in crisis. Compliance with the normal procedures for granting such licences, specified in Article 31 of the TRIPS Agreement, in particular paragraph (Q, should not be necessary; however, patentees affected by the compulsory licence should be provided a nominal remuneration of say 2 to 4 percent. The country/countries granting the compulsory licence should co-operate with tradmg partners to ensure that drugs produced under such compulsory licences do not find their way into markets other than those affected by the crisis. The international community, under the aegis of the WHO, should make concerted and expeditious efforts to ensure that drugs produced under such licences satisfy the regulatory criteria for marketing approval.

Another reason why such a proposal might necessitate changes to current TRIPS rules is that TRIPS, even if it allowed compulsory licences to be used for exporting, would not allow hfferent compensation levels to the patentee depending on whether the production under compulsory licensing was destined for the domestic market or for poorer foreign markets. Ths differentiation must be allowed, not just for the obvious equity reason that the poorest countries should have to pay less, but also, as will be explained below, because compensation under compulsory licensing in middle-income countries should contribute toward bearing research and development (R&D) costs. Hence there will, in general, be good theoretical reasons, to calibrate the compensation under compulsory licensing to the user of the product.

IV. OTHER OPTIONS FOR AFRICA

A. Increased Aid

A number of respectable voices, including Harvard’s Jefiey Sachs, have argued strongly in bvour of addtional aid to finance the provision of low-priced drugs to

3 In discussions of differential pricing, legitimate concern are expressed by the pharmaceutical companies about the leakage of “parallel goods” into rich country markets, undermining patent protection there. However, it should be noted that this threat existed, in a more serious form, in a pre-Trws world and was reasonably successfully dealt with. As long as rich country markets have good enforcement capability, the leakage problem need not be serious. The arrival of the Internet and the attendant increase in Internet-based sales, of course, makes national enforcement more difficult, underlining the need for greater co-operation between countries.


countries in crisis, and against any dilution of international intellectual property rules to achieve this objective.

Consider the question: additional aid or du t ion of IPrules? The underlying economics can be posed starkly as follows. Drugs to AIDS sufferers need to be provided at the lowest possible cost. This can be achieved in two ways that are not mutually exclusive:

- by diluting the patent rights conferred by IPrules, allowing drugs to be produced at the lowest marginal cost of production; or

- by maintaining the monopoly or quasi-monopoly power of the pharmaceutical companies, with the taxpayers making good the difference.

In the former case, the pharmaceutical companies would contribute to the implicit subsidy to AIDS victims.

Reliance on the aid route alone is likely to be insufficient. First, there can never really be a guarantee that truly additional aid would be forthcoming: given the rising number of claims on a diminishing supply of aid, there is the likelihood that the resources that flow on account of AIDS have merely been &verted away from other uses. Second, while aid might provide the money, it will have to be accompanied by a mechanism for delivering drugs to those in need. Experience suggests that even in the best of circumstances, aid delivery in Afiica is encumbered and inefficient.

On the other hand, the advantages of diluting IP protection are twofold. First, it will represent a market-based solution to improving the access of AIDS victims to cheap drugs, obviating the need for aid and for any attendant delivery mechanism. Its chief &sadvantage, namely the resulting dent to the profits of pharmaceutical companies and the blunting of incentives to undertake R&D, will probably be minimal because of the low purchasing power of the affected markets. Hence, diluting IP protection must be part of the complementary international effort to tackling the AIDS crisis. Of course, it is possible, indeed highly likely, that even the near-competitive prices achieved through the compulsory licensing solution proposed above will be unaffordable for most AIDS victims, so that additional aid might remain a necessary policy response by the international community.

B. WHO’S Essential Drugs List

Another recent proposal would allow countries not to accord patent protection to drugs that are on WHO’S Essential Drugs List. However, the List excludes drugs that are deemed costly to produce even if they are essential from a public health perspective, intrinsically biasing the List against the inclusion of patented drugs. Many current drugs, such as those for treating AIDS, and future drugs could thus be excluded, limiting the


value of this approach for the poorest countries. Another problem would be its potential for misuse. If a large number of countries chose to deny protection to these drugs, the loss in profits to the patent holder could be significant enough to deter R&D.

C. Voluntary Eforts by Pharmaceutical Companies

One of the noteworthy features of the recent AIDS crisis has been the response of pharmaceutical companies in agreeing to voluntarily lower the price of AIDS drugs (presumably well below what they would otherwise have charged). In part, this has been the consequence of effective and concerted pressure by a wide array of consumer groups and NGOS. But another important contributing factor has been the threat of competitive supplies from third countries such as In&a and Brazil which has made this market “contestable”, even if actual supplies have not been forthcoming from firms in these countries. It would be absolutely crucial that this contestability be preserved and rendered clearly legal and legitimate, as the proposal made above would ensure.

V. THE MIDDLE-INCOME COUNTRIES

Applying differential pricing to middle-income countries such as Brazil, Argentina, South Africa, Turkey, possibly China or even India is more complicated. And it is one that arises because of distributional considerations both within and across countries. The dilemma is highlighted by considering the application of two extreme patent regimes- full patent protection or no patent protection.

For the sake of simplicity, let us assume that middle-income countries have two groups of consumers of medicines-rich and poor. With no patent protection, supplies are forthcoming at competitive prices for both groups. While this is fair to the poor (after all, this was the logic of the first proposal made above for the least-developed countries) in the middle-income countries, it can justifiably be seen as unfair to the patentee because he receives no profit fiom sales to the rich in that country. The rich in the middle-income countries do not contribute to the R&D costs that go toward creating pharmaceutical inventions. In this context, the allegation of fiee-riding assumes greater legitimacy. After all, if the rich in high-income countries can be expected to bear the burden of creating pharmaceutical inventions, the mere fact of borders should not be a persuasive argument for the rich in middle-income countries to also not take on a similar burden. It might even be inefficient in so far as the rich in all middle-income countries could constitute a large enough market and account for a non-neghgible share of pharmaceutical companies’ global profits.

On the other hand, the opposite solution of full patent protection, while being fair to the rich, is unfair to the poor, as their access to drugs is impeded and the contribution that they make toward pharmaceutical company profits can be seen as excessive.


The problem, in a nutshell, is that the patent regime is a very blunt instrument; given the territorial application ofpatent laws, they have to be uniform within a country and hence, by definition, cannot distinguish between rich and poor. Any resulting outcome will be unfair to one group.

It is thus clear that no patent regime in the middle-income country can solve this distributional issue within it. Governments will therefore have to rely on other instruments for acheving segmentation consistent with social objectives. There is, however, an IP issue, which needs to be addressed through compulsory licensing.

We can now define a socially efficient and internationally equitable patent regime. Ths would involve poor consumers paying marginal or close to marginal cost and the rich paying the monopoly price. This way, the latter group can also contribute toward R&D costs. It is fair, because the middle-income country can achieve an outcome where the negative externality imposed by the international regime on the poor within it is ofliet, while at the same time ensuring that the rich contribute fully toward R&D costs.

Suppose that the government of the middle-income country proposes to acheve this segmented outcome by procuring drugs and then using domestic instruments to segment the two markets. Suppose further that these drugs wdl be procured through compulsory licensing. What would be a fair r0yalty?4

What constitutes reasonable compensation under compulsory licensing? The TRIPS Agreement is ambiguous, even unhelpfid, on this score. Its Amcle 31 requires that, in the event of compulsory licensing, the patentee must be paid “adequate remuneration in the circumstances of each case, taking into account the economic value of the” compulsory licence. No standards for giving greater specificity or meaning to the notion of adequate compensation are provided. Summarizing the cross-country experience with compulsory licensing, Scherer and Watal note that if the profits lost by the monopolist because of the compulsory licences were the standard for determining adequate compensation, the resulting royalty payments would be so high as to prevent price reduction and increased drug availability.5 Thus, there is an inherent contradiction between compulsory licensing, which aims to increase competition, and a profit-based standard for compensation that would preserve the monopoly right of the patent.

Votaries of compulsory licensing tend to advocate the Canadian practice of granting a 4 percent royalty as the standard for adequate compensation, particularly in

4 Compulsory licensing will, in general, not be the first-best policy response to achieving the socially efficient and international equitable outcome. It could be superseded by two others: first, the country can abandon patent protection altogether but transfer to patent owners the monopoly profit that they would have obtained had they been able to enforce their patent vis-d-vis the rich in the country; alternatively, the country can enforce full patent protection on the understanding that the patent owner returns to the country any profits in excess of that obtained fiom the rich consumers.

5 F.M. Scherer and J. Watal, Post-THPS Optionrfor Aaess to Patented Medicines in Developing Countries, mimeo, Harvard University, 2001.


the pharmaceutical sector. But this number has no appealing justification, because it is not anchored in commonly understood economic or legal concepts.

It would seem that any notion of adequate compensation must reconcile the equity objective that underlies the use of compulsory licensing of pharmaceuticals with the need to preserve, at least to some extent, the incentives for R&D. An alternative perspective suggests that adequate compensation must reconcile equity objectives with a basic himess objective, namely, that users of patented products contribute toward R&D costs. Where a country is large relative to the world market, fairness and incentive objectives are essentially the same. But where a country is small, it is possible to make a fairness case even in the absence of a significant impact on incentives for R&D.

This fairness agreement, while difficult to defend when applied to poor countries, assumes greater legtimacy when applied to a set of rich consumers, even in developing countries. Because the quantitative magnitudes related to these equity, fairness and incentive objectives will vary across countries, it is possible, even likely, that adequate compensation will be country-specific rather than country-invariant.

A simple framework for determining adequate compensation is proposed here. Each country should divide its population into two groups-the poor, who should obtain drugs under competitive or close-to-competitive conditions, and the rich who should contribute their hll share toward R&D costs. In practice, any cut-off between the two wiU prove to be arbitrary; but the essence should be to divide the population into identifiable groups according to their ability to contribute to R&D costs. Some dlustrative calculations to determine what the orders of magnitude of this royalty should be and what factors should condition this royalty are also provided.

Figure 1 explains this framework. It has three panels: Panel A represents the market for drugs constituted by the rich in middle-income countries; Panel B shows the comparable demand curve for the poor; and Panel C is the country-wide demand curve, obtained by horizontally summating the curves in the first two Panels.

The first-best outcome is one where the rich pay monopoly prices (the monopoly outcome in Panel A) and the poor pay competitive prices. If the government decided to procure drugs under compulsory licensing, it should aim at an outcome that provides pharmaceutical companies the profit as in Panel A. The compulsory licensing outcome is shown in Panel C. Very simply, t h s outcome should be such that the total royalty paid to the patentee (royalty rate R times the quantity Q) is the same as what the patentee would have obtained had he been allowed to charge the monopoly price to the rich segment of the market in the middle-income country.

Graphically, the area EFCPCL in Panel C should be identical to the area ABCPM in Panel A. The point A in Panel A represents the monopoly outcome in the rich segment of the market; if the patentee had been able to segment markets within the middle

AIDS, DRUG PRICING AND TRIPS

A

333

A

D

PCL

C

D

PCL

C

/‘aneIC: Comb- f

Outcome W r conrpuIsory licemjng

DI

income country he would have been able to charge a price PM and obtain a profit of ABCPM. With compulsory licensing serving the combined market, market equilibrium is at E in Panel C, resulting in a royalty-inclusive price PCL. The royalty rate R (the difference between the price PCL and marginal cost C) should be such that the resulting royalty payment EFCPCL is the same as the profit that the patentee could have obtained by exercising his patent right in the rich segment of the market. This royalty R can thus be seen as fair compensation under a compulsory licence because the middle-income country is contributing M y toward R&D without fiee-riding.

How much WID R be? It is easy to calculate the value of R. In the rich segment of the market, the analysis of moving &om a patent regime to a compulsory licensing


regime is formally equivalent to that of examining the impact of a cut in the tax rate on tax revenues. In the patent regime, the “tax” rate was equal to PM-C. Under the compulsory licensing regime, this rate is cut from PM-C to R. Unless the initial equilibrium is at a Laffer point, this reduction in tax rate will lead to a decline in revenues (royalties to the patentee in this instance). The difference wdl be made up by royalties in the poor market equal to R times the demand in the poor market.

Formally, it can be shown that:

Where M is the monopoly royalty in the rich segment; PM is the price in the rich segment with hll patent protection and PCL is the price in both markets with compulsory licensing; M+PM is thus the ad valorem “voluntary” royalty rate, the rate that a monopolist would have charged a licensee under a voluntary contract. Q refers to the equilibrium quantities with superscripts denoting the relevant market and subscripts the relevant policy regme (monopoly (M) and compulsory licensing (CL)).

R+PcL is the ad valorem royalty rate under compulsory licensing. Thus, the monopoly rate is the weighted average of the compulsory-licensing royalty rates where the weights denote the share of the rich and poor segments (in terms of value) in relation to the revenue in the rich market under 111 patenting6

The expression in the first set of brackets denotes the ratio of consumer expenditures after and before the reduction in royalty and is hence directly related to the elasticity of price demand. The greater the elasticity, the lower the royalty rate under compulsory licensing @.+PcL) d need to be to ensure that the patentee makes his original profit (the left hand side of the expression). Similarly, the larger the poor segment of the market (greater the expression in the second brackets), the lower will be the royalty under compulsory licensing.

Table 1 provides some illustrative calculations as to the fair royalty rate under compulsory licensing for different values of the key underlying determinants. Three features are worth noting.’ First, as emphasized above, fair royalty rates are likely to vary across situations and hence across middle-income countries. Thus, any suggestion (as in Scherer and Wattal) that countries adopt a fured royalty under compulsory licensing as in Canada, is not really defensible on theoretical grounds. Second, the dismissal of the “profits-lost” test for determining royalty rates under compulsory licensing is also untenable. The essential point here is that while equity considerations may justiq a departure from this test, by the same token, this departure must be confined to groups

6 These weights do not add up to one. 7 It is clear that this fiamework can be refined further. For example, the requirement that the poor should also

contribute something, albeit much smaller in amount than the rich, can easily be incorporated into the fair royalty calculation.


TMLE 1 : ROYALTY RATES UNDER COMPULSORY LICENSING IN A MIDDLE INCOME COUNTRY- ILLUSTRATIVE CALCULATIONS

When elasticity ofdemand ofrich consumers = -2

And share of poor in total demand (percent) =

13 33 49 60 13 33 44 58 The royalty rate will be 10.3 8.0 6.2 4.9 13.4 10.9 8.8 6.8

When elasticity of demand of rich consumers = -1.75

And share of poor in total demand @ercent) =

who really deserve the equity opt-out. In other words, the profits-lost test should be applicable to richer income groups.

Third, the calculations also have some intuitive appeal. The fact that royalty rates decrease as the share of the poor in total drug consumption increases translates into an appealing rule that the poorer the middle-income country the lower will be the royalty rate. Fourth, under the proposed fi-amework, the data requirements for calculating the fair royalty rate are reasonably simple. Essentially, the demand curve for rich and poor need to be estimated, which would provide the basis for computing the fair royalty rate.

Finally, the proposal made in Section 111 that TRIPS rules should be changed to allow compulsory licensing for exports to the poorest countries could also apply to the middle-income countries. That is, a middle-income country (or indeed any other country) should be allowed to export drugs produced under compulsory licensing to another middle-income country. However, a key pre-condition must be that the remuneration paid to the patentee should be “fair” in the sense described above. Ths means also that production under compulsory licensing in a middle-income country may have differential rates of compensation depending on the destination of such production.

VI. CONCLUSION

Differential pricing for pharmaceuticals has assumed increased significance recently and is seen as an important way of meeting the needs of the poorest and middle-income developing countries. Differential pricing encompasses a variety of options for developing countries as regards the choice of patent regmes but, in the context of obtaining affordable access to drugs, meaningfbl dfferential pricing can only result through the use of compulsory licensing. This article has made two suggestions on compulsory licensing, one relating to the poorest countries in Afkca and the other relating to middle-income developing countries.

For Africa, providng affordable access to drugs, especially in the context of the current AIDS crisis, will require changes to current TRIPS rules. In particular, third- country governments should be allowed to grant compulsory licences to their


pharmaceutical companies, under some safeguards, so that they can export drugs at close-to-competitive conditions to Africa. Effective patent protection fosters R&D activity, but safeguarding the poorest countries’ access to medcines, at a time of a truly devastating epidemic, need not undermine it. Indeed, the proposal outlined above would result in a distinct improvement in global welfare-better fiordability of drugs for the poorest of the poor without weakening the global innovation climate for medicines. To be sure, the large pharmaceutical companies would see some reduction in their profits, but these are likely to be negligible. On the other hand, the gain in lives saved and averting a catastrophe-human and economic-in the poorest countries would be immeasurable. Surely, this is a trade-off well worth making.

As regards compulsory licensing by middle-income countries, a good case can be made that the compensation that is paid to patentees must be fair, in the sense that the rich in these countries (not the entire population) contribute toward R&D costs. This article has proposed a simple framework for determining such compensation and provided some illustrative calculations. In general, fair compensation will be country- specific, and is likely to be higher than the 4 percent (based on the Canadan experience) that is often cited as a standard for compensation under compulsory licensing. Two key determinants of fair compensation will be the elasticity of demand of the rich for medcines, and the number of poor consumers.

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The Aidsm Crisis, Differential Pricing of Drugs, and the Trips Agreement : Two Proposals