According to the media report, Head of the General Bureau of Anti-Embezzlement and Bribery under the Supreme People’s Procuratorate of the PRC declared on October 31st, 2014, that a total of 11 cases with 11 suspects had been investigated for alleged bribery concerning the former high-level officials of the Price Department of the NDRC. The details of the suspects are as follows: Mr. CAO Changqing, Head of the department for over 7 years, in charge of the adjustment of property prices, oil price, price of pharmaceuticals, and the tiered pricing of electricity; Mr. LIU Zhenqiu, Deputy Head of the department, in charge of price of electricity and pharmaceuticals, who replaced Mr. CAO as the Head of the department in May; Mr. ZHOU Wangjun, long-time Deputy Head of the department, in charge of price of pharmaceuticals. Mr. GUO Jianying, Head of the Office of Pharmaceuticals of the department, who was also a deputy inspector of the department. Mr. LI Caihua, former Head of Office of Price of Electricity under the department, who was promoted to Deputy Head of the department.
Four of the five former officials were in charge of the pricing of pharmaceuticals, and three in charge of the pricing of electricity. It makes us wonder when we take into account the fact that another six government officials from the National Energy Administration were sacked. This illustrates that the alleged crimes of these former government officials were involved with pharmaceutical business, and the pricing system. Therefore, they touched upon an important problem of the healthcare system, the pricing system, and the reforms in these two systems.
On April 6th, 2009, the CPC Central Committee and the State Council issued the Suggestion on Deepening the Reform in Pharmaceutical and Healthcare System that started the new round of reforms in this area with a goal to complete and improve the system and to establish a basic institution that encompasses residents of the rural and urban areas, which would solve the issue of inadequate and overly expensive medical service. On November 13th, 2013, the Decision of the Central Committee of the Communist Party of China on Some Major Issues Concerning Comprehensively Deepening the Reform further clarified the direction and tasks on this matter as Article 46 of the Decision stipulates comprehensive and detailed guidance to “proceed with a comprehensive reform in medical security, medical care, public health, and the medicine supply and regulatory system”. To be exact, these stipulations are not only necessary but also correct. As long as these stipulations are followed and undertaken, the reform of China’s medical and healthcare system would be successful, and the concerns of the citizens would be solved.
Then, let’s take a look at the reality. Even though the government has proposed to establish and enhance the healthcare service institutions of the basic level, complete and improve a proper tiered medical treatment model, and promote the vertical mobility of quality medical resources, yet as the medical resources allocation is still over concentrated and heavily imbalanced with huge gap between the rural and urban areas, it is very common to see that there are much less patients at low-level medical service institutions and a lot more at big hospitals where two to three minutes of service time is commonplace. The government also proposed to speed up the reform of public hospitals, and to establish a scientific evaluation system and a set of institutions for education and training of professionals and salary system that suits the industry. However, it is astonishing as we witnessed the commercial bribery case involving GlaxoSmithKline and the corruption cases in the pharmaceutical business. Even though it is openly stated that government’s obligations should be implemented,[Page] and between 2008 and 2012, a total investment of over 2 trillion RMB was made by the government in healthcare, it is a shame that this investment was most completed utilised as it was designated, but it ended up in the pockets of corrupted government officials. Individual spending on medical resources is still skyrocketing. We have already established the institution for basic medicines and the division between medical treatment and pharmaceuticals with the cancellation of the medicine-supplementing-medical-treatment mechanism, however, it has become a normal phenomenon that the price of medicines is distorted, with some over expensive and manipulated, and the institution of basic medicines has also become corrupted. The government also proposed to improve the strategy and mechanism of traditional Chinese medicine(TCM), but under the existing system, there’s a crisis for TCM as traditions and methods are deteriorating and the some TCM prescriptions do not have effect. China’s export volume of TCM has been surpassed by South Korea and Japan. It is apparent that the reform of China’s healthcare system has deviated.
How does this take place? The criminal cases of the five former officials in charge of pricing may shed some light upon the reasons. It was in 1999 that China began to adopt a pilot plan of concentrated bidding for medicines. For the regulated medicines, the lower the bidding price is, the higher the profit margin is for hospitals. This policy did not manage to eradicate the conventional medicine-supplementing-healthcare mechanism, but the prices for medicines has been steadily decreasing at a margin of 20%, which benefited the citizens in general. However, as it is not reasonable to regulate the highest price for medicines, Mr. GAO Qiang, a former official from the National Health and Family Planning Commission(NHFPC), claimed that “if you take a serious look at the price of medicines, even though there have been rounds of increases, the prices never surpass the regulated price. That is to say, no matter how expensive the medicines are, they are legal.” And another Mr. LIU Zhenqiu spoke to the press that, “there is not much room for price increase due to multiple adjustment of the regulated price of medicines.”
In 2006, Mr. LIU Zhenqiu and Mr. GUO Jianying, along with their fellow officials, adopted a new policy that regulated the increase rate of price of medicines in the name of solving the problem. This policy regulated the increase rate of 15% and a zero price different mechanism, which interrupted and damaged the system and norms of the production, sales, prescription, and usage of medicines. The increase rate of 15% refers to a 15% increase of price on the basis of the procurement price by the hospital; and the zero price difference mechanism refers to the mechanism that forbids the hospitals to further raise the price for sales. This regulation seems to have prevented hospitals from arbitrarily raise the prices for medicines. However, let’s take a closer look. The key to the problem is the procurement price of medicines. Suppose three companies produce one medicine at three different prices, RMB 10, RMB 20, and RMB 30. Under the existing mechanism, the sales prices for this medicine by the hospital will be RMB 11.5, RMB 23, and RMB 34.5 respectively. In the current system, it is easy for hospitals to procure this medicine at a price of RMB 30 from one of the three companies. This sends off a very strong signal for pharmaceutical companies that they should raise the price of medicines in order to make a profit and to compete in the market.[Page]
However, the price of medicines is under the regulation of the Price Department of the NDRC. Therefore, this set of institutions and policies have become the instrument for government officials to fulfil the purpose of rent-seeking, which in turn interrupts the order for the industry and for the market. As a result, medicine manufacturing companies do not compete in terms of quality, low cost, and innovation, but they begin to take efforts in public relations and bribing government officials. These government officials are not only the subject of rent-setting and rent seeking, but they are also the object of the public relation campaigns. The reason why it is so is because these government officials are deluded to believe the pharmaceutical companies will crawl under their feet and make contributions to them. According to some source, the pricing of a certain type of medicine will cost an average PR cost of some RMB10 million. It is therefore not surprising that government officials in medicine-related departments get rich easily. However, this is just the first step.
As the price of medicines is the lifeline for manufacturers, after they bribe the government officials and get their high price of medicine approved, they obtained a gold mine. Now that the price of the medicine is high, what they need to do is to sell the medicine. So the manufacturers will use a part of the overdue price to bribe the executives and procurement staff of the hospitals in order to win the bid for medicine procurement. This is the second step.
The third step is prescription of this medicine after selling it to the hospitals and give cutbacks to the doctors. As there is an information asymmetry between the doctors and the patients, many patients will naturally think the expensive medicine is good. Therefore, it get popular to buy expensive medicine. This information in turn gets back to the manufacturers, which completes the closed cycle of a twisted price and product system. The root reason for this twisted system is the government officials, and now it is a shame that we have to depend on these government officials to push forward reforms in this industry.
These are the routine steps for GSK and many other pharmaceutical companies, this is also the story and logics behind the regulation of medicines and prices. Therefore, we see that the price of medicines is raised, and the corruption and bribery behaviours are springing out: cutbacks for doctors account for a very high proportion of the retail price of medicines. Sales revenue of GSK in 2012 in China amounted to RMB 7 billion, and a modest estimation of the amount used for bribery amounted to 20% to 30%. In Zhangzhou, Fujian Province, there were 73 public hospitals involved in this case, a rate of 100%, including 95% doctors, and the amount for bribery accounted for 50% of the sales revenue of medicines. On this rate, as public hospitals nationwide procure medicines for almost a trillion RMB every year, the amount for cutbacks can approach RMB 500 billion, which is incredible. This phenomenon has resulted in the deterioration of ethics and honesty of government officials, manufacturers, hospitals, doctors, and patients, which is a huge price. [Page]
Now that some of the former heads of the Price Department have been sacked, but the system is still functioning. When new officials take office, they will most likely follow the old path. This problem cannot be solved by the General Bureau of Anti-Embezzlement and Bribery under the Supreme People’s Procuratorate of the PRC.
What we can learn from the incident of the five former government officials in terms of reforms of the pharmaceutical industry and in terms of the price system are multi-faceted.
Firstly, price is the most important mechanism and signal of the market economy. Once the price is twisted, the relations between and the behaviours of the market subjects will be interrupted and guided to a wrong direction. Therefore, to quote the late economist Professor SUN Yefang, the profit is to the management of the enterprise is what the nose is to a cow, and the price is the baton to the market economy. It is of critical importance to determine the price. Whoever handles the baton will be able to handle the market, and pricing is of key importance. Therefore, in the market economy, the price can only be determined by market competition. Whoever controls the market is violating the law. When enterprises control the price, they form a market monopoly. When the government controls the price, it forms an administrative monopoly. And these two kinds of monopolies should be avoided. Therefore, two things can twist the price, one is the government power, and the other is market monopoly. So, when the government controls the price, anti-market monopoly does not make much difference.
The government distorts prices by price regulation. Even when the government controls the price of public goods, including public utilities, it has to take into account the supply and demand and the market. It also has to hold public hearings instead of leaving it to government officials. Even for the regulation of medicines and healthcare services, what the government can control is the approval of new medicines and the price of new medicines, which should neither be approved by the department heads, but by a commission of experts.
Secondly, after thirty years of reform of the price, people begin to think that the price for medicines have been totally liberalised. However, the sacking of the five government officials served as a reminder. The price of medicines is not open, neither is the price to electricity, petroleum products, and many other commodities. The pricing power of these commodities is controlled by government officials who are the real decision maker of the manufacturing, circulating and using of the commodities. They are the real manipulator of the market. No wonder people call the Price Department of NDRC the “No. 1 Department in the World”.
If the price of medicines are liberalised, then manufacturers will focus on the market, instead of the government officials, and produce high quality low price medicines. They will compete in the market and win with the best medicines. By doing so, the government officials in the Price Department will be out of jobs, and the No.1 Department in the World can be canceled. In fact, as China has chosen the market economy, it does not make much sense to have a price department. The five corrupted officials have proved this. The first thing to do is to cancel the price department if we really want to promote the reforms of the healthcare industry and the prices. Taking into account the six sacked officials in the Energy Administration and Mr. LIU Tienan who’s in charge of investment, the NDRC also needs to limit its power, reform and transform its system. It is necessary to cancel and limit the powers of the departments that control manufacturing, investment, and price, and enhance departments like anti-monopoly, and those in charge of food and drug security. [Page]
What’s more, the biggest success of China’s reform is the implementation of dual-track system, however, the biggest failure is the limitless expansion and continuous implementation of the dual-track system. Not to mention the dual-track system in the political and economic sphere, or with the state-owned enterprises and private enterprises, the dual-track system in the prices of commodities and with the factor prices, especially the dual-track system in the financial area, has greatly suppressed the cost of production, which severely distorted the market signals, resulted in serious mismatch of resource allocation and huge imbalance of the economic structure.
Is it so hard to undertake the reform of prices? No. Will there be chaos when the market determines the price? Will the economy collapse? No. These presumptions are made up to pose obstacles for pushing forward reforms. The failure of the price reform in 1988 and the success of the dual-track price system in 1991 for most commodities have proved that human manipulation does not work. The right thing to do is to open the market and let the market determine the price.
The real problem here is that once the market determines the price of commodities, it will be impossible for government officials to intervene and control the resources, and therefore, the economy. It will then be very difficult for rent-seeking. However, when the factors are marketised, the market will determine the allocation of resources, and the most important statement of the Decision of the third plenary session of the 18th Central Committee will be implemented in its full meaning, that is, to let market have the dominant role in the economy. This is not to say that there will not be any risks to open the price of the factor market. There will be risks, but they are not unmanageable. The mistake of the 30 years of reform is the stagnation of the factor market. In order to avoid and manage risks, an incremental approach is favorable. As long as there is a process of opening the market of factors, one by one, step by step, there will not be any problem that cannot be solved.
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