A proposal to establish a state-run company to locally manufacture pharmaceuticals may, at first, sound appealing. After all, local production of pharmaceuticals would provide local jobs, increase expertise, cut dependence on foreign suppliers and reduce transport costs.

After consideration, one has to admit that the South African market is just too small to achieve economies of scale in production. This means prices probably would have to be high and a local state-run manufacturer of drugs would not be able to compete against the already established private manufacturers. And more probably, it would never be able to compete with large multinational companies so exports would be out of the question.

South Africa already has a number of highly efficient generic manufacturers of drugs that meet the international quality standards. It is imperative that these quality standards are met because without them there could be treatment failure or drug resistance and an entire class of drugs could be rendered useless.

To have a state-run company locally manufacture pharmaceuticals, as suggested recently by Zwelinzima Vavi, General Secretary of the Congress of South African Trade Unions, is worrisome. The economic consequences of local production are entirely predictable. A state run company will be a drain on the economy. It will not have the same economic incentive to improve as a privately owned company because there will always be the taxpayers to bail it out. It will predictably ask for protection from more efficient foreign producers, increased trade barriers and continual cash injections (probably under the guise of restructuring costs). This will create uncertainty among investors and deter investment in South Africa by international companies who are not only creating jobs but also transferring knowledge and skills.

Instead of trying to produce the drugs itself, the government should rather create a better economic environment to attract more international companies, both generic and originator to this country. What is needed is for the government to ensure a sound property rights environment by enforcing trademarks, protecting intellectual property rights, and ensuring that contracts are enforced, so that South African taxpayers do not foot the bill through subsidies.

The registration process conducted by the Medicines Control Council (MCC) should also be streamlined. The MCC is responsible for registering all new medicines and ensuring the efficacy of the drugs on the market. According to recent media reports, the MCC is currently dealing with a backlog of nearly 3,000 medicines that could take it another two years to resolve. Some may consider it necessary to have a regulator to ensure that products are safe, but it is no use if the delays caused by the size of the task prevent life-saving drugs from entering the market. This bureaucratic delay is a major deterrent for manufacturers wishing to invest in South Africa because it reduces the effective life of their patents.

The South African government has already taken a step in the right direction by eliminating all tariffs on pharmaceuticals, thus increasing access to medicines. It should now consider the removal of VAT on all pharmaceuticals if it wants to help the sickest and most vulnerable members of our society more effectively.

The government’s introduction of price controls was a knee-jerk reaction. In the long run, price controls actually reduce access to good quality medicines because they reduce competition, the best means of keeping prices down, and deter companies from registering any new medicines. When prices are set below the market clearing rate, shortages occur. Price controls deter purveyors of good quality medicine, who typically have higher manufacturing costs in order to maintain internationally acceptable quality standards, from entering the market. The controls not only create shortages in the market, but also open the door for counterfeiters and the producers of sub-standard medicines who do not abide by the same manufacturing standards.

The idea of a state-run pharmaceutical manufacturer may be appealing at first but any rational individual, after digging a little deeper, will conclude that the origins of this idea have more to do with politics than economics or the desire and determination to see the best possible medications made accessible to all South Africans.

By Jasson Urbach,  Director of the Health Policy Unit (a division of the Free Market Foundation).