Bibek Debroy: The Precedence Principle

For every silly policy, there is a precedence somewhere in the world.

There is a law in economic policy-making. For every silly policy, there is a precedence somewhere in the world. Indians should be flattered that the Indian Drug Price Control Order (DPCO) of 1955 is being cited by the Philippines and Malaysia, in an attempt to introduce price controls in the pharmaceutical sector. The antecedents of DPCO may not be generally known.

The DPCO is one of several orders issued under the Essential Commodities Act (ECA) of 1955 and ECA's ancestry is rather odd. It was originally introduced under the Defence of India Rules of 1939, under an exogenous shock of war-time shortages. Thereafter, it became the Essential Supplies (Temporary) Powers Act of 1946. The use of the word "temporary" is interesting, because this statute was supposed to die a natural death on January 26, 1955. That never happened. Instead, ECA gave it a completely open-ended unnatural life and stricter and stricter amendments in 1964, 1966, 1967, 1971, 1974, 1976, 1981 and 1986 followed to ECA. ECA provided an enabling framework through which, under Sections 2 and 3, various control orders on production, marketing and distribution could be issued, not just for pharmaceuticals or manufacturing, but for agricultural commodities also.

Section 2 listed some commodities as essential, such as cattle fodder, coal, automobile parts, textiles, drugs, foodstuffs, iron and steel, paper, petroleum, cotton and jute. But this was illustrative and other commodities could be declared essential by either the Centre or state governments, giving powers of licensing production, manufacture, storage, transport, distribution, stocking, use, consumption, compulsory sales to the government and even price controls. Consequently, a pathology of controls, including those on prices, emerged. Because of licensing, there was a shortage. Left to the market, prices would have increased. To prevent price increases, there were price controls, deterring investments and supply-side responses. The shortage perpetuated itself and became a vicious cycle. Price increases were suppressed, but shortage manifested itself through queues, rationing, bribery and corruption.

Not long ago, Members of Parliament had discretionary quotas for allotting watches, not to speak of telephone and gas connections. There were black markets for scooters and foreign exchange. As India liberalised and discarded licensing, all these shortages have disappeared. Nor have real prices increased as a result. To keep the record straight, post-reform India has only removed controls on product markets, and there too, only in manufacturing. Product markets continue to be controlled in services such as education and health and agriculture and there are controls on factor markets like land, labour and capital. These controls amount to licensing, not regulation.

Specifically in the pharmaceutical sector, did the DPCO and price controls help? Of course, not all drugs were subjected to price controls. There was a list of essential drugs, different from WHO's list, which were subjected to price controls. Non-essential drugs were left to market forces. The number of essential drugs has varied. There are around 500 common bulk drugs. In 1995, mirroring reforms, the number under price controls was reduced to 76, down from 145 in 1987. In 2002, there was a proposal to reduce the number to 30. And now, given the UPA government's tendency to control, there is a proposal to increase the number to 300. Other than bulk drugs, retail prices of formulations were also determined through DPCO, as were distribution margins. The pharmaceutical sector was also messed up by an absence of product patents from 1970, through the Indian Patents Act. This encouraged piracy and production of sub-standard drugs in garages. In judging success or failure of India's pharmaceutical policy, the criterion used for evaluation is, thus, important. If the number of producers is an indication, the policy was successful, the number of manufacturers having increased to 25,000. Since some of these drugs were sub-standard and didn't involve bearing fixed costs, prices were lower. (With competition and better enforcement of standards, the number of manufacturers has now dropped to around 9,000. And there is nothing wrong with this.)

The effect of these policy-induced distortions was to discourage investments and innovation and encourage piracy, average R&D expenditure was less than 1 per cent of turnover. (As a result of allowing product patents, R&D expenditure has now increased to almost 10 per cent of turnover for larger Indian pharmaceutical companies and patents have been obtained, not only in India, but also in developed countries, the PCT having helped.) Companies moved away from producing essential drugs to non-essential drugs. Sometimes, they moved away from drugs to cosmetics and toiletries. Consequently, essential drugs had to be imported, a perverse instance of import-promoting industrialisation, probably the only country in the world to actually adopt such a strategy. Instead of research on drugs relevant for India-specific diseases, there was an obsession with cardio-vascular diseases, drugs for which could be pirated. The Indian pharmaceutical industry is now in a period of transition, no longer scared of intellectual property protection and in a position to tap India's strengths in human resources, science and technology. Policies still suffer from distortions, including restrictions on human and animal trials. However, it is bizarre that other countries don't pick Indian policies that facilitate this transition and instead, pick policies that India has discarded.