The 1998-2001 legal interaction between the South African government and the international pharmaceutical industry: a game-theoretic analysis
Susan Cleary
University of Cape Town
Don Ross
University of Cape Town
In 1997, the South African Government passed the
Medicines and Related Substances Control Amendment Act (1997-90). Almost
immediately, the Pharmaceutical Manufacturers’ Association of South Africa
(PMA) challenged the constitutionality of the Act, arguing that it contravened
South Africa’s obligations as a member of the World Trade Organisation. After
three years of dispute, the case came to court in March 2001. Within a month
the parties settled out of court. To many observers and commentators, the history of this interaction has seemed confusing and contradictory.
Popular media commentary generally supposed that the Government would use the
Amendments Act to increase access to antiretroviral drugs. To date, however,
Government policy on drug provision has not matched this anticipation. This fact
appears to call forth a less straightforward hypothesis concerning the
Government’s legal and political strategy with respect to the PMA suit. In the
following paper, we propose such an hypothesis by motivating a more complex but
realistic utility function for the Government and then showing, by means of
game-theoretic analysis, that this would rationalize the actual behavior of
both parties.
The paper is organized as follows. First, we provide
crucial background information on the context of the dispute with respect to
relevant legal and economic issues concerning intellectual property rights, as
defined by South Africa’s domestic law and as constrained by the Trade in
Intellectual Property Rights Agreement (TRIPS), to which South Africa is a
signatory. We then describe the actual behaviour of the Government in detail,
for the purpose of proposing an hypothesized utility function that rationalizes
this behavior in accordance with a `principle of charity’ reflecting a default
presupposition of rationality. A similar exercise with respect to the utility
function of the PMA is then required, since to rationalize an outcome by means
of game theory involves showing that all parties' strategies are in
equilibrium. We avoid ascriptions of esoteric or ad hoc knowledge to either party. Testimonial evidence is then
provided so as to establish the plausibility of our imputed Government utility
function. The imputed PMA utility function is justified by industry analysis,
concentrated on the financial implications of the various dispute outcomes
possible ex ante. Finally, we render
our model and its assumptions suitably precise, and show that it indeed
rationalizes the actual outcome, by modeling it game-theoretically and showing
that given our imputed pair of utility functions the terms of settlement were
the game's unique Nash equilibrium.
TRIPS provisions
Under the Uruguay Round agreements as signed by South Africa, domestic intellectual property rights laws and administration are required to conform to the minimum standards set by the Trade in Intellectual Property Rights Agreement (TRIPS). In this context, the 1997 Medicines and Related Substances Control and Amendment Act (henceforth, `the Act’) was regarded by some commentators as contentious because it appeared to weaken intellectual property rights protection for medicines to an extent that might contravene TRIPS. Although this concern was expressed with respect to various sections of the Act, we concentrate on Section 15C, which appeared to allow for parallel importation and / or compulsory licensing, depending on interpretation.
A medicine is said to be parallel imported into a country a if, once it is sold by the patent owner or a licensee in a second country b, a third party sells it on into a’s market. Parallel imports are viable and economically significant only given significant pre-importation price differentials between the markets in a and b. Compulsory licenses allow a generic manufacturer to produce a drug before the patent on the brand name drug has expired. Typically, some royalty is paid to the patent owner. Countries that engage in compulsory licensing usually justify it by reference to `patent abuse’ under some interpretation. As will be seen, much of the complexity surrounding the legal argument between the South African Government and the PMA resulted from uncertainty concerning the extent to which the intended purpose of the Act was to facilitate one of these measures or the other, and under what circumstances.
The TRIPS agreement prescribes a minimum standard of intellectual property protection binding on all WTO members. For industrialised nations, intellectual property protection is particularly important because a significant aspect of their comparative advantage in trade lies in their capacity for R&D in high technology fields. Without strong intellectual property protection, it would be difficult for these countries to ensure an adequate return on their and their citizens’ investments in new technology. Countries with comparative disadvantages in this capacity have often resorted to pirating. This practice is sometimes defended on the grounds that intellectual property protection can be harmful to developing countries because it raises the price of technology beyond affordability to them. This concern is often compounded by two others in the specific case of medicines. Drug companies may be under-incentivized to invest in research on drugs for developing-country diseases, it is argued, because the value of these markets is relatively small. And since the incentive structure underlying pharmaceutical research is generally analyzed in terms of trade-offs between expected corporate returns on R&D and losses to consumer welfare, it is potentially problematic if losses to consumer welfare due to under-researched diseases are, in general, marginally higher in developing countries than probable such losses in developed countries (McCalman, 1999). In light of disquiet about the TRIPS provisions among developing-country governments, motivated by these concerns, it is generally accepted that those of them that sanctioned the inclusion of TRIPS in the Uruguay Round agreement did so for the sake of perceived compensating gains in other parts of the Uruguay package (Wolson, 1997).
Under TRIPS provisions (World Trade Organisation, 1994) a
patent confers on its owner exclusive rights for a period of 20 years from
filing date (Article 33). During this time, third parties may not make, use,
offer for sale, sell or import the product obtained directly from the patented
process without the owner’s authorisation (28:1b). However, patent owners may
choose to grant voluntary licences on the patent (28:2). WTO members can refuse
to grant patents on grounds that relate to public health (Article 27), where
these apply to inventions whose commercial
exploitation needs to be prevented to protect human, animal or plant life or
health (27:2), or where they would interfere with provision of diagnostic,
therapeutic and surgical methods for treating humans or animals (27:3a) (TRIPS and pharmaceutical patents: fact sheet, 2001).
Both parallel imports and compulsory licenses are
permitted under TRIPS. The right to parallel import
depends on the domestic legal system’s definition of exhaustion of rights.
Under some codes, rights are exhausted after the first sale of the good, and
the patent owner cannot control resale. The TRIPS agreement makes clear that
invocations of this `doctrine of first sale’, where legal, cannot be challenged
under the WTO dispute settlement mechanism as long as there is no
discrimination on the grounds of the nationality of the patent holder (Article
6, Pharmaceutical patents and the
TRIPS Agreement 2000; Health Care and Intellectual Property: Parallel Imports, 2001).
TRIPS itself explicitly disclaims authority over national definitions of
exhaustion of rights.
Once a patent has been granted, Article
30 states that members may make limited exceptions to the exclusive rights
conferred by a patent. However, these must not unreasonably conflict with the
rights of the patent holder, taking account of rights of third parties in this
context (World Trade Organisation, 1994). Article 31 of the agreement deals
directly with the issue of using patents without the authorisation of the
rights holder (World Trade Organisation, 1994). Any usage without authorisation
needs to be done with reference to the specific laws of the member. Such usage
includes compulsory licensing, and use by government for its own purposes.
According to the WTO’s TRIPS and
pharmaceutical patents: fact sheet (2001), compulsory licensing is part of
“the agreement’s overall attempt to strike a balance between promoting access
to existing drugs and promoting research and development into new drugs”. Prior
to such recourse, the government in question must make efforts to obtain
authorisation from the patent-holder on “reasonable commercial terms”. Such
efforts must be unsuccessful within a “reasonable period of time”. However,
this requirement may be waived in cases of “national emergency” or “extreme urgency”
or “public non-commercial use”. In the first two cases, the patent holder must
still be notified as soon as reasonably possible. In the third case, the right
holder must be informed immediately if the government knows that a valid patent
is in existence (World Trade Organisation 1994: 332; TRIPS and pharmaceutical patents: fact sheet 2001).
There are thus measures that allow for
fast tracking of compulsory licensing if the government is prepared to offer
drugs in the public sector, or to declare a national emergency. This
interpretation of Article 31 is in keeping with interpretations in the WTO’s
own documents, and with the European Union paper (European Union 2001)
submitted to the TRIPS council special discussion on intellectual property and
access to medicines. If use is made
without authorisation, this will be limited to the specific purpose for which
it was authorised in scope and duration (31:c), for supply of the domestic
market (31:f). Such use will be terminated as soon as the particular circumstances
have ended (31:g). The patent holder will be paid “adequate remuneration ...
taking into account the economic value of the authorization” (World Trade
Organisation 1994: 333) (31:h). All of this will be subject to judicial review
in the country having recourse (31:i; 31:j). In cases of anticompetitive
practice (Article 40) a country may make use of the patent without a national
emergency (31:b) and not necessarily produce only for the domestic market
(31:f). The need to correct anti-competitive practice is to be taken into
account when determining remuneration to the patent-holder (31:k). According to
Love (2001a), production for export is possible under TRIPS if, through local
administrative processes, a patent is seen to lead to anticompetitive practice
and to create a barrier to access. According to article 44, if use of a patent
is granted in terms of article 31 provisions, then the only remedy available to
patent holders is that of remuneration in accordance with 31:h.
TRIPS is thus relatively permissive
about unauthorised use of patents, especially in the case of HIV/AIDS, which is
widely recognised as constituting a national emergency in South Africa.
Furthermore, according to Love (2001a)
many developed countries (United States, United Kingdom, Ireland, Germany) give
government very broad powers to authorise use of patents for public
non-commercial use (as allowed in section 31:b). Before signing NAFTA, Canada
regularly issued compulsory licences for pharmaceutical drugs. Compensation was
based upon expected royalties, and was usually set at 4% of the patent holder’s
sales price.
In practice, however, some countries have been cautious about exploiting this flexibility in TRIPS (TRIPS Council Meeting on Access to Medicines, 2001). The US Government has a recent history of applying pressure to South Africa and other countries to apply stronger patent protection (so-called `TRIPS-plus’ protection) than the TRIPS minimum standards, and the clear basis for this pressure is implicit linkage to other trade provisions and measures that give developing world countries incentive to be viewed as `model WTO citizens’ in general.
The legal
background to the court case
In South Africa, patent rights are protected by the Patents Act (1978). South African courts are generally regarded as having placed strong burden of proof on challenges to patentees’ rights, and have normally refused to grant compulsory licenses (see below) for alleged patent rights abuses, even though the law allows compulsory licensing under certain circumstances (Wolson, 1998).
The Medicines Act of 1997 was designed to correct
some of the distortions of the apartheid years, where private sector health
care was very expensive, and the public sector health system charged prices in
excess of those in neighbouring countries. Along with other provisions, there
were two measures introduced to encourage reductions in prices. The first -
generic substitution - entails prescribing a generic drug once the patent has
expired on the brand name drug as long as the generic is cheaper. The second is
parallel importation. The large pharmaceutical companies vigorously opposed
these provisions, arguing that parallel importation was a violation of the
Patents Act, which does not allow for exhaustion of rights once a product is
sold for the first time. Instead of amending the Patents Act, the government
responded by introducing Section 15C to the Medicines Act. This section was
designed to override the exhaustion of rights problem by giving the Minister of
Health new over-riding administrative discretion. The text of 15C closely
follows that of a WIPO document, which was designed expressly to allow only
parallel importation. The text of 15C reads as follows:
The Minister may prescribe conditions for the supply
of more affordable medicines in certain circumstances so as to protect the
health of the public, and in particular may-
(a)
notwithstanding
anything to the contrary contained in the Patents Act, 1978 (Act No. 57 of
1978), determine that the rights with regard to any medicine under a patent
granted in the Republic shall not extend to acts in respect of such medicine
which has been put onto the market by the owner of the medicine, or with his or
her consent;
(b)
prescribe
the conditions on which any medicine which is identical in composition, meets
the same quality standard and is intended to have the same proprietary name as
that of another medicine already registered in the Republic, but which is
imported by a person other than the person who is the holder of the
registration certificate of the medicine already registered and which
originates from any site of manufacture of the original manufacturer as
approved by the council in the prescribed manner, may be imported;
(c)
prescribe
the registration procedure for, as well as the use of, the medicine referred to
in paragraph (b)” (Department of Health, 1997).
Unsurprisingly, it is the clause “The Minister may prescribe...” as well as section 15C (a) that particularly upset the PMA. It argued that this section could be used to justify and sanction both parallel importation and compulsory licensing of certain medicines.
On February 18, 1998, the pharmaceutical company
lawsuit by forty-two applicants against the Government of South Africa was
filed. (The number of applicants would decrease to thirty-nine by the time the
case reached court, Pfizer being the most notable of the companies to
withdraw.) According to the PMA’s Notice of Motion, Section 10 of the Amendment
Act, introducing Section 15C of the Medicines Act, is unconstitutional on one
or more of the following grounds:
1.
It
allows the Minister of Health to prescribe the conditions for the supply of
more affordable medicines. It does not set out any guidelines which would limit
the power of the Minister in this regard.
2.
It
allows the Minister to decide on the extent to which rights under a patent
shall apply, irrespective of the provisions in the Patents Act.
3.
It
allows the minister to deprive patent owners of their property without any
provisions for compensation.
4.
It
only discriminates against patent owners in the pharmaceutical field. This is
in conflict with TRIPS, which has been given effect in South Africa by the
passing of the Intellectual Property Laws Amendment Act of 1997.
(Pharmaceutical company
lawsuit (forty-two applicants) against the Government of South Africa (ten
respondents)
1998).
Public lobbying pressure was put on the South
African Government by both the PMA at home, and by PhRMA (Pharmaceutical
Research and Manufacturers of America) and the United States Government abroad
to alter Section 15C. Although, as we have seen, parallel importation can be
TRIPS-compliant, the US, PhRMA and the PMA argued for `TRIPS-plus’ patent
protection. Highlights of this pressure include the placing of South Africa on
the United States Trade Representative’s Special 301 Watch List (mainly because
of the Medicines Act) in May 1998 (Department of Health, 2001a). An example of
the level of feeling against Section 15C is evident in a US Department of State
Report (US Government efforts to
negotiate the repeal, termination or withdrawal of Article 15(c) of the South
African Medicines and Related Substances Act of 1965, 1999). According to
the report:
“All relevant agencies of the U.S. Government, the
Department of State together with the Department of Commerce, its U.S. Patent
and Trademark Office (USPTO), the Office of the United States Trade
Representative (USTR), the National Security Council (NSC) and the Office of
the Vice President (OVP) – have been engaged in an assiduous, concerted
campaign to persuade the Government of South Africa (SAG) to withdraw or modify
the provisions of Article 15 (c) that we believe are inconsistent with South
Africa’s obligations and commitments under the WTO Agreement on Trade Related
Aspects of Intellectual Property Rights (TRIPS)
…
Since the passage of the offending amendments in
December 1997, U.S. Government agencies have been engaged in a full court press
with South African officials from the Departments of Trade and Industry,
Foreign Affairs, and Health, to convince the South African Government to
withdraw or amend the offending provisions of the law, or at the very least, to
ensure that the law is implemented in a manner fully consistent with South
Africa’s TRIPS obligations”
The PMA insisted that 15C could be used for compulsory licensing (the “broad” interpretation of the act), while the Government initially insisted that its intention was only to facilitate parallel importation (the “narrow” interpretation). However, in 1998, having been advised that the law could be used more broadly than initially envisaged, the Government appears to have considered using the law for compulsory licensing. Although compulsory licensing is possible under the Patents Act, it is a slow and costly process. Broad interpretation of 15C would allow the government to bypass the Patents Act and issue “fast track” compulsory licenses on pharmaceutical patents (Love 2001b). This measure has the benefit of keeping pharmaceutical patents separate from other patents. This was deemed necessary because the Department of Trade and Industry (DTI) did not wish to threaten general intellectual property rights under the Patents Act.
By mid-1999, the initial issue, centering around
issues of access to drugs in general, had become publicly focused on HIV/AIDS
therapies, though the South African Government resisted this focus.
Intellectual property rights activists tended to demonize the large
pharmaceutical companies as a core part of their political strategy, and
linkage of this campaign to the southern African HIV/AIDS epidemic clearly
enhanced popular interest in the case. This was particularly true outside of
South Africa itself. While we have no direct evidence to substantiate a charge
of disingenuousness concerning the activist spokespeople, the interpretation of
15c as being primarily linked to mass antiretroviral access, which the
activists successfully established in the public mind and the media, did not
reflect legal facts. 15C as drafted is aimed at access to essential medicines,
as defined by the WHO in the Model List
of Essential Drugs. In 1997, AZT was added to the WHO’s tenth MEDL solely
for the prevention of mother to child transmission. In 1999, Nevirapine was
included in the MEDL, again exclusively for the prevention of mother to child
transmission (Unicef et al, 2001). Thus antiretrovirals, as used in adult
therapy, are not covered by 15c. Nevertheless, once activists emphasized the
idea of a link between 15c and HIV/AIDS therapy access, the media discussed
little else in connection with the case (see evidence below). This was true
both inside South Africa and abroad. Following mass demonstrations by American
AIDS activists, particularly against the Gore presidential campaign, the United
States Government dropped the trade pressures it had brought against South
Africa as a result of the Medicines Act. A “Joint understanding between the
governments of South Africa and the United States of America” was issued by the
South African Department of Trade and Industry (1999). In this agreement, the
US Government agreed to remove pressure from South Africa. South Africa agreed
in return that:
“It is the express position of the South African
Government that, in the implementation of provisions of the Medicines Act –
which permits parallel importation and compulsory licensing of patents for
pharmaceuticals – it will honour its obligations under the TRIPS Agreement”
(Department of Trade and Industry, 1999: p.1).
Note that this statement clearly signalled the
Government’s intention to use the Medicines Act for both parallel importation
and compulsory licensing.
From September 1999, the companies in the litigation
announced that they would suspend their lawsuit in order to enter into
negotiations for a settlement. There was no publicly revealed movement for
about a year subsequent to this, and popular media opinion in South Africa
assumed almost unanimously that if the Government were to win the court case,
it would authorise the domestic production of generics or would import cheap
generic HIV/AIDS drugs (Love 2001b). Eventually, declaring that Government was
not negotiating seriously, the PMA took up the suit again (“World Trade Rules
and Cheaper Drugs”, 2001).
By the time the case came to court in March 2001,
the Government had changed its stance. We speculate that two developments had
contributed to this change. First, South Africa’s greatly enhanced public role
in WTO politics during and after the lead-up to the failed Seattle negotiations
of late 1999 enhanced the attention paid in Government public relations to its
commitment to holding developed-world countries accountable to moralized
standards on trade liberalization and market access; and this message regularly
incorporated the claim that South Africa was an exemplary observer of Uruguay
treaty commitments, including TRIPS obligations. Secondly, once the activist
campaign had closely associated 15C with increased access to antiretrovirals in
the popular media, it was no longer in the Government’s interests to implement
a “broad” interpretation of the Act, since the Government’s opposition to
enhanced access to antiretrovirals was then a dominant theme in its health
policy. By the time the case reached court on 5 March 2001, the Government’s
filed Heads of Argument had come to indicate their intention to argue that the
law could only be used for parallel importation, whereas the PMA (who presented
their case on the first day of proceedings) was arguing that it could also be
used for compulsory licensing.
Resolution of the court case
The amendments to the Medicines Act on the
interpretation that survived the legal settlement have not, in practical terms,
directly increased levels of access to publicly funded anti-retroviral
treatment. However, the progress and ultimate resolution of the case clearly
had some outcomes consistent with the Government’s goals as hypothesized above.
It contributed to substantial reduction in the prices of some antiretrovirals.
This was caused by worldwide activist pressure and critical media attention
brought to bear on the PMA as a result of publicity around the court case. Furthermore,
the southern African AIDS crisis itself received increasing international media
coverage. This likely increased moralized political pressures on OECD countries
to give new `breaks’ to developing world countries with respect to multilateral
trade regulations, including TRIPS provisions and their interpretation in
practice. This is potentially useful for South Africa’s strategy of achieving
trade reform through exploitation of moral leverage. However, this
consideration also introduced complications with respect to the Government’s
tactics in the court case. The general moral leverage strategy requires the
Government to maintain support from international and domestic humanitarian
lobbies. Furthermore, Cosatu, South Africa’s largest trade union and a formal
constituent part of the governing coalition, publicly allied itself with the
TAC. These considerations sharply limited the extent to which the Government
could simply ignore activist pressure and declare its utility function
transparently. In this context, the opportunity to present the legal settlement
as a Government victory against the
PMA, a presentation with which the PMA refrained from demurring, represented
partial extraction from a difficult political bind.
Before we later specify this intuitive
interpretation by technical analysis, we will briefly review some empirical
evidence in its favor. Our empirical review included surveys of the following
materials: speeches made by President Thabo Mbeki on all topics from 1997 to
the present; government documents on HIV/AIDS, foreign policy, and trade;
government legislation relating to health and property rights; information on
HIV/AIDS contained on the ANC website ANC
Today (www.anc.org.za), any other
relevant information contained at the government web site (www.gov.za); websites of activists and NGOs
with particular interest in HIV/AIDS and intellectual property rights (www.tac.org.za; www.cptech.org ); local newspapers (Mail & Guardian and Business Day and their online
equivalents, and www.woza.co.za which has
subsequently closed); international publications (New York Times and The
Economist); electronic journals; and various other sources including
personal conversations with informed people. It is obviously not possible in
this paper to closely scrutinize the resulting mass of evidence. What follows
is therefore intended as a representative summary, designed to provide
potential critics of our interpretation with a basis for discussion and
argument.
1. The contextualization of HIV/AIDS in Government
speeches and documents. During the period of our analysis, the Government was highly consistent
– and therefore, we presume, careful and deliberate – with respect to the
context in which it placed HIV/AIDS. It was called a disease of developing
countries or of the poor, and linked with clear instances of such diseases,
including malaria and tuberculosis. None of the proffered plans to cope with
AIDS promoted the usage of anti-retrovirals except in the mother-to-child
transmission programme or as a short course for rape survivors (although, as
will be shown, the Government was highly obstructive in the implementation of
these programmes).
Central to the government’s campaign has been the
repeated insistence that poverty plays an overwhelming role in the transmission
of HIV/AIDS. At the ANC Today site
(“ANC Message on HIV/AIDS: Prevention is our best defence”, 2001) the following
is written:
Central to the ANC’s campaign against HIV/Aids is the message that preventing the spread of the HIV virus is the best defence against Aids. This message reinforces the organisation’s commitment to addressing the role of poverty in the spread of Aids;
...
While HIV/Aids can affect anybody, it hits the poor
hardest. The programme to combat the epidemic must therefore be part of the
fight against poverty: to make basic health services, clean water and
sanitation accessible to all South Africans; to improve nutrition and food
security; to fight against diseases such as tuberculosis, STDs and
malnutrition; and to promote the empowerment of women and young people.
On the topic of anti-retroviral treatment, the
documents regularly refer to issues of affordability and to lack of
infrastructure, and argue that public health interests can be better served
through developing public health infrastructure to combat all the diseases of
poverty. This attitude is reflected in President Mbeki’s Opening Address at the
13th International AIDS Conference, given on 9 July 2000. Much of
this address quotes directly from the 1995
World Health Report, which names poverty as the greatest cause of ill
health in the world.
2. Government reluctance to accept aid for
anti-retroviral treatment assistance from other governments. There has been a general
trend by the South African Government to refuse offers of aid or loans that
could be used specifically to provide AIDS medication in the public health
system. For instance, an offer by the United States Government to provide an
annual $1billion in loans to finance purchases of anti-AIDS drugs in Africa was
turned down by the South African Government (Swarns, 2000a). Acceptance of such
loans, it was argued, would jeopardise the strategy of fiscal restraint.
3. Ambiguous responses to proffered donations from
pharmaceutical companies. The South African Government has accepted some offers to donate
medicines used in the treatment of AIDS, but it has simultaneously obstructed
delivery of these offers while refusing others. Three examples are given. (i)
Pfizer offered to provide free diflucan (a drug used in the treatment of
opportunistic infections) in the public health sector. Although the government
accepted the offer, it did so a full year from the date at which it was
initially made (Swarns, 2000b). It took the Medicines Control Council seven
months to approve the tablet form even though the drug had already been approved
in a different form (HIV/AIDS Barometer 2001). (ii) Boehringer Ingelheim
offered to provide free Nevirapine for five years, for use in the prevention of
mother-to-child transmission of HIV/AIDS (Swarns, 2000b). The
cost-effectiveness of programmes using Nevirapine to prevent mother-to-child
transmission is well documented (relative to the literature on generalised
anti-retroviral therapies). Nevertheless, barriers were raised by the
Government through the Medicines Control Council (Sidley, 2000). By March 30
2001 the MCC had yet to register the drug (Sidley, 2001c) because of issues
about the development of resistance to it. According to Beresford (2001b), “the
government has still not announced when it will fully implement a pilot
programme to give Nevirapine to HIV-positive pregnant women that had been due
to start in March,” despite nationwide announcements at the end of January that
treatment would begin “immediately” (Smith,
2001). Pilot programmes were eventually set up in all of the provinces, but the
TAC’s contention that this was inadequate provoked its series of successful
court challenges on the matter that contributed to change of policy by the
Government on this issue in April 2002. (iii) Some NGOs that provide
anti-retrovirals have encountered Government resistance to their activities.
The Greater Nelspruit Rape Intervention Project was evicted from state
hospitals in Mpumalanga, where they had been counseling rape victims and
supplying post-exposure packs of anti-retrovirals to reduce chances HIV
contraction. Part of the reason for the eviction, according to the MEC, was
that the GNRIP’s activities created pressure on all hospitals in Mpumalanga to
deliver anti-retrovirals. At the time, the Minister of Health defended the
decision of the Mpumalanga government on the grounds that there was no
conclusive proof that anti-retrovirals would lower the chances of contracting
HIV/AIDS from rapists. Ironically, some Government hospital workers were then
treated with anti-retrovirals after needle stick injuries to lower the chances
of HIV transmission (Beresford, 2001b).
4. Evidence concerning the court case as a public
relations exercise. The interpretation of 15c according to which it would allow for both
parallel importation and compulsory licensing of drugs, thereby increasing
access to anti-retroviral therapy, was common in the local and foreign press,
and in statements by Government during the court case. In South Africa’s
national daily Business Day, Barber
(2001a) wrote “If 15C is upheld, government will have freed itself from its
obligations under existing law not to import Indian or Brazilian knockoffs of
drugs whose patents it hitherto recognised and protected.” Peter Goosen, who
spoke at the World Health Assembly on behalf of the South African government on
January 26 1999, said that the legislation allowed for the issuing of
non-exclusive compulsory licenses (government production) and for parallel
importation (South Africa Comments to WHA
Executive Board on Revised Drug Strategy, 1999). Patricia Lambert, legal
advisor to the Minister of Health in the lawsuit, told The Economist that if the
government deemed a drug to be too costly, the legislation would allow it to
license a local generic manufacturer to make it more cheaply or to buy a
generic version from another country under the discretion of the health
minister (“A war over drugs and patents” 2001). Dr Glaudine Mtshali,
representative of the South African Department of Health in the US, Canada and
Brazil, said that if the court ruled in the Government’s favor, the legislation
would be used to produce generic AIDS drugs locally (Barber, 2001b). Through
its encouragement of statements such as these, the Government encouraged the
PMA’s belief in the need for its lawsuit in the first place, and suggested that
what was at stake in the case was its right to champion provision through
compulsory licensing. However, the new draft regulations do not in fact allow for compulsory
licensing. In addition, the Government has not, thus far, exploited the cheaper
prices offered for antiretrovirals to increase access in the public health
sector.
Nevertheless, following the resolution of the court
case the Government enjoyed substantial positive publicity. Sidley (2001b)
wrote in the Business Day:
Government basked in the glow of positive publicity
this week as it faced the multinational pharmaceutical companies in court...
For a moment there the past year of acrimony between
government and HIV/AIDS organisations was forgotten.
No mention was made of the president’s questions
about the causes of AIDS. Forgotten, too, was the case of the rape crisis
workers in Mpumalanga against whom the provincial government had acted for
supplying AZT to rape victims. No mention was made of babies born with HIV that
might have been spared infection if at least one donation had been acted on
earlier.
If the week’s events looked like a game of poker, bluffing included, the stakes were particularly high.
The settlement reached in the court case was called a: “total capitulation of the drug companies in their legal action against the medicines legislation” (Sidley, 2001d). The ANC (2001) called the court case “an historic agreement” that “lays the basis for cooperation towards health for all,” while not mentioning HIV/AIDS specifically. Instead, the document talks about “the diseases of poverty” and “the diseases that cause poverty” (“Historic agreement lays the basis for co-operation towards health for all”, 2001). Belinda Beresford (2001a) of the Mail & Guardian, who has won international awards for her reporting on HIV/AIDS, wrote: “At the 13th hour the pharmaceutical industry backed down. The law it fought for three years to prevent being enacted will go ahead, unchanged … The law that the PMA has now accepted is the same as the one signed by then president Nelson Mandela three years ago... The government had drawn a line: it would not rewrite the disputed areas of the legislation”.
It is not any part of our purpose here to argue polemically that the above `spin’ put on the court case by the South African media and the ANC was or was not normatively appropriate or factually confused. We have reproduced the above selection of remarks merely to lend empirical support to our ascribed – and, of course, streamlined and simplified – utility function to the Government. In order to construct our game-theoretic model of the court case, we now must do some analogous work with respect to the other party to it, the PMA.
PMA objectives and strategy
The desire to protect patents explains the
involvement of the PMA in the court case. Their fear was that the Medicines
Act, especially Section 15C, would lead to a weakening of patents in South
Africa for all drugs. In addition, it was feared that the actions of South
Africa would set an example for other developing countries.
As of 1998, when our analysis begins, attempted blocking of the Medicines Act was consistent with the standard patent-protection strategy of the pharmaceutical industry. Political and legal assistance in such efforts was often provided by the US Government. The United States Trade Representative (USTR) did not distinguish amongst rights in different sorts of intellectual property markets, e.g., software versus drugs. USTR’s generic policy was encouragement of TRIPS-plus protection measures in all jurisdictions, for all intellectual property. As we will now show, however, the situation in which simple maximization of patent-exclusivity on all drugs in all countries was seen as equivalent to profit-maximization by the PMA and its Government allies evolved over the period under analysis. We will focus on the approximately shared utility function of the so-called `Big Five’ pharmaceutical companies: Merck, Roche, Boehringer Ingelheim, GlaxoSmithKline and Bristol-Myers Squib. They are the main players in the antiretroviral market, are part of the UNAIDS Accelerating Access Initiative, and collectively determined the final terms of settlement in the case from the PMA’s side.
The pharmaceuticals industry is imperfectly
competitive. While the industry as a whole is characterised by a large number
of firms, the various market segments for individual therapeutic classes are
typically fairly concentrated. The first drug to use a specific mechanism to
treat an illness is called a `breakthrough drug,’ which, by definition, has no
close substitutes on the market. Demand for these drugs is therefore fairly
inelastic while their period of exclusivity lasts. However, patents do not
prevent companies from developing different chemical entities that use the same
basic mechanism to treat an illness. These are called `me-too’ drugs. A
Congressional Budget Office (1998) study estimates that a breakthrough drug
typically has between 1 and 6 years of pure market exclusivity before a
`me-too’ drug enters the market. These do not offer novel treatments, but may
have fewer, or different side effects and may treat some patients more
effectively (CBO, 1998). Demand for a breakthrough drug is expected to become
more elastic when a `me-too’ substitute enters the market, though overall
demand levels may also be stimulated. However, barriers to entry into
individual markets often limit this competition. There are usually only a
certain number of chemical entities that can effectively exploit the same
treatment mechanism. In addition, larger firms have an advantage in marketing
and in the Food and Drug Administration approval process. This is because a key
element of competitive strategy is advertising, in which there are major
economies of scale available through promotion across large product lines. In
addition, studies have shown that new drugs from bigger companies are three
times more likely than those from less experienced companies to be approved by
the FDA (CBO, 1998).
Antiretroviral drugs are divided into three classes: nucleoside reverse transcriptase inhibitors, non-nucleoside reverse transcriptase inhibitors and protease inhibitors (Unicef et al, 2001). Table 1 provides a list of the various antiretroviral drugs available on the market today, divided by class and manufacturer. There are three different manufacturers of NNRTI’s, three different manufacturers of NRTI’s and three different manufacturers of PI’s.
Table 1:
Antiretrovirals Sorted by Therapeutic Class
Source:
Unicef et al, 2001
Competition amongst brand name antiretrovirals cannot be modeled as a series of simple price / quality tradeoffs, because complex treatment regimens are frequently combinations of two or three different drugs, from different therapeutic classes and different manufacturers. For example, the Médecins Sans Frontières project in Khayelitsha has recently started an adult triple therapy programme. This is the only public sector project of its kind in South Africa. Their first line treatment is a combination of AZT, 3TC and Nevirapine. This is a combination of two NRTI’s made by GlaxoSmithKline and one NNRTI from Boehringer Ingelheim. Their second line treatment is a combination of ddI, d4T and Nelfinavir. This is two NRTI’s manufactured by Bristol Myers Squibb and one protease inhibitor made by Roche. While ddI and d4T are relatively inexpensive due to Bristol Myers’ recent price cuts, Nelfinavir is expensive. This makes this treatment regimen the pricier of the two. Part of the decision to pursue the first line regimen over the second must come down to considerations of cost. Médecins Sans Frontières may also prefer the first line treatment because the GlaxoSmithKline drugs are combined in one tablet, and are therefore easier to take. However, the regimens may be altered because of side effects relating to one of the drugs, or because of relatively low efficacy. Such cross-firm product bundling encourages the large firms to act as a cartel in their dealings with governments and public providers, and helps to stabilize the cartel against incentives to defect.
Providing the incentive to invest in R&D is the
primary justification of the patent system. While certain drugs may indeed be
expensive to develop, others are not. Drug companies generally do not provide
publicly accessible, meaningful breakdowns of their R&D costs on specific
products or product-classes. Most estimates of the costs of drug development
are extrapolated from a 1991 study by DiMasi et al, using their methodology and
data. They estimate the pre-tax mean expected capitalised costs of drug
development to be $231 million in 1987 dollars. To calculate this figure, they
obtained micro-level data on the cost and timing of development for 93 randomly
selected New Chemical Entities [2]
first investigated in humans from 1970 to 1982 in the United States, with
reported development expenditures running until 1987. Using this data, DiMasi
et al calculate the average expected out-of-pocket-costs of clinical testing
for all New Chemical Entities to be $11.1 million. However, because not all New
Chemical Entities will be marketed, the researchers factor in a 77% risk of
failure, or an expected success rate of 23%, on each potential product. This
implies that the aggregate cost of New Chemical Entities that make it to market
is $48.1 million.[3] To this is
added the cost of long-term animal testing and an estimate of the cost of
pre-clinical phases (for which there is no micro-level data). This yields
estimated uncapitalized expected costs of each phase for a New Chemical Entity
that makes it to market.
We will summarize the calculation method used by
DiMasi et al. This is necessary because we will subsequently show that when
probable R&D costs for existing antiretrovirals are critically re-examined
relative to this method and its underlying assumptions, the figures standardly
cited in public by the PMA become far less plausible. Court proceedings, had
they been allowed to unfold, would certainly have exposed this fact in detail,
and this was surely relevant to the PMA’s incentives for settling.
In order to calculate the opportunity cost of
capital, DiMasi et al estimate a representative time profile. They find that it
takes approximately 12 years and 5 months to bring a new drug to market. Phase
costs are assumed to be distributed uniformly over actual mean (pre-clinical
and clinical) phase lengths and capitalized at a discount rate r. This is a real rate of return of 9%.
Capitalized mean phase costs, cj
are calculated as
cj = ò zjzj-tj (xj / tj) ert
dt for j = 1, 2, 3
where index values 1, 2 and 3 refer to phases I, II
and III respectively, xj
is the uncapitalized cost of the particular phase, tj is the phase-length and zj is the time
from the beginning of the phase until the drug is approved and brought to
market. Capitalized preclinical cost per NCE Pc can be given by
Pc = ò TT+tp (Pu / tp) ert
dt
where Pu
is the uncapitalized pre-clinical cost, T is the total time for the clinical phases and tp is the time for the preclinical phase
(DiMasi et al, 1991: p 118). Animal testing costs are capitalized in a similar
manner.
In 1990, an Office of Technology Assessment study recalculated DiMasi et al’s figures using an opportunity cost of capital that decreases linearly from 14 to 10 percent from the beginning to the end of R&D to get a total of $359 million in 1990 dollars. This was assumed to be the upper bound of fully capitalized costs per successful chemical entity.
The DiMasi et al methodology has been subject to some criticism. Their data was obtained from a confidential survey of a group of twelve US-owned pharmaceutical firms (DiMasi et al, 1991), and so the accuracy of their out-of-pocket cost estimates cannot be verified by other researchers. In addition, no project-level data was available for pre-clinical phases of drug development, so their estimate is based on aggregate industry level data. This data is likely to be less accurate than the data for clinical periods. Secondly, their calculations are pre-tax. A dollar invested in R&D is a dollar on which corporate profit taxes are not paid (at a current US average rate of 34%). This means that every dollar spent on R&D represents an actual outlay of $0.66. The CBO (1998) study argues that DiMasi et al’s figures should be recalculated to account for these tax concessions.
Most importantly for the present analysis, DiMasi et al’s estimate is specific to innovative drugs that are discovered and developed entirely by one company. It is therefore not applicable to most existing antiretrovirals, which were frequently developed with funding from government, or in certain cases, were discovered by federal agencies and licensed to drug companies for marketing. Information on government aid in the development of antiretrovirals is widely available in activist circles, and increasingly in the media. This type of information would have been part of the Treatment Action Campaign’s testimony in the South African court case (Love, 2001c). We will summarize its potential implications with respect to the antiretroviral products of each of the Big Five firms. GlaxoSmithKline owns the patents for AZT (the only breakthrough drug that it markets), 3TC, Ziagen and Amprenavir. The Michigan Cancer Foundation initially synthesised AZT on a grant from the National Cancer Institute. BioChem Pharma invented 3TC and licensed it to Glaxo for a 14% royalty. It is also probable that Yale and Emory Universities played a role in development, while the US government sponsored more than 40 clinical trials for 3TC. The University of Minnesota invented Ziagen with support from the National Institute of Health. Amprenavir was discovered by Vertex but licensed to Glaxo for development. Amprenavir is a protease inhibitor and the National Institute of Health was pivotal in the discovery of protease inhibitors as an effective treatment for HIV/AIDS. The United States Government was involved in clinical trials on Nevirapine, Boehringer Ingelheim’s only breakthrough antiretroviral. Bristol-Myers Squib manufactures ddI and d4T, both of which are `me-too’ drugs; the United States Government invented ddI and licensed the drug to BMS on an exclusive basis. d4T was synthesized by the Michigan Cancer Foundation on a grant from the National Cancer Institute. Yale University holds the key patent for d4T. Roche manufactures ddC and Saquinavir. ddC was initially synthesised under a National Cancer Institute grant at the Michigan Cancer Foundation. It was then exclusively licensed to Roche for the treatment of HIV/AIDS. In addition, the National Cancer Institute conducted the first clinical trials of ddC (a `me-too’ drug). Roche also holds the patent for Saquinavir, the first drug in the class of protease inhibitors. However, the National Institute of Health did much of the initial research in determining the efficacy of protease inhibitors in the treatment of HIV/AIDS. There was also government involvement in clinical trials for Saquinavir. Merck manufactures Indinarvir, and Efavirenz, both `me-too’ drugs. Indinarvir is a protease inhibitor. The US Government was involved in the initial development of protease inhibitors as a treatment in HIV/AIDS. There was also federal involvement in the clinical trials for both drugs (Balasubramaniam, T. 2000; Additional notes on government role in the development of HIV/AIDS drugs, 2000).
DiMasi et al’s value for the opportunity cost of
capital is heavily reliant on their estimated representative time profile. For
breakthrough antiretrovirals, the average length of time from filing a patent
application to marketing is 3.13 years, as shown in Table 3. Although the data
does not indicate at what point of development patent applications were filed,
this normally happens before the start of the clinical testing phase. To be
safe, one could assume that the drugs took 3.13 years from the start of
clinical testing until approval, which is less than half DiMasi et al’s
estimate. This means that opportunity costs would be much lower. This
difference has implications for the effective patent life of the drugs. Drugs
in DiMasi et al’s study have an average effective life of about 8 years, while
antiretrovirals have an average effective patent life of 16.9 years. This
increases the period of monopoly power and hence the profitability of a drug. A
Tufts Center for the Study of Drug Development report shows antiretrovirals
brought to market in 1996, 1997 and 1998 as having had the shortest development
time from clinical to approval for all classes of drugs (Kaitin & Healey,
2000).
Table 2:
Development Times for Antiretrovirals
Source: Balasubramaniam, 2000; Unicef et al, 2001
In light of both the general criticisms of DiMasi et al’s model,
and of the specific issues concerning antiretrovirals just reviewed, we need to
recalculate estimations of their costs and profitability. We re-estimate DiMasi
et al’s figures for all breakthrough antiretrovirals, and then for AZT
separately. For breakthrough antiretrovirals, the calculation retains DiMasi et
al’s estimate of preclinical development time, but prorates the clinical development
times over 3.13 years. It uses the same uncapitalized expected costs as DiMasi
et al. The different result is therefore entirely attributable to shorter
development times leading to a lower opportunity cost of capital. For AZT, the
clinical development times are prorated over 1.5 years and the preclinical
costs are assumed to be zero, because Glaxo did not carry out the preclinical
development of AZT.
Drug development costs change over time, which means
that DiMasi et al’s estimates are most accurate for drugs first investigated
between 1970 and 1982, with development continuing until 1987. The
antiretrovirals currently on the market were developed between 1985 and 2000.
But it is likely that the uncapitalized expected costs of antiretrovirals were still
lower, because of US Government involvement and funding.
Table 3:
Expected phase costs per marketed NCE (in millions
of 1987 dollars) versus costs for antiretrovirals and costs for AZT
DiMasi et al, 1991 p 125
For
DiMasi’s figures, all costs were deflated using the GNP Implicit Price
Deflator. To the phase lengths (monthly periods) is added the New Drug Approval
review period, estimated to be 30.3 months. Animal testing was estimated to
start 4.0 months into Phase II.
Costs
were capitalized at a 9% real discount rate.
Costs
are capitalized from start of phase until market.
All figures in 1987 dollars
Table
4:
After-tax
Development Costs for Antiretrovirals and AZT
using the current
corporate profit tax rate of 34%
These estimates suggest that adjustment of the
length of time for drug development changes the estimates of opportunity cost
of capital substantially. Reducing the figure to account for tax savings gives
an estimated average after-tax capitalized cost of breakthrough antiretroviral
development of $61.06million in 1987 dollars. This would still represent an
overestimate for those drugs that were not developed solely by the company that
marketed them. This is why the estimated cost of AZT development is only $22.74
million. Glaxo was not involved in the preclinical trials on AZT, and it took
Glaxo 1.5 years to bring AZT to market.
A simple calculation can be made to estimate the
break-even sales quantity for AZT. Assume a simple cost equation:
TC = k + xQ [1]
where TC
is total cost, k is the cost of
R&D, x is marginal cost (assumed
constant) and Q is output (Crotty,
2000). For drug manufacturers to be successful, the present value of their
future profits from the sale of new products (discounted to the date the
products were introduced) must exceed the capitalized cost of their original
R&D investment (capitalized to the date of market introduction), including
investment in drugs that never make it to the market. (That is, total revenue
must exceed total cost.) Where total revenue equals total cost, the firm will
break even. For AZT
TR = TC
P.Q = k + xQ
Q =
k / (P – x) [2]
where Q is
units sold, k is the estimated cost
of R&D of $22.74 million, x is
the marginal cost, and is assumed to be Cipla’s latest generic price of $0.84
per daily dosage of 2 x 300mg tablets.
Ideally, P would represent the
developed market ex-works (or manufacturer’s) price of AZT. Unfortunately, it
is not easy to get an indication of the ex-works price of AZT in the developed
markets. In the interests of caution, and in light of the fact that ex-works
prices have likely declined over time, we base our estimate here on the 2001
Spanish consumer price, the lowest in Europe, and calculate a developed-market
ex-works price from this (Unicef et al, 2001). We thereby set P at $3.96 per day (2000 dollars).
Solving for equation two reveals that Glaxo would
break even after selling 7.288 million daily dosages of AZT, or after
treating19,968 people for one year. AZT has been on the market since March 1987
(14.4 years). Thus Glaxo needed its product to be used in treatment of 1,387
people per annum to break even, at a daily price of $3.96. In addition, the US
patent only expires in September 2005, which gives them another 4 years to
price above marginal cost. HIV 2000:
Major and Emerging Markets (2000) reports that global efforts by Glaxo
resulted in $101million in AZT sales in developing countries alone in 1997. Médecins Sans Frontières
reported to the South African government in 2000 that global sales on AZT less
marginal cost had earned Glaxo $694million between 1997 and 1999 (in Achmat,
2000). In other words, Glaxo has been profiting from sales of AZT for years.
Calculations of this sort make clear that the Big
Five faced no risk of losses on their investments if they were to lower the
prices of antiretrovirals. Indeed, they show the high profitability of these
drugs. This type of evidence was part of the Treatment Action Campaign’s case
as Amicus Curiae (Love, 2001c).
Recent years have in fact seen a dramatic
fall in the prices of antiretrovirals, as shown in figure 2.
Figure 2: The Decline in Antiretroviral Prices
$10,000
$
8,000
UN Drug Access
Initiative
$ 6,000
Domestic
Production
$ 4,000
Accelerated
access initiative
$
2,000
February
– March 2001 Offers
$ 0
1996 1997 1998 1999 2000 2001 2002
Source: Presentation by Dr J. Quick in Report of the Workshop on Differential Pricing and Financing of Essential Drugs 2001: 8.
The post-cut prices of BMS, and Merck are in line
with, or cheaper than, generic offers. Boehringer Ingelheim’s Nevirapine is
free for mother-to-child treatment but pricier than the generic for adult
treatment. These prices are available in the private sector. Roche has offered
price cuts in the public sector through the UNAIDS Accelerating Access
Initiative, but its cuts have been the least substantial and its antiretrovirals
are currently the most expensive. Glaxo has also been reticent about its
offers. No reductions have been offered for Abacavir, and its prices for 3TC
and AZT are above the generic price. Its cuts are also available only in the
public sector (Unicef et al, 2001).
What has led the industry to cut prices so
drastically? According to a report in the Wall
Street Journal:
“These days, the world-wide drug industry is reeling
from an unprecedented wave of public scorn. Coming from so many corners and
with such ferocity, the attacks have put the hugely profitable and politically
influential industry on the defensive as never before” (Harris, 2001: p. 2)
This turn in public opinion has been caused by the
direct action of activists worldwide, who have drawn media and public attention
to the African HIV/AIDS crisis. As noted earlier, the effectiveness of this
campaign eventually led the US Government to withdraw its support for
TRIPS-plus patent protection for antiretrovirals in South Africa.
By 2000, the position of the Big Five was visibly
evolving. In that year, UNAIDS started an Accelerating Access Initiative in
partnership with the Big Five, who offered to sell their antiretrovirals in the
developing world at price reductions of up to 80%. However, this offer was
hedged with numerous caveats, which made implementation difficult. Ultimately,
drugs were delivered to less than 2,000 people in Rwanda, Senegal and Uganda.
Activists successfully publicized this outcome and encouraged the media to spin
it as resulting from corporate hypocrisy. The industry’s case further worsened
when Cipla offered to deliver drugs at even lower prices, suggesting that the
80% reductions still left the Big Five with mark-ups over marginal costs.[4]
The fall in prices of brand-name antiretrovirals to
near-parity with those of their generic equivalents is thus clearly a
consequence of political and media pressure, which was effective in part
because claimed threats to profitability were not in fact true. According to
Merck CEO, Raymond Gilmartin:
“The actions we’ve taken with pricing and the
settlement of the lawsuit in South Africa were important for taking away the
notion that intellectual-property rights are a barrier to access”
(“A Healthy Diagnosis”, 2001: p.22)
We suggest that the PMA’s willingness to settle was thus based on a calculation that the costs to their public reputations from stubborn maintenance of their 1996 position exceeded the value of continued sales at high prices in the developing world, especially in light of the fact that investments in antiretrovirals had already been recouped. Had the settlement of the court case threatened patent protection more generally the PMA might well have been incentivized to continue fighting. However, as we saw in our review of the terms of settlement in the previous section, this was not the case, public perceptions to the contrary notwithstanding.
Economic analysis
Having empirically justified our attribution of utility functions to both the South African government and the PMA, we will now explain the development and settlement of their interaction as the outcome of a game. We proceed by representing two games, one hypothetical and one actual. The first shows the situation that confronted the two players given their perceptions of their payoffs from the beginning of 1998 until the end of 1999. Analysis of this game predicts what would have happened had the controversies around the Medicines Act not come to be exclusively focused around the antiretroviral access issue. Our second game models the strategic interaction as it appeared once the success of the HIV/AIDS activists in `spinning’ the issue had become evident. This game has a different equilibrium from the first, one corresponding to the actual outcome.
1. First Game
This game starts with the passing of the Amendments
to the Medicines Act in 1997, intended to increase access to essential
medicines and to decrease the costs of drugs in the public sector.
Suppose that PMA sues the South African Government
(SAG) in an attempt to block the passing of the Amendments Act. The issue is
initially about parallel importation of patented drugs, but increasingly, there
is a distinction between broad 15C (TRIPS-compatible parallel imports and
compulsory licensing) and narrow 15C (parallel imports only). It is not clear
whether the Government means to use 15C in the broad or the narrow sense. The
PMA is strongly supported by PhRMA and the United States Government, pushing
for TRIPS-plus protection that would prevent even parallel importation.
This situation is modelled following Gintis’s
Nuisance Suit game (Gintis 2000: 100). In Gintis’s formulation of this game, it
is essential for the plaintiff to make
their threat to sue credible. Clearly this is not a problem in this case,
because the suit is not frivolous. This is because the cost of litigation,
especially given the support of both PhRMA and the US Government, is less than
the value of the patent protection that the PMA might lose if 15C is
implemented on the broad interpretation of it. Patent litigation is standard
practice for PhRMA, which has appropriate lawyers for the purpose permanently
on retainer.
If PMA wins, its payoff x represents the expected value of avoiding compulsory licensing
and parallel importation. If PMA loses, its payoff is arbitrarily set at 0. Similarly, if SAG wins, its payoff x represents the expected value of
implementing compulsory licensing and parallel importation. If SAG loses, its
payoff is set at 0.
If SAG offers to settle, and PMA accepts this, assume
that PMA gets a settlement payoff of sx
where s is some proportion of x such that 0<s<1. SAG gets (1-s)x.
s represents the expected value of
avoiding compulsory licensing for PMA while (1-s)
is the expected value of parallel importation to SAG. A settlement on these
terms, therefore, would represent an outcome in which PMA drops its suit and
SAG agrees not to use 15C for compulsory licensing.
If PMA were to pursue the suit and set it down for
hearing, they have a probability of winning
p. The probability of the SAG
winning is (1 – p). Players evaluate
the expected values of lotteries as follows:
E[l] = å pixi
For PMA, the expected value of the lottery is:
E[l]PMA = px + (1 - p) (0)
E[l]PMA = px
For SAG, the expected value of the lottery is:
E[l]SAG = (1 - p)x + 0p
E[l]SAG = (1 - p)x
The extensive form of this game is depicted in
Figure 3.
Figure 3:
Law Suit Game
PMA
Do Nothing Sue
SAG
0,
x
Offer Settlement No
Offer
PMA PMA
Accept Reject
Drop
Suit Pursue Suit
sx , (1 –s)x PMA 0, x px,
(1 – p)x
Drop Suit Pursue Suit
0, x px,
(1 – p)x
Through backward induction on this tree, one sees
that the strategy Pursue Suit strictly dominates Drop Suit for PMA, unless the
probability of winning is zero, in which case the payoff from Pursue Suit is
equal to the payoff from Drop Suit. If SAG were to offer a settlement, PMA
would evaluate a payoff of sx against
a payoff of px. In other words,
accepting SAG’s offer would depend on the values of p and s. If p > s they will reject the settlement
offer and visa versa.
SAG must evaluate (1 – s)x against (1 – p)x
in deciding whether to offer a settlement. It could be argued that the odds of
SAG winning the lottery are reasonable. However, the payoff of (1 – s)x is a relatively small
proportion of x because if it settles
then SAG cannot compulsory license. Therefore, under certain values of p, No Offer would dominate Offer
Settlement. SAG’s actual observed behaviour during 1998-99 is consistent with
an evaluation by it that No Offer dominates Offer Settlement. It staunchly
refused to modify 15C even though it was under strenuous pressure from the US
Government to do so.
If this game were to have been played out to
conclusion, the payoffs to the players would have been:
px , (1 – p)x
PMA sues, SAG offers no settlement, and the court decides the outcome of the game. This is a subgame perfect equilibrium.
2. Second Game
However, the game as shown depicts the players’
initial conceptions of it; before its resolution the game changed. One event
that altered it was the abortive attempt at launching a new WTO multilateral
bargaining round in Seattle in December 1999. At Seattle, many activists, NGOs
and, to a more moderate extent, the US negotiators, promoted incorporation of
special environmental and labour standards provisions within the WTO. This was
widely perceived in the developing countries as a potential threat to their
interests, and encouraged the South African Government to consolidate and
re-emphasize its policy of fully and visibly upholding the terms of TRIPS for
moral leverage, while arguing that OECD countries were shrinking from the full
spirit of reciprocal concessions.
Secondly, as described in the previous section,
HIV/AIDS activists, both inside and outside of South Africa, succeeded in
capturing the issue of the court case with respect to the focus of the media.
From early 2000, the conflict over 15C came to be popularly interpreted as a
story about a poor country valiantly fighting cruel pharmaceutical companies to
increase access to antiretroviral drugs in the midst of an epidemic. In light
of its utility function as discussed above, this raised a complicated situation
for SAG: victory in the court case could have committed them to mass provision
of antiretrovirals, which they opposed, as a result of freedom to grant
compulsory licenses. Why doesn’t SAG simply settle at this point? Its behavior
is rationalized, consistently with all available evidence, if we suppose that
it saw the opportunity to gain moral capital by being perceived to be “taking
on” the pharmaceutical companies.
The game then becomes, from SAG’s perspective, an
exercise in bluffing. SAG knows whether it actually intends to implement broad
or narrow 15C, but the PMA does not. It is in SAG’s interest to exploit this private
information in such a way as to encourage PMA to believe that the game’s
structure has not changed.
However, relevant parametric circumstances have also changed for PMA. First, it no longer has the support of the US Government and its trade-related pressure. Second, it continues to suffer from an accelerating public relations disaster while the case goes on, as a result of the activists’ media success.
We model the resulting interaction using the
standard approach to games involving asymmetric information. The game tree is
given in Figure 4.
