Protecting price discrimination in the wake of medical tourism

Price discrimination occurs when a firm sells the same good or service to different consumers at different prices, and where those different prices do not arise from differences in cost to the firm. The firm price discriminates by selling the good or service at a low price to consumers that have relatively elastic demand (those that are very responsive to a change in price), while selling the same good or service at a higher price to consumers that have relatively inelastic demand (those that are less responsive to a change in price).

A good example of price discrimination is in the market for pharmaceuticals (which I've written about before), where firms sell the same drugs in different countries for different prices. In lower-income countries, they typically sell the drugs at lower prices than they do in higher-income countries. Unsurprisingly, those that require the drugs respond to these incentives, as Alex Tabarrok noted last week on the Marginal Revolution blog:

In our principles textbook, Tyler and I open our chapter on price discrimination with the following:

"After months of investigation, police from Interpol swooped down on an international drug syndicate operating out of Antwerp, Belgium.  The syndicate had been smuggling drugs from Kenya, Uganda and Tanzania into the port of Antwerp for distribution throughout Europe.  Smuggling had netted the syndicate millions of dollars in profit.  The drug being smuggled?  Heroin?  Cocaine?  No, something more valuable, Combivir.  Why was Combivir, an anti-AIDS drug, being illegally smuggled from Africa to Europe when Combivir was manufactured in Europe and could be bought there legally?

The answer is that Combivir was priced at $12.50 per pill in Europe and, much closer to cost, about 50 cents per pill in Africa.  Smugglers who bought Combivir in Africa and sold it in Europe could make approximately $12 per pill, and they were smuggling millions of pills."

Instead of smuggling the drugs to Europe, it’s also possible to send the European and American patients abroad. Gilead’s Solvadi, for example, is a very effective drug used to treat hepatitis C. In the United States a course of treatment costs about $85,000 but due to an agreement between Gilead and generic manufactures in developing countries, in Egypt, India and much of the developed world it can be had for less than $1000.

There are several conditions that need to be in place in order to practice effective price discrimination:

1.  Groups of customers that have different price elasticities of demand (heterogeneous demand);
2. Different groups of customers can be identified; and
3. No transfers across submarkets.

When consumers (as medical tourists) are able to travel across borders from higher-income countries to lower-income countries in order to obtain their drugs at a lower price, that violates the third condition and means that price discrimination becomes ineffective (at least, for those consumers that can afford to travel across borders). The last thing you want as a price discriminator is the high-price consumers buying at the low price (or buying from the low-price consumers who are on-selling the product). You'd expect the pharmaceutical firms to act to stop this, and indeed that is what has been happening, as Tabarrok notes:

To prevent resale Gilead requires ID and it labels and tracks every bottle sold abroad:

"[Patient IDs] will be used to put an identifying barcode on the bottles they receive with their name and other info. Not only can the code be used to guarantee only residents of the country get the drugs…the provisions require that patients then return a bottle to get a new bottle and allows them to get only one bottle of their prescription at a time, even though allowing them to get multiple bottles could “ease the burden on patients and health providers,” MSF says."

It's not clear to me how labelling and tracking every bottle sold effectively prevents cross-border sales, unless combined with something else like strict residency requirements (such as those noted in this article). For example, perhaps you have to be a resident of the country you are purchasing the drugs in, or else you have to pay the U.S. price. That would prevent the transfers between the submarkets. Unless, you know, the high-income person pays a low-income local resident to get the drugs for them? That might work in some instances, and it's not clear how the drug companies could effectively combat it.

Price discrimination is hard, but as evidenced by the pharmaceutical companies, enormously profitable even if you can't get it perfectly right.