Medicines parallel trade in the European Union: a gravity specification

While recent research has explored the phenomenon of drug parallel trade in regulated environments such as the European Union (EU), or the European Economic Area, little is known about the mechanisms that explain its origin or the role of the distribution chain in exporting and importing countries in determining its extent. By building on theoretical literature explaining the role of the distribution chain, this paper draws on an empirical specification of a gravity model to examine the determinants of inter-country flows of parallel-traded drugs. In this context, the paper deals with the effect of differences in the regulation of and competition in the distribution chain in the countries of origin and destination. The paper draws on proprietary data from the Intercontinental Medical Statistics database (for the Netherlands and other EU countries that export to the Netherlands) which identify the country of origin of parallel-imported medicines from 1997-2002 for a therapeutic group (statins) for which there is no generic competition. The study reveals that although parallel trade is a specific form of arbitrage, it is primarily a regulation-induced phenomenon. As a result, although the driving force for parallel trade is price differences across countries, the propagation mechanism lies in (a) the way drug prices are regulated across countries and (b) fragmentation and the underlying incentive structure in the wholesale distribution chain in countries where drug prices are regulated. The implications that flow from our study are that a more flexible and competitive and less fragmented (along national borders) distribution chain, particularly at wholesale level, might reduce the extent of and potential for parallel trade.