Working Papers,
Copenhagen Business School, Department of Economics

Abstract: On the possibility of reducing public expenditures on medicine through

deregulation. The market for medicine is special in three essential respects: (a) The

role of the buyer is divided by three agents: the (informed) doctor, who prescribes

the medicine, the public health insurance, which pays most of the bill, and the

(uninformed) consumer, who benefits from the medication and pays part of the bill.

This division creates obvious incentive problems. (b) The distributors (pharmacies

and wholesalers) have no market power as they are obliged to procure the medicine

prescribed by the doctors - no more no less. (c) Competition among suppliers is

limited; most medicine is provided by either a single producer of patented drugs or

by a few competitors. Economic efficiency calls for some combination of regulation

and competition, the exact combination depending upon the market structure of the

various sub-markets. - First, we discuss the possibilities of designing an appropriate

combination of administrative regulation and incentives suitable for enhancing cost-efficiency

of prescription. Second, we analyse the economies of deregulating the

pharmacy sector which, by now, is subject to both controls on both (total) gross

profits and establishment. The conclusion is that deregulation is unlikely to increase

economic efficiency. Third, we take a look at the whole sale sector which, by now, is

subject to binding re-sale prices determined by the producers. Economic efficiency

dictates that binding resale prices are upheld. Finally, we discuss the possibilities of

strengthening the demand side as a way of reducing expenditures and recommend

that the organization of the demand side should reflect the market structure of the

supply side: In case of monopoly, the bargaining should be entrusted to a single,

powerful public body. In case of imperfect competition, tendering appears appropriate.

Keywords: Public expenditure; Medicine through deregulation

JEL-codes: I11

34 pages, July 18, 1999

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