We use data from the Intercontinental Medical Statistics (IMS) database, which contain quarterly records on import sales and units over the 1997–2002 periods for a set of products that fall in the therapeutic product category of statins and exhibit parallel trade during the study period. The gives rise to a total sample size of 768 observations. However, due to the presence of some missing observations we were left with a final full sample of 625 for all variables. The data exhibits a three-way panel structure, 4 products 8 exporters to the Netherlands, in 24 quarters. Data for each product were made available at dispensation level. IMS collect data on prices and sales for a number of countries, including the Netherlands, and for the selected product group, statins, on a product-by-product (e.g. simvastatin, pravastatin, etc) and product presentation basis (e.g. simvastatin, 20 mg, 28 tablets). The accuracy of the data sources has been validated externally (IMS 2004). Data on both wholesale margin and regulation was obtained from publicly available sources for each country Ministry of Health. Rather than relying in different therapeutic groups, which are subject to different degrees of competition and the presence of generic competitors, we instead rely on a single therapeutic group (statins) which accounts for a significant proportion of total retail sales of prescription only medicines in European countries (5.7 % in 2002) (see Fig. 1).
Statins are products that lower levels of LDL (“bad”) cholesterol by 30–50 %, and have been popularly prescribed to prevent coronary heart disease (CHD), including myocardial infarction (MI), and their use has been increasing over time, making them, in turn, desirable targets for parallel trade. All products within the group were protected by a patent during the study period, therefore, the effect of parallel trade could be isolated from other effects, such as competition from generic equivalents, and studied without having to account for the competition effect due to generic penetration (Frank and Salkever 1991; Grabowski and Vernon 1992; Ganslandt and Maskus 2004).
Table 1 illustrates the difference in statutory margins and competition (number of companies) in the product distribution of each country. We report the number of competitors in the source country used to instrument distribution prices, as it is unlikely to affect the quantity of imports in any other way but though its effect on product prices. This is important for our instrumentation strategy below. Overall, Table 1 suggests marked differences in the regulation of prices and the wholesaling competitive conditions across European countries. We find that in France, wholesaler margins are the lowest in the period of analysis, which is consistent with France being the main source country of parallel imported medicines to the Netherlands. Similarly, we find Southern European countries exhibit a significantly higher fragmentation in their wholesaling and retailing practices compared to other European countries.
Table 1 Pharmaceutical price structure and distribution chain market structure in selected EU countries, 1997–2002. Sources: Paterson et al. (2003) and European Association of Pharmaceutical Wholesalers (2005)
Table 2 Variables and descriptive statistics
An important feature to note is that we were able to identify the price and volume of each product at any point in time. The dependent variable is the logarithm of imports of statins into the Netherlands. First, we use the basic specification and consider the impact of core explanatory variables such as GDP, population and distance. Subsequently, in line with recent theoretical developments (Egger 2002), we include variables measuring the size of trading countries and other barriers that might explain the development of parallel trade such as distance and exchange rates.
Although the influence of price differences on parallel imports to the Netherlands is consistent with the presence of both the common and regulatory arbitrage; the significance of differences in statutory distribution margins provides cleaner evidence of ‘regulatory arbitrage’. The only downside is that, as reported elsewhere (Kanavos and Costa-Font 2005), some of the gains from parallel trade are invisible because of the incentive structures of different stakeholders are influenced by rebates and informal discounts.
We first report the results of a pooled cross-section specification purely for comparative purposes it as relies on implausible assumptions (e.g., the presence of unobserved heterogeneity resulting from unobserved characteristics related to bilateral trade relationships). Then, we show the estimates of a panel data specification including country-pair “individual” effects, which partially account for the clustered nature of the data and hence, captures some of the existing unobserved heterogeneity. The panel specification refers to a generalised least squares (GLS) model with random effects consistent with the gravity specification outlined above whereby some variables are country-specific (e.g. distance) and does not allow country fixed effects. The interpretation of such a specification is that a country would export different volume of the same product to two other countries, even if their GDPs are identical and they are equidistant from the exporting country. This is due to potential differences in drug regulation, which affect prices and margins, and hence gains from PT.
We then estimate both two stage least squares (2SLS) and two stage generalised least squares (2SGLS) models to account for the endogenenity of price differences and the panel structure of the data. To instrument price differences, we are able to observe the variability in the competitive conditions in the drug distribution in the source country which we do not expect it would affect the volume of parallel traded product though other mechanisms but prices. Specifically, we use the relative number of wholesalers as an instrument for product price at the wholesale level. Given that prices are regulated, one would not expect they would conflate with direct price regulation in some countries (e.g., some countries might have free drug pricing and regulate heavily the margins of pharmaceutical distributors). We test and confirm the existence of endogeneity in the price formation, and the statistical validity of the instrument with the common F-test.
The variables employed in the analysis are presented in Table 2 and are reported as follows: (a) the observed volume of each statin imported into the Netherlands from another EU country; (b) the distance between two countries defined as the Euclidean distance of latitude and longitude between country capitals; the reason for measuring distance in this way rests on the fact that kilometers are not necessarily a good approximation for transport costs given alternative and more direct ways of transportation (e.g. air travel); (c) exchange rate is an obvious determinant of parallel imports insofar as it impacts price transparency (given that not all countries examined are in the euro area and the period examined corresponds to before the euro was introduced), especially in the context of European integration.; (d) following the predictions of a gravity model, our model includes the bilateral sum of country GDPs (in logs) \(\ln \left( {GDP_{it} +GDP_{jt} } \right) \) , as it is conventional in the literature we measure relative country size (in logs), the difference of GDP per capita (in logs), and the sum of statins sales in € (in logs) that is the specific therapeutic group in question which has been growing in size during the study period which were included after testing for colinearity in the regression; (e) furthermore, we consider the point of entry of a parallel imported drug or product presentation. As expected from a model of arbitrage, relative prices between countries (in logs) should be a key determinant, with a negative expected sign. Finally, (g) a set of variables has been added to measure the aggregate number of distributors, which accounts for the degree of competition in the distribution chain in both countries proxied by the relative number of wholesalers in the Netherlands and the exporting country and the (h) relative wholesaler and account for possible economic incentives for parallel trade which are exogenous proxies for regulations.