Misunderstanding "Market Failure"

Roger Bate | 14 Apr 2005
TCS Daily

A noble effort is underway to improve research and development into diseases that kill the poorest people in the poorest countries by offering guaranteed sales to pharmaceutical research companies that make breakthroughs. Healthcare spending is pitifully low in many developing countries, so efforts by the industrialized world to make up for lack of demand by creating markets for drugs and vaccines are to be praised. And last week the Center for Global Development (CGD), an influential non-governmental organization, launched its "making markets" initiative in Washington DC.

But it's important to keep in mind that the lack of medicines for poor countries is not a result of market failure, but of disastrous economic policy choices made by leaders in those poor countries themselves. Development professionals are getting themselves embroiled in pseudo-economics to try to induce guilt among donors. This is not necessary: the case is plain enough at first glance and, importantly and rarely, a workable solution is at hand.

There are several international private-public partnerships which are already making real achievements. Most are bankrolled by the Bill and Melinda Gates Foundation along with products, personnel and expertise being donated by the pharmaceutical industry. The CGD initiative is in addition to these efforts. CGD aims to artificially create guaranteed purchases for future drugs and vaccines, for while there is need for these products, there is no effective economic demand for them.

Nancy Birdsall, head of CGD, says that:

"We are all aware of global bads like human caused climate change,
but we are not aware of global goods like vaccines; that needs to change ...
Just 10% of the world's research and development on health is targeted
on diseases affecting 90% of the world's people. Of more than a thousand
new medicines developed over the last 25 years, just 1% were specifically
for diseases of tropical countries. There is not enough research and
development because technological progress is a global public good [a
good no private entity will develop because it cannot capture the benefit from
the provision of the good]. In the case of tropical diseases, no single individual
enterprise has an incentive to pay for the full costs of developing new medicines.
As a result, we invest far too little as a global community."

But while it is sad that there is not more R&D into the diseases affecting the poorest, the only meaningful sentiment in Birdsall's remark relates to the lack of incentive to pay for the full costs of developing new medicines. We should be reminded that research-based pharmaceutical companies are businesses, not charities and as such have to generate their own income on the profits they make. It is not the fault of corporations that there is no effective demand for products in poor countries.

Yet CGD has some powerful allies. Richard Klausner, Director of the Global Health Program at the Gates Foundation, whose aim is to "improve global health equity" takes up another arm of development economic thinking. "We are failing to deliver drugs for poor countries because of market failure," he says. This is nonsense; I only hope that Bill Gates himself has a better grip of economics.

A market "fails" when a third party is left with costs which spill over from a transaction between contracting parties. A classic example is pollution from a factory. The burden falls on neighbors while the producer and the buyer take only the benefits. This is an external cost or externality and the remedy is to internalize the cost by making the producer compensate those harmed, clean up the damage to others, or preferably prevent pollution in the first place. In no way is this applicable to drug or vaccine development.

After all, there are plenty of drugs and vaccines for diseases which are not even being used. As Mark Feinberg of the industry group BIO says, "a lot more than just a product is required" to successfully treat a sick person. Three million children die every year from diseases for which vaccines are available. The recombinant vaccine for Hepatitis B has been around for 19 years but still a million people die annually from it. Vaccines are available for influenza (ammophilous type) and the rotavirus, which causes gastric diseases, but still each kills 500,000 a year. April 12th 2005 was the 50th anniversary of Jonas Salk's development of a safe, effective polio vaccine. It may be a shock to learn that polio still killed over 1,000 people in 2004. In 1988, the death toll was 350,000, so considerable progress has been made and the WHO is pleased to announce that the current multi-agency eradication program which began in 1985 is on track to succeed in 2008. It will have taken 23 years because eradicating disease is very hard work.

I welcome real incentives to encourage the best brains from companies into HIV/malaria/leishmaniasis etc. research. But the opportunity cost is that these scientists will not be working on cancer and hypertension, where real (effective economic) demand, rather than artificially created (through CGD-style guaranteed markets), demand exists. There is undoubted need for new drugs for poor countries, but not effective demand. I am personally happy to skew demand in the direction of most obvious need, but that is how such a re-focusing of research effort should be seen (and debated accordingly) -- not as a failure to be overcome.

Using taxpayer funds to buy new vaccines and drugs is simple but only a part of the solution to the problem of access for the poor. The hard part is effective spending in poor countries, and for that, western guilt and the soft target of wealthy western pharmaceutical companies is not appropriate. Fixating on "market failure" rhetoric and western production forgets the more important reasons that the poorest lack access to drugs -- their poverty and the policies that encourage poverty promoted by so many of their governments.

Roger Bate is a Resident Fellow of the American Enterprise Institute