WINTER 2024 NO.89 / THOUGHT LEADERSHIP BRIEF 2 Pharmaceuticals represent a deep-seated problem in China’s healthcare system. Total drug expenditures increased 17 times from 1990 to 2009 at an annual growth rate of 15.2%. These expenditures used to form close to 50% of China’s total expenditures on health, which is significantly higher than the average level in OECD countries. A dysfunctional drug procurement system was partly responsible, whereby a 15% price markup was allowed in public hospitals. The use of drug commissions in hospitals became commonplace, creating perverse incentives for doctors to overprescribe medication. This resulted in the medical impoverishment of grassroots patients due to high drug costs. This issue sat in sharp contrast to large volumes of sales made at pharmaceutical companies, which in turn were to benefit a few corrupt government officials and hospital administrators, ultimately leading to significant public discontent. ASSESSMENT In 2009 a landmark national healthcare reform vowed to achieve universal and affordable healthcare. The controversial 15% price mark-up on drugs was abolished, and the National Essential Medicines System was implemented to regulate the procurement and use of basic drugs in public medical facilities. In order to promote affordable pharmaceuticals, a two-invoices policy and a centralized procurement system were put in place. THE TWO-INVOICE SYSTEM The Chinese government stipulated regulatory control by centralizing pharmaceutical procurement to the provincial level, through which public hospitals acquired the bulk of their supplies. Unfortunately, there was little evidence that provincial competitive bidding had either increased competition among suppliers or controlled price increases. Too many intermediaries were involved in the supply chain, exacerbating cost inflation. The actual factory exit price barely accounted for 10% to 50% of the retail price on average. Sales-related expenses including kickbacks and commissions offered to doctors, intermediary agencies, hospitals, and sales representatives used to account for 30% to 70% in the cost structure of pharmaceutical companies that in turn created disincentives for innovation. Building “an appropriate pharmaceutical supply system” was envisioned as a key policy objective in the national healthcare reform. Inspired by a local experiment in Fujian, the State Council officially adopted the “two-invoices” system in 2016. This system, designed to streamline the distribution chain, allows only two invoices to be issued in the procurement process: one by the pharmaceutical manufacturer and another by the distributor. By cutting out many of the previous intermediary agents, the cost of drugs fell rapidly. This policy led to a new ecology for the pharmaceutical supply chain in China. Fujian Province was the first to implement the two-invoices system and witnessed a significant decrease in the number of pharmaceutical wholesale enterprises from 375 in September 2014 to 272 by the end of 2015. Large enterprises started to hold even larger market shares. Retail sales for the top 10 pharmaceutical enterprises in Fujian surged to 86.5% in the wholesale market following the introduction of the two-invoices system. NATIONAL VOLUME-BASED PROCUREMENT SYSTEM The launch of the national volume-based procurement system in 2018 by the newly established National Healthcare Security Administration (NHSA) aimed to streamline pharmaceutical procurement at the national level and seek substantial price reduction through centralized bargaining with pharmaceutical manufacturers. The vast quantity of national-level procurement gave the NHSA enormous bargaining power while companies were able to secure significant sales volume. Both original branded drugs and generic ones were included in the procurement program, and price was considered the most critical factor in purchase decisions. By the end of 2023, the NHSA had completed 9 rounds of procurement exercises for 374 types of drugs, saving over 500 billion yuan for health insurance funds. Table 1 below exhibits the details of the exercises, while their effects on drug prices are shown in Figure 2. Notably, 96% of the products procured are generic drugs.
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