INTRODUCTION

More than ever before, public health policy is required to articulate with economic, trade, and intellectual property policies (1). Nowhere is this more evident than in the case of prescription drugs, which are central to the provision of medical care and public health. National governments now formulate pharmaceutical policies in the context of a globally integrated industry that has unprecedented influence within international organisations such as the World Trade Organisation (WTO), and a heightened capacity to demand and expect a role in shaping pharmaceutical regulation. This influence is gradually reconfiguring the central institution of Australia's pharmaceutical regulation, the publicly funded Pharmaceutical Benefits Scheme (PBS), towards meeting Australia's international commitments. Edged forward by an insistent industry and increasingly accommodated by a sympathetic government, the imperative of "innovation" is steadily subordinating equitable access to safe and proven medicines – the historical focus of Australia's regulation. The interrelatedness of pharmaceutical markets and the dominance of the industry by a few multinational firms bearing the will and capacity to globally harmonise national regulations in their favour makes what happens in Australia of interest to all countries with publicly funded pharmaceutical benefits programmes.

Regarded as the predicate of growth – the sacred dynamic of all contemporary economies, innovation has become the primary conceptual device used by critics to push for reform of Australia's pharmaceutical regulatory arrangements, in particular the use of price control. While Australia represents only a tiny fraction of the global pharmaceutical market, its drug pricing regime has been an exemplar of national autonomy in setting public health priorities and a model for governments seeking to constrain drug expenditure (2). As such, multinational pharmaceutical companies view Australia's pharmaceutical regulation as an obstacle to the goal of globally elevating trade and intellectual property imperatives over public health. Substantial change to Australia's price control regime, an undisguised objective of industry, has international public health implications (3).

In this paper, we briefly consider the increasing salience of innovation in the debate for reform of the Australia's pharmaceutical regulation. The established standards of Australian pharmaceutical policy – the strict evidence-based approach to achieving the core objective of efficiency (4) – has made Australia's pharmaceutical regulatory process virtually unassailable on scientific/rationalistic criteria. With innovation, the predicate of growth arguments for reform based on it gains new, economically rational, leverage. Claimed by critics to inhibit innovation, the PBS' pricing regime runs counter not only to the interests of an industry dependent on it for competitive advantage but also to the predominant national aspiration. We argue that in a political environment increasingly geared toward securing economic development, the appeal to the logic of innovation has become a particularly useful route for forcing policy change.

AUSTRALIAN PHARMACEUTICAL POLICY

For over 50 years, the imperatives of equity, cost-containment, and efficiency have dominated Australia's pharmaceutical regulatory system. Like the majority of industrialised nations, Australia utilises price control to manage pharmaceutical expenditure (5). In Australia, price control is imposed through the PBS, making it the regulatory institution central to the state-capital interaction in the pharmaceutical sector (6). The PBS is a universally accessible national formulary that covers approximately 90% of prescriptions available in Australia and subsidises around 75% of the prescriptions used (7, 8). Universal pharmaceutical insurance through the PBS means that Australians have been comparatively protected from high drug prices. Australia's drug prices are lower than almost all other OECD countries (8, 9). As one of Australia's few remaining universal welfare systems, the PBS holds broad public support and is widely regarded as an electorally sensitive institution.

Universal prescription insurance has meant that to maximise Australian drug sales, manufacturers have little option but to have their product listed on the PBS. The listing process requires that manufacturers receive quality and safety approval by the Therapeutic Goods Administration (TGA), safety and efficacy approval by the Australian Drug Evaluation Committee (ADEC), and cost-effectiveness evaluation and approval by the Pharmaceutical Benefits Advisory Committee (PBAC). Following the decision to list the drug, the Pharmaceutical Benefits Pricing Authority (PBPA) uses the PBAC's advice on cost-effectiveness and evaluates the manufacturer's requested price against an international benchmark price for drugs in that class.

Currently, and historically, the most contentious element in this process is the cost effectiveness evaluation by the PBAC. Legislation requires the PBAC to base its recommendation on a pharmacoeconomic comparison of the "effectiveness and cost of a drug proposed for listing against an alternative from the relevant therapeutic class". If the proposed product is "substantially more costly" than the selected comparator in its class, it will not be recommended by the PBAC for PBS listing unless it provides a significant improvement in efficacy or safety over currently available therapies. Referencing the price of the proposed drug to the lowest cost therapeutic alternative (including existing generic products in a therapeutic class) restricts the listed price of a new drug that performs no better than currently available products. Industry claims that this does not reward "incremental innovation" – small advances that, over time, provide greater acceptability or convenience, but are difficult to demonstrate in the interim using the traditional clinical trial methodology. In defending higher prices for "breakthrough" products companies must demonstrate an acceptable incremental cost-effectiveness ratio (the additional cost for an additional beneficial effect, or Quality of Life Years (QALY) gained). Historically, the PBS does not list drugs whose comparative effectiveness is low relative to their cost (10).

For Australian governments, the monopsony (single buyer) power conferred by the PBS has allowed them to successfully counter the monopoly rent power of patent holders (11). This bargaining power, coupled with the strict application of evidence-based principles and administrative innovations (such as channelling of treatments to specific categories of patients and the use of price volume trade-offs), has delivered notable value for money 8, 12, 13, 14). For manufacturers, however, the PBS' squeeze on return for innovation in the Australian market is compounded by the fact that its success has seen it become a model for other governments seeking to limit pharmaceutical expenditure (2). Unable to seriously challenge the PBS on value-for-dollar efficiency, industry has turned to its contribution to innovation as an avenue for criticism and change.

PRICE CONTROL AND DRUG INNOVATION

Drawing on a long tradition of criticism of pharmaceutical price control per se (see, e.g., Calfee 2000, Danzon 1997) (15, 16), critics of Australia's pricing regime argue that cost-containment (and reference pricing in particular) makes it difficult for innovative drugs to enter the Australian market, and that Australia's pricing regime can only be sustained by opportunistically free-riding on the research and development spending of other nations (especially the US). Critics argue that price control systems such as the PBS are anti-intellectual property, anti-competitive, and anti-trade; that they create a regulatory environment hostile to investment and innovation and may eventually precipitate a withdrawal of international manufacturers from the sector to more favourable regulatory environments 2, 17, 18, 19). Further, it is argued that at a time when the global pharmaceutical industry is undergoing profound change, Australia's rigid adherence to cost containment will deny it the opportunities for growth that this change represents (20, 21, 22, 23).

It is widely accepted that the global pharmaceutical industry is undergoing a period of profound structural change. This change is in response to a number of major developments, most importantly the declining productivity associated with the "blockbuster" drug pipeline, advances in the life sciences and genetics that are transforming the drug discovery process, and an increasing focus among regulators on cost containment (24, 25, 26). The era of spectacular growth in the pharmaceutical industry underwritten by rapid and successive introduction of blockbuster drugs (single drugs applicable to large population diseases – cholesterol-lowering agents for example) appears to be waning. The majority of the blockbusters will come off patent by 2008 and the markets for existing blockbuster drugs are crowded with competitors. The likelihood of discovering new blockbuster drug markets is diminishing and drug research and development is increasingly difficult and expensive (26, 27 and 28). A less fruitful drug pipeline means declining productivity, lower expectations for new drug revenues, and consequently diminishing market valuation of pharmaceutical companies (29). Redressing the productivity "gap" is the most important task facing the pharmaceutical industry (26).

With the viability of a growth strategy centred on the blockbuster drug highly uncertain, the pharmaceutical industry is turning towards new technologies as a vehicle for future growth. Significant basic advances in areas such as molecular biology, cell biology, biochemistry, and genetics, together with the advent of new drug discovery technologies, such as genomics and proteomics, have significantly transformed the product, process and organisation of drug research and development (30). New biotechnology-sourced products differ from the large population-applicable blockbuster drugs being potentially more individualised, with efficacy more selectively targeted at smaller patient populations with specific genotypes (26). The emerging discovery paradigm of biotechnology-sourced therapeutics imposes new organisational imperatives. The long-established in-house drug discovery process of the large (vertically integrated) pharmaceutical firms has given way to a more complex and dynamic network of alliances with smaller specialist start-up companies, public research institutes and contract research organisations (31).

Alliances allow the large established pharmaceutical firms to access the new biotechnology products – both therapeutic drugs and intermediate "platform" technologies (technologies used in support of the drug discovery and development process, e.g. bioinformatics) developed by the smaller specialist firms (21). In light of the declining productivity, alliances present important opportunities for the large pharmaceutical firms to generate new products and improve the efficiency of the discovery process. For the smaller start-up biotechnology firms, alliances with the pharmaceutical companies provide access to the investment capital necessary to develop their innovative technologies. The growth in the number of alliances over the last 15 years attests to the increasing importance of this mechanism as a means of stimulating and sustaining much-needed industry growth. The growth in the formation of such alliances, however, while internationally spread, is heavily concentrated in the US, one of the few industrialised nations without a centralised drug pricing regime (21, 22). For critics of drug price control, this is no coincidence – price control and particularly reference pricing reduces revenues and stifles research and development investment (31).

The conclusion drawn by critics of price control (e.g. Calfee 2000, Danzon 1997) (15, 16) that the correlation of increasing use of price control among industrialised countries and the increased concentration of research and development in the US is a result of the price control regimes is highly contestable (32). A whole host of salient factors other than price differentials may account for the US research performance. The US system is coherently organised around the "nexus" of academia, intellectual property rights, and capital (33). The US is the largest single drug market, its well-developed academic research establishment is complemented by legal conditions that facilitate technology transfer from government-funded research to the private sector, and there is extensive public investment in biomedical research (32, 34). The impact of price control and other forms of regulatory intervention are contingent on the particular national historical and political economic paths of development.

It is difficult to imagine that removal of price control on its own would establish the conditions and competencies necessary to improve Australia's research productivity. Further, the more general point of critics – that price regulation always has an identifiable, negative impact on the capacity to innovate – is difficult to sustain on the historical evidence (33). The UK, for example, is a nation that exercises price control but has continued to be competitive in pharmaceutical and biotechnology innovation (35). The same argument can be applied to several other countries in Europe. The precise empirical impact of price control on research and development continues to be subject to debate (36). However, even if we accept that the impact is negative, it is debatable that allowing the market to dictate prices will necessarily result in truly innovative and important therapies rather more than more imitative "me-too" drugs (37).

AUSTRALIA'S PRICE CONTROL AND RETURN TO INNOVATION

Critics of Australia's pharmaceutical system argue that at the precise moment that the pharmaceutical industry is undergoing a profound and accelerating transformation to structure and strategies, Australia has significantly tightened the PBS pricing regime (18). In doing so, Australia misses opportunities for international investment in its small but significant biotechnology industry.

A recent case study comparing the performance of Australia's biomedical industry with Canada's concluded that Australia was significantly underperforming (27). Australia lags behind Canada on a number of indicators, but importantly Australia is failing to secure alliances of significant value with the most important investors, the mainly US-based pharmaceutical companies. While a number of factors (physical distance and scale among them) may explain this comparative investment lag, the author argues that "the views of large Pharma" about Australia's pricing regime may be acting as an important disincentive (italics added).

That Australia's prices for new drugs are too low appears to have become something of an axiom for critics of Australia's pricing arrangements. At least one well-conducted empirical study of Australia's drug prices has concluded otherwise. The Productivity Commission (2001) (7) examined the differences between manufacturer prices in Australia and seven other OECD countries for 150 of the most prescribed PBS-listed pharmaceuticals. The Commission found that Australian drug prices are considerably lower than United States, Canada, the United Kingdom and Sweden, closer to those in France and about the same as those in Spain and New Zealand. Importantly, price differences varied for different drug categories. The largest price differences applied to "me-too" drugs (and generic drugs). Australian prices for new innovative pharmaceuticals were closer to those in the other countries. The Commission concluded that the PBS pricing regime, may contribute, but cannot itself explain the observed price differences. A combination of factors such as basic differences in health systems and differing market conditions, it was suggested, would better account for Australia's comparatively low drug prices.

Economic modelling has also been used to demonstrate that Australia's pricing arrangements are more favourable to manufacturers than is often claimed or that simple comparisons might suggest. Drawing on a bargaining model of Australia's drug pricing "game", Wright (2003, 2004) demonstrates that manufacturers will make more profit in Australia's regulated system than they would in the absence of price regulation (38, 39). Wright argues that direct comparison of Australian and US drug prices is inadequate to demonstrate the effects of price on demand and resulting profitability. In the USA, unregulated drug demand is governed by market price, in Australia's regulated market demand is governed by the regulated price. To the extent that Australia's pricing regime lowers price, it also ensures profitability by ensuring sales volume through the universally accessible PBS.

It is far from straightforward to demonstrate a uniform negative impact of price control on research and development activity. Equity, as a regulatory objective, is in constant "tension with economic static and dynamic efficiency and claims on either side that no trade-off actually exists are at best difficult to prove theoretically, let alone empirically" (Lacetera and Orsenigo, 2001, p. 42) (33). In terms of Australia's experience, when evaluated in terms of cost-containment, efficiency and equity, the PBS is consistently judged to have performed well (9, 14). The impact of the PBS on company profitability, and research and development activity (the latter being an objective of Australia's National Medicines Policy) is less clear.

Regardless of the ambivalent empirical and theoretical evidence on the relationship between price control and innovation, the strategy of linking low drug prices in Australia to diminished likelihood of future investment in research and development, and to threatened industry viability more generally, is set to continue. Certainly, the desire for reform is undiminished (40, 41). The international status of the PBS as a model scheme for controlling drug prices to achieve equity while containing cost ensures the reform agenda. In the absence of a convincing critique on grounds of inefficiency or inequity, characterising Australia's regulatory arrangements as an impediment to innovation is perhaps the only best strategic option for industry to enable change. The strategic usefulness of innovation is confirmed in its use as the rationale for including pharmaceutical-relevant provisions in the Australia United States Free Trade Agreement (AUSFTA), the first bilateral trade agreement to include measures specifically seeking to change a national pharmaceutical scheme (42).

THE AUSTRALIAN UNITED STATES FREE TRADE AGREEMENT

Although pharmaceuticals are only a small part of the AUSFTA, the lengthy negotiations made it clear that change to Australia's pharmaceutical regulation and price control regime in particular was a central and important objective of the agreement. The relevant provisions of the AUSFTA were widely argued to be necessary to redress Australia's undervaluing of drug innovation and stimulate further innovation and industry development (19, 43). Framed around a set of interpretive principles that emphasise strengthening recognition, reward, and protection for drug innovation, the AUSFTA contains a number of provisions allowing manufacturers greater representation during the PBS listing process and providing for an "independent" review of negative listing decisions. Although the AUSFTA does not ostensibly modify the structure of the PBS, establishing a new set of overarching principles and giving greater representation to manufacturers substantially increases the salience and weight of innovation in the PBS deliberative process.

The interpretive principles, however, are pointedly vague and ambiguous (despite its centrality, even here "innovation" is not defined clearly), allowing considerable scope in interpreting what obligations they create (44, 45, 46). Given Australia's commitment to, and US antipathy towards, reference pricing, there is clearly a potential (if not intent) for ambiguity to result in divergent interpretations. Where differences in interpretations arise, disputes about expectations and obligations are likely to follow (3). The principles and provisions of the AUSFTA represent the "spirit" of the agreement regarding pharmaceuticals – greater recognition and reward for innovation. With innovation, poorly defined but clearly premium, decisions not to list "innovative" new US drugs (on poor cost-effectiveness grounds for example) may be interpreted as a breach of that spirit and potentially provide the basis for a trade dispute. A trade dispute with the US is unlikely to end in Australia's favour (45).

The likely material consequences of the AUSFTA have been subject to considerable contentious debate. Critics argue that the AUSFTA is an increment in the process of regulatory globalisation that, although deeply contingent, has the capacity to erode Australia's sovereignty, leaving governments vulnerable to economic coercion and subordinating Australian to US objectives (42). AUSFTA changes may ultimately weaken the PBS, increase drug expenditure and diminish equity of access to essential medicines (45, 46). There is some evidence that the AUSFTA is already imposing the principle of innovation on the PBS. Changes to the PBS, recently announced by the federal government, represent a clear attempt to modify the system of reference pricing to reward "innovation". Broadly described, the changes create a new category for "innovative" drugs, a category quarantined from reference pricing based on clinical equivalence. In other words, drugs in this new category will maintain higher prices even though they may offer no greater clinical benefit compared with the established alternative treatments. This is a major departure from the evidence-based approaches described above and effectively breaches the spirit of the legislation under which the Pharmaceutical Benefits Scheme operates. By contrast, in seeking to de-link innovation from reference pricing as historically applied in Australia, the changes reflect the spirit if not the letter of the AUSFTA.

The immediate consequences of the AUSFTA, such as a loss of government autonomy within the sector, are uncertain and contingent. However, the precise extent to which the AUSFTA diminishes government autonomy in the sector may ultimately be less important than the extent to which innovation becomes the supreme regulatory objective. The changes to process required by the provisions of the AUSFTA entrench innovation as a consideration in every step of governance of the sector. Ideas and values matter in the shaping and expression of policy (47, 48). Although again contingent and uncertain, the cognitive and normative cogency of innovation and its heightened prominence in the regulatory process may act to subordinate Australia's historical focus on cost-containment and equity. It is far from obvious that policy can successfully achieve the public health objectives of equitable access to safe and proven medicines if it gives greater importance to supporting drug innovation, private sector profitability and expansion.

CONCLUSION

Innovation has emerged as the primary conceptual device in the push for reform of Australia's pharmaceutical policy. Australia's continuing commitment to universal pharmaceutical access and cost-containment demonstrates that reform is far from complete. However, developments such as the AUSFTA show that at a time when private sector growth is essential and public welfare is problematic, characterising regulation as an impediment to innovation is cogent enough to force change. Should innovation come to dominate Australian pharmaceutical policy, there is the potential to precipitate a devaluing of the sectors' public orientation. Requiring the PBS to stimulate or sustain private sector growth is problematic for a scheme committed to universal access. If this were to happen in Australia, an important and successful model of pharmaceutical provision where public health is paramount would be lost to the international community. It would also sound a clear warning to all countries that operate publicly funded pharmaceutical benefit programmes that make extensive use of evidence-based reference pricing as a cost-containment mechanism.

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About the authors

Dr. Evan Doran, Ph.D. is a social scientist and currently a research fellow with the Discipline of Clinical Pharmacology.

Professor David Henry, FRCP is a conjoint professor of Clinical Pharmacology at the University of Newcastle.