The welfare impact of parallel imports: A structural approach applied to the German market for oral anti-diabetics

The controversial welfare effects of parallel trade in pharmaceutical markets have been critically debated in health economics and policy in the last few decades. The core of this policy debate is the tension between incentivizing long-run innovation into new drugs and achieving price reductions that directly or indirectly benefit consumers in the short-run. We investigate the welfare impact of parallel imports using data on the German market for oral anti-diabetics between 2004 and 2010. With a large panel data set from IMS Health containing monthly information on sales, ex-factory prices, and further product characteristics for 700 anti-diabetic drugs sold in Germany during the sample period we estimate a structural model of demand and supply. The demand model is a two-stage nested logit where the upper-nest corresponds to the chemical group (ATC 5) and the lower-nest corresponds to the active substance (ATC 7). Based on an oligopolistic model of multi-product firms, we then recover the marginal costs and mark-ups and finally evaluate the effect of the parallel imports' policy by calculating a counter-factual scenario without parallel trade. We obtain estimates of -7.6 for the mean own-price elasticity and estimates that range from 1.5 to 0.005 as mean cross-price elasticities. Marginal costs and, accordingly, mark-ups are between 5% and 65% depending on the specific chemical group. Using these estimated demand- and supply-side parameters, we then simulate the new equilibrium prices, market shares, and changes in demand-side surplus and producers' variable profits that would result if parallel trade was not allowed. According to our estimates, parallel imports reduce the prices for patented and generic drugs by 39% and 0.05% respectively. This amounts to an increase in the demand-side surplus by Euro 11.4 million per year which is relatively small compared to the market size of around Euro 570,470 million. Manufacturers of original drugs, instead, lose more than half of their variable profits when parallel trade is allowed and only a small fraction of these rents are appropriated by the parallel importers.