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Date Posted: 22:49:22 08/04/06 Fri
Author: Brian Woodall & Aki Yoshikawa (Draft completed: March 1997)
Subject: Japan's Failure in Pharmaceuticals: Why Is the World Saying "No" to Japanese Drugs?
In reply to: A PRIMER ON US CRIMINAL ANTITRUST 's message, "American Antitrust Institute Web Resources" on 22:42:17 08/04/06 Fri

Japan's Failure in Pharmaceuticals: Why Is the World Saying "No" to Japanese Drugs?

Brian Woodall Georgia Institute of Technology

and

Aki Yoshikawa Stanford University

Draft completed: March 1997

I. Japan's Failure in Pharmaceuticals

Driven by a large population and a universal health insurance system, Japan's pharmaceutical market is the world's second largest. Nevertheless, in contrast to Japanese conquests in automobiles, semiconductors, and consumer electronics, Japan's pharmaceutical industry has failed to seize a global leadership position. As with Japan's aircraft industry, the pharmaceutical industry is one of the few high technology industries in which the country runs a trade deficit (amounting to ¥250 billion in 1993). Yet, unlike Japan's tiny aircraft industry, there are a myriad of Japanese drug companies. Japanese drug companies tend to be smaller and less diversified than their American and Western European counterparts. According to 1993 total drug sales, the largest Japanese company, Takeda Chemical Industries, ranked a distant fifteenth in the world. Most Japanese firms focus almost exclusively on the manufacture of pharmaceuticals, and, compared with the leading drug makers in the West, they tend to rely heavily on domestic sales. For example, the 1990 export ratio (the company's export sales as a percentage of total sales) for the seven largest Japanese drug makers was 7.6 percent as compared with 70.1 percent for seven of the largest Western companies. In sum, compared with the Japanese industrial giants that dominate a range of important world markets, Japan's drug companies tend to be small, undiversified, and very domestic.

What explains Japan's failure in pharmaceuticals? Japan's automobile and semiconductor industries adopted aggressive export strategies to promote growth, creating comparative cost advantage by mass-producing standardized products and progressively cutting costs. However, because competition in the pharmaceutical industry centers around innovation and the introduction of new drugs, Japanese pharmaceutical companies have not been able to seize this advantage. On the surface, several factors appear to account for Japan's inability to build a world class pharmaceutical industry. For one thing, ineffective R&D coupled with Japan's relative backwardness in basic science and the subordination of scientists to bureaucrats in scientific policymaking partially explains the inability to develop truly innovative breakthrough drugs. In addition, high-profile scandals involving regulatory mishaps and a reputation for unreliable drug testing have generated skepticism about the ability of Japanese pharmaceutical companies to manufacture and market drugs capable of success in overseas markets.

But these are, we argue, merely the side-effects of a deeply rooted malady. To be sure, the Japanese system has been justifiably lauded for providing universal health insurance at a relatively low cost to taxpayers (Steslicke, 1990; Powell and Anesaki, 1990; Ikegami, 1991; Ikegami, 1992; Ikegami, 1993; Ikegami, and Campbell, 1996; and Campbell, 1995). While conceding that Japan's health care system has many tangible benefits, we argue that there are also many hidden defects. In the case of pharmaceutical industry, the most critical defect derives from a universal fee schedule that dictates the precise amount of reimbursement to providers of medical services and pharmaceuticals. Under the official drug price schedule (yakka), new drugs obtain higher reimbursement prices. The apparent rationale for this policy practice is to stimulate product innovation by setting higher prices for newly listed drugs. In reality, however, this policy provides a powerful incentive for pharmaceutical companies to develop "me-too" drugs solely for the domestic market. Moreover, because Japanese physicians also dispense drugs, drug companies have good reason to supply their products at a price below the official reimbursement rate. This, in turn, gives physicians a pecuniary incentive to prescribe and dispense high-priced drugs that offer a hefty "doctor's margin" (yakka saeki). Thus, we argue that the ultimate cause of Japan's failure in pharmaceuticals derives from perverse incentives deriving from the same regulatory institutions that others have singled out for praise.

In the section that follows, we survey the Japanese pharmaceutical industry and weigh the data relating to drug-related R&D. We also probe inside the drug approval system and examine several highly publicized scandals attributed to shoddy testing and approval procedures. Although reform efforts are underway, government cost containment efforts have resulted in tougher conditions in the domestic market. With their domestic orientation, Japanese pharmaceutical companies are facing stiffer competition and ever steeper challenges to future growth. We briefly explore the implications for policy change and business strategy in the concluding section.

II. A Profile of Japan's Pharmaceutical Industry

Compared with their Western counterparts, Japanese drug companies are small, undiversified, and oriented toward domestic market sales. According to 1993 sales data, Merck and Glaxo were about the twice of the size of Takeda, Japan's largest drug maker. Meanwhile, Sankyo, Japan's second largest drug maker, ranked 18th, while Shionogi, Yamanouchi, Fujisawa, Daiichi, Sumitomo, and Eisai occupied ranks between 26th and 36th in the world. Table 1 presents comparative statistics concerning the world's largest drug makers.

[Insert Table 1 about here]

Japanese companies are less diversified than their American and European counterparts. With the exception of Takeda, more of an integrated chemical company than a mere drug maker, most Japanese firms focus almost exclusively on the manufacture of pharmaceuticals. This is evident in the ratio of pharmaceutical sales to total sales, the so-called "drug ratio." Typical of the situation for Japanese drug makers, companies such as Shionogi (87.5 percent), Yamanouchi (79.7 percent), Fujisawa (87.8 percent), Daiichi (94.2 percent), and Eisai (85.9 percent) all have relatively high drug ratios. The average drug ratio for twelve of the world's 14 largest drug makers (excluding Merck and Glaxo) in 1993 was 48.9 percent. In contrast, the average for seven of the eight largest Japanese companies (excluding Takeda) was 85.4 percent.

The subordinate position of Japan's drug makers in world markets is further witnessed in a list of the world's best-selling drugs. Glaxo's Zantac, with over $3.5 billion worldwide sales, was the world's highest best selling drug in 1993. Among Japan's few global success stories were Sankyo's Mevalotin and Tanabe's Herbesser. It is interesting to note that biotechnology-based products, such as EPO and interferon, have begun to assume more prominent roles in the international market. Yet, as discussed below, Japan has failed to become a major competitor in biotechnology research and development.

[Insert Table 2 about here]

Japan's pharmaceutical companies rely heavily on domestic market sales. As the 1990 data displayed in Table 3 reveal, the export ratio (the company's export sales as a percentage of total sales) for the seven largest Japanese drug makers was 7.6 percent as compared with the 70.1 percent ratio for seven of the largest Western companies. Of course, part of the difference in overseas sales ratios between Japanese, American, and European companies is due to differences in the degree of diversification and product mix, as well as the size of the respective domestic market. This is not to say that Japanese drug makers failed entirely in their efforts to export efforts. For instance, thanks to the domestic and overseas success of the cardiac remedy Herbesser, Tanabe had the highest export ratio among major Japanese firms, although that ratio dropped to 16.1 percent with the expiration of its patent in 1992. Meanwhile, sales of Sankyo's Mevalotin, an antihyperlipedemic, propelled the company's export ratio from 5.3 percent in 1990 to 8.1 percent in 1993 (Yakuji Handobukku, 1995). But the modest export successes of Tanabe and Sankyo are the exceptions that prove the rule about Japanese drug companies.

[Insert Table 3 about here]

With the rapidly increasing cost of developing new drugs, it has become essential to introduce a new drug simultaneously in the three largest pharmaceutical markets: the United States, Europe, and Japan. While a large domestic market partially explains the passive attitude of Japanese companies toward multinationalization, Japan's drug makers -- with the encouragement of the Ministry of Health and Welfare (MHW or Health Ministry) -- made efforts to globalize by establishing overseas subsidiaries during the "bubble economy" of the 1980s. The brief burst of foreign direct investment that followed led many observers, including one of the authors of this study, to predict that Japanese drug makers would soon come to challenge their American rivals as had been the case in automobiles and semiconductors (Yoshikawa, 1989).

To date, however, the Japanese pharmaceutical industry has failed to mount a strong challenge, owing largely to the inability to develop breakthrough drugs. While developing and marketing a breakthrough drug is necessary to gain a foothold in a foreign market, establishing a sustainable overseas market base requires a continuous flow of successful new drugs. Given their track record, there is able reason to doubt that Japan's drug makers have what it takes to succeed in this enterprise.

III. The Proximate Causes

Several obvious factors account for Japan's failure in pharmaceuticals. One set of factors is the domestic obsession of Japanese drug makers and their relatively small and ineffective R&D expenditures. In addition, Japanese drug makers are constrained by the inability to develop breakthrough drugs owing to Japan's weakness in basic science. And a succession of high profile drug scandals have raised doubts about the efficacy and safely of Japan's drug testing and approval process. Let us briefly examine each of these factors.

A. Ineffective R&D

A 1984 report from the Office of Technology Assessment (OTA) predicted that Japan would soon become America's leading competitor in biotechnology (OTA, 1984). More than a decade later, however, we have yet to witness any exciting discoveries of biotechnology-based drugs by Japanese pharmaceutical companies. Why is this so?

Japanese pharmaceutical companies exhibit high R&D intensity yet devote less money to that enterprise than do their American counterparts. In 1990, the average R&D expenditure per sales of the 15 biggest Japanese drug companies was 10.8 percent, as opposed to the 9.3 percent average on the part of the largest American firms. At the same time, the average net profit margin for Japanese companies was 6.1 percent as compared with 15.9 percent for their American rivals. In terms of R&D expenditures as a percentage of sales, Japanese drug companies exhibit higher R&D intensity than their US counterparts. Nonetheless, in terms of actual R&D money spent, American companies outpace their Japanese rivals. In 1990 (at an exchange rate of $1 = ¥135.4), the average R&D expenditure for America's 12 largest drug companies was $603.4 million, while the Japanese firms spent an average of $158 million.

[Insert Table 4 about here]

Between 1975 and 1991, nearly two-and-a-half times more new drugs were launched in Japan that in the United States, a country with twice the population. However, while Japanese-origin drugs commanded a significant share of the domestic market (35 percent), they accounted for less than ten percent of new drugs launched in the major overseas markets. Meanwhile, American-origin drugs accounted for 47.2 percent of new drugs launched in the United States and between one-quarter and one-third in Japan and the major European markets. Relevant data are shown in Tables 5A-C.

[Insert Tables 5A, 5B, and 5C about here]

There is evidence to suggest that Japanese pharmaceutical companies are developing products drugs suited only for the domestic market. Table 5-C displays the ratio of new drugs launched in a foreign market to the number of drugs originated in the country and launched domestically. Even though 384 Japanese-origin drugs were launched in Japan, only about one-in-ten of those drugs managed to be launched in the United States, England, or France. In contrast, American-origin drugs enjoy high prominence in foreign markets. In this regard, the number of Japanese-origin drugs in the domestic market may seriously overstate Japan's competitive strength in the pharmaceutical business.

Using data from the Food and Drug Administration (FDA), Hawkins and Reich found that Japan had more new chemical entities (NCEs) approved for marketing in the United States than did England, Germany, Switzerland, or France (Hawkins and Reich, 1992). They found that, at the beginning of 1990, Japan-originated new drugs constituted about 15 percent of all the NCEs pending FDA marketing approval and that there were more than 70 Japanese-origin compounds in various stages of clinical development. Nevertheless, in the pharmaceutical business where a few super drugs dominate the market, the number of NCEs alone cannot predict future success. In this regard, it is significant to note that there were no biotechnology-based products among the sample of NCEs assessed in the Hawkins and Reich study. Inasmuch as the Japanese government explicitly targeted biotechnology as a strategic technology and sponsored various joint research projects to promote its development, this result surprised many observers.

This may suggest that Japanese style government-led joint research program may not function effectively in biotechnology research. In the Very Large Scale Integrated Circuit (VLSI) Project VLSI project, a handful of companies were invited to participate in the government-led joint research association that successfully developed technologies necessary for production of the final product. The companies involved in the VLSI project cooperated to the extent that they shared process technologies, some of which were eventually patented. Yet there is little incentive to cooperate by sharing technologies relating to the development of biopharmaceutical products. Indeed, innovations in biotechnology and pharmaceuticals rely on breakthroughs in basic science, rather than on a learning process based on the accumulation of know-how. In electronics and machine-related technologies, innovation is made possible by the combination of various technologies. In biotechnology, the main manufacturing technology is in a self-contained process. In fact, patents in biomedical research make cooperation among different companies difficult. This motivational problem may account for the failure of joint biotechnology R&D in Japan.

B. Weakness in Basic Science

Japan's weakness in basic science is another factor behind the failure in pharmaceuticals. In the United States, drug companies have close links with universities where basic research is conducted, and the growth of biotechnology-based start up companies has been closely associated with industry-academia interaction. In addition, federal funding supports basic research and training: In 1990, the federal government funded almost $10 billion in health-related R&D, while the National Institute of Health (NIH) provided 35 percent of total outlays for health-related R&D. The NIH supplied nearly $110 million for human genome related research, while the Department of Energy provided an additional $60 million. Meanwhile, the Japanese government's support for basic science is much more limited, and, owing to a lack of capital investment, the research infrastructure at many Japanese universities is clearly second rate. Whereas the US government funds approximately one-half of the nation's R&D, the Japanese government funds less than one fifth. On this score, Japan has been criticized for free-riding on America's efforts in science and technology (Sun, 1987).

Another reason for Japan's weakness in basic science may be owed to the fact that scientific policy making is controlled by bureaucrats who engage in perpetual turf wars. In fact, battles to control scientific policy turf frequently pit the Ministry of International Trade and Industry, the Health Ministry, and the Ministry of Education. Meanwhile, the Science and Technology Agency, the would-be coordinator of such policy, does not have enough political firepower to impart a coherent vision to policy making. In this regard, Robert Cook-Deegan, who directed an OTA study of human genome research, was able to observe the bureaucratic chaos in Japan's genome program. He found that Japanese

biologists knew of their sorry state in comparison with their industrial counterparts and wished for a bigger slice of the national economic pie. Policy was dominated by bureaucrats and industrial interests only slowly learning the connections between science and technology, quite distant from the science base. The difficulty of forging a coherent plan was made clear by the proliferation of bureaus mounting genome projects. For scientists in Japan, the future might be bright, but it seemed a long way off . . . . [American] scientists identified an objective for the genome project and quickly persuaded Congress and federal science agencies to use public resources to attain it. In Japan, scientists appeared to wield far less direct power over the agencies that funded their work. The federal agencies in the United States controlled the lion's share of funding for basic biology research; in Japan, the anemic government support for basic research left more uncertainty about the future character of genome research (Cook-Deegan, 1994, pp. 226 and 229).

[Insert Table 6 about here]

In 1995, as part of an effort to catch-up in genome-related research, the Japanese government by provided public funds and invited specific companies to participate in two joint R&D corporations. According to a report published in the Nihon Keizai Shinbun (23 October 1995), approximately ¥70 million will be invested over a period of seven-years in the Helix Research Institute, a MITI-sponsored joint research corporation. Some 70 percent of the Institute's funding will be provided by the Basic Technology Center utilizing a public fund made available from the sale of Nippon Telephone and Telegraph stock. The remainder of the funding will be shared by participating firms, such as Yamanouchi, Hitachi, Mitsubishi Chemical, Toray, and Kyowa Hakko. In addition, the Health Ministry announced plans to establish its own cooperative genome corporation, tentatively named Genome Pharmaceutical Science Corporation. Half of the funding for that project -- approximately ¥40 million over a seven year period -- is to be provided by MHW's Fund for Adverse Reaction Suffering Relief and Research Promotion with the remainder coming from participating companies.

C. Flawed Testing, Peculiar Drugs, and Drug-Induced Tragedies

Japan's failure in pharmaceuticals cannot be attributed to the absence of regulation. Before a drug can be manufactured or sold in Japan, approval must first be obtained from the Ministry of Health and Welfare. The MHW decides on the approval of new drugs based upon the recommendation by the Central Pharmaceutical Affairs Council. The actual task of screening and evaluating test data is the responsibility of the 15 medical and pharmacological specialists who compose the Council's New Drug Screening Subcommittee. The Committee meets approximately twice each month to evaluate test data, but does not conduct hearings to obtain additional information from manufacturers. Instead, applicants are informed of the Committee's opinion and of any requirements to submit additional data. In the event that additional data is required, an applicant must prepare a new submission and repeat this costly, time-consuming process.

Prior to authorizing the manufacture, importation, or sale of a drug, the Health Ministry determines whether the facilities and equipment of the manufacturing facility or sales office meet the required standards. An approval is an official recognition that a drug is considered both effective and safe. A license certifies that establishments producing or importing the drug meet appropriate safety and manufacturing standards, and that their board members are legally able to serve in that capacity. It is well to note that, under Japan's universal health insurance system, a drug will not be prescribed by doctors unless a reimbursement amount is listed on the official drug price schedule. Approved drugs are re-examined every six years (or, in some cases, every four years). Companies that discover previously unknown and potentially harmful side-effects are required to report them to the MHW within one month. These reports are reviewed by the Central Pharmaceutical Affairs Council, which is empowered to order revisions in product information as well as changes in dosage and duration of use. In extreme cases, MHW is empowered to recall a product or to order a halt to its manufacture and use.

In light of this voluminous and complex body of regulations, one is left to wonder what forces conspired to produce the succession of drug scandals that have afflicted Japan ever since the 1950s. Yet, as the following examples illustrate, considerable skepticism exists concerning the effectiveness and reliability of Japanese drug approval procedures.

1. Flawed Testing and Peculiar Drugs

Studied observers have wondered why some of Japan's top-selling drugs are anti-cancer agents of questionable efficacy that are sold only in Japan. For example, Masanori Fukushima, a specialist at the Aichi Cancer Research Center, asks:

how can drugs be million-dollar sellers in Japan and yet not sell elsewhere in the world? The answer is that there is a whole series of defects in Japan's drug approval process and in the system for dispensing approved drugs...They (phase 3 clinical testing) do not meet the rigorous requirements of such trials elsewhere in the world -- they tend to assess effect only (reduction in tumor size, for example), which is measured during phase 2 trials, rather than benefit (risk-to-benefit, and cost-to-benefit) which is measured during phase 3....the anti-cancer drugs, PS-K (Krestin), OK-432 (Picibanil) and Tegafur, all available only in Japan. Research on Tegafur has been abandoned elsewhere in the world, but in Japan, Tegafur, together with Tegatur uracil, has annual sales of $280 million. PS-K and OK--432 are widely prescribed...Total sales of these and other anti-cancer drugs peculiar to Japan are about $1,000 million per year (Fukushima, 1989).

It was only in the wake of a deluge of criticism from individuals such as Dr. Fukushima that the Health Ministry was compelled to re-investigate the efficacy of Krestin and Picibanil, and, subsequently, to restrict their use.

[Insert Table 7 about here]

[Insert Table 8 about here]

Doubts have also been raised about the nature and reliability of clinical testing in Japan. Critics maintain that clinical testing is neither properly conducted nor reliable. This sentiment is articulated by Dr. Fukushima, who argues that

[t]o understand why there are so many dubious drugs on the Japanese market, one has to understand the unhealthy close relationship that exists between doctors, pharmaceutical companies, and the MHW. Data presented to the MHW for approval are in mainly in the form of unpublished results or of reports published in Japanese in company-financed or company-related journals. Those in charge of clinical trials often set up their own foundations, funded by the pharmaceutical companies, for which they organize clinical trials. And often some heads of clinical trials also belong to the drug-approval committee. Thus a data-producing mechanism by the company for the company is inherent in the system (Fukushima, 1989).

For example, a rare investigation revealed that one individual who was a member of the subcommittee that granted approval to the dubious anti-cancer drug Krestin also participated in its clinical testing and submitted test results to that subcommittee.

2. A Succession of Drug-Induced Tragedies

The widespread incidence of AIDS among Japanese hemophiliacs illuminates several maladies inherent in the country's drug regulation system. Although heat-treated blood coagulants were first marketed in the United States in March 1993, 27 months passed before those products were approved for use in Japan (heat-treated coagulants were first developed in West Germany in May of 1981). Moreover, after the FDA prohibited the manufacture of unheated blood products in the United States, Japan became the only remaining major market for such products. Indeed, Japan's imports of the untreated coagulants continued to rise, reaching a peak in 1985, when heat-treated products were finally allowed into the market. A Japanese newspaper, the Mainichi Shinbun (3 December 1988), reported that manufacturers of unheated blood products took advantage of Japanese tardiness in shifting to heated products as well as the relatively high prices set for such products in Japan. In August 1985 various companies began to market heated blood products. Yet, since no recall order had been given, unheated blood products remained on hospital and clinic shelves. The slow introduction of heated blood products, coupled with the continuing use of unheated blood products, contributed to the large number of HIV-infected hemophilia patients in Japan. This demonstrates a lack of attention among Japanese doctors to cautionary information (possibly owing to the low prevalence of malpractice suits), and highlights the paternalism of Japanese system, "in which patients receive little explanation of the treatment they are receiving" (Pollack, 1995; see also Leflar, 1996).

Doubts about the reliability of clinical testing in Japan were also raised by a 1994 scandal involving the use of Sorivudine, a drug for the treatment of herpes zoster. In that case, the drug was prescribed with no warning of the potentially lethal consequences for patients simultaneously being treated with a fluorouracil anti-cancer drug. Although three deaths had occurred during the clinical testing of Sorivudine, drug maker Nihon Shoji submitted misleading and inaccurate data concerning the cause of death. For its part, the MHW approved the drug without taking steps to assess the veracity of those clinical testing results and failed to issue a warning until a number of deaths had already occurred. To compound the problem, employees of Nihon Shoji were found to have sold shares of stock in the company immediately prior to the onset of media reporting on the Sorivudine's role to what turned out to be 16 deaths.

An executive of an American clinical testing company likens Japan's clinical testing environment to that in the United States prior to the Thalidomide tragedy of the early 1960s. In that case, the danger of Thalidomide-induced birth defects among infants born to mothers who had taken the tranquilizing agent was first reported by a German scientist in 1961. This warning brought a halt to sales of the drug in most of the advanced countries. Even though the only cases of Thalidomide-induced birth defects in the United States occurred during clinical testing (ten cases were reported), the vast scope of the tragedy overseas led to passage of the 1962 Kefauver-Harris Amendments, which dramatically bolstered America's testing and regulatory process. Despite knowing the danger, Japanese drug-maker Dai Nippon Seiyaku continued selling Thalidomide for nine months following the issuance of the warning, and the Health Ministry failed to order a recall of the product. This deficiency of corporate conscience coupled with government inaction resulted in 309 cases of birth defects, double the number that would have been prevented by swift and timely action (Katahira, 1995). Despite this succession of drug-induced tragedies, Japan continues to have a serious lack of regulatory personnel. It has been reported that the number of personnel at MHW involved in drug approval is only one-twentieth of that in the FDA.

In order to safeguard the health of the citizenry and to develop the pharmaceutical industry, Japan's drug regulation system desperately needs an overhaul. The establishment of reliable clinical testing procedures is important in order to promote Japan's pharmaceutical industry and to generate credible data to satisfy foreign regulatory agencies. In the hemophiliac HIV case, the doctor who headed the committee responsible for approving heat-treated blood coagulants is alleged to have deliberately delayed approval of clinical testing and marketing so that Japan's Green Cross Corporation could catch up with its foreign competitors. Green Cross, which dominated Japan's blood-products market, provided funds to that doctor to set up a non-profit corporation to promote research on hemophilia. According to one observer, "The ministry's scientific committees are manned by medical doctors who often collaborate with pharmaceutical companies in research. It is these doctors and the pharmaceutical companies who really determine policy" (Swinbanks, 1988). Some Japanese companies have taken matters into their own hands, conducting clinical testing in the United States and in Europe before conducting them in Japan.

IV. The Ultimate Cause: Price Control and the "Doctor's Margin"

Nevertheless, we contend that ineffective R&D, weakness in basic science, and a shoddy drug approval system are side-effects of an invisible structural malady. As we shall demonstrate, the ultimate cause of the failure in pharmaceuticals derives from the system of financing and reimbursement under the Japan's universal health insurance system.

Under Japan's universal health insurance system, all medical facilities (clinics and hospitals) are reimbursed for medical services according to the official fee schedule (shinryo hoshu). The fee schedule is a detailed form of pricing control, listing more than 3,000 medical procedures for physicians alone. There is a separate brand name reimbursement schedule for pharmaceuticals -- the official drug price schedule -- that lists more than 13,000 drugs by brand name. Providers are reimbursed only for drugs listed on the official fee schedule; hence, a detailed product listing is essential. The Central Social Insurance Medical Council, an advisory board for the Health Ministry, sets reimbursement prices. Patients are responsible only for a small co-payment at the point of service, and all costs incurred by medical providers are reimbursed on a fee-for-service basis according to points system listed on the fee schedule. Japanese physicians not only prescribe drugs, they also dispense them. The official drug price schedule provides physicians with an intricate profit-generating mechanism. Drug companies and wholesalers, as a matter of sales practice, offer discounts from the official reimbursement price depending upon the customer (mostly doctors), product, and volume of order. The physician or hospital is reimbursed for the drug at the official list price and pockets the difference, which is called the "doctor's margin" (yakka saeki). This creates a strong incentive to over-prescribe drugs, and, predictably, Japanese physicians prefer higher-priced drugs that carry a bigger doctor's margin.

The over-prescription and over-use of drugs has been know to trigger disastrous consequences. For instance, the reason why per capita consumption of blood plasma in Japan is so high (about three times the British figure) derives from the enormous discounts, 35-85 percent below the fee schedule price, offered by the pharmaceutical companies. According to the Japan Pharmaceutical Manufacturers Association, total pharmaceutical reimbursements for the 1993 fiscal year were approximately ¥6.5 trillion, of which approximately ¥1.2 trillion (or 18.6 percent) was consumed in the doctor's margin.

A case of tragedy linked to over-prescription was seen in the side-effects of Chinoform, a drug widely used in Japan as a digestive stabilizer. Because relatively few instances of Chinoform-induced subacute myelo-optico-neuropathy (SMON) occurred outside of Japan, it was initially thought to be a "Japanese disease." The strange disease began appearing in Japan in 1955, and it was not until 1970 that a Japanese researcher linked its cause to the over-prescription of Chinoform. Even though the possible side-effects of the drug had been known since 1935, the government failed to adequately investigate these safety concerns and drug companies continued to market the drug. Moreover, some Japanese doctors failed to heed the warnings and went on prescribing Chinoform in large dosages. Ultimately, the SMON tragedy afflicted more than 11,000 Japanese victims.

Since the 1980s, MHW has endeavored to cut pharmaceutical reimbursement prices in order to reduce the doctor's margin. The most drastic cut came in 1981, when pharmaceutical prices were slashed by 18.6 percent. Moreover, since that time increases in medical fees have been accompanied by cuts in pharmaceutical fees. Since the Japanese health care financing system is a global budget system, this zero sum trade-off was employed as a blunt instrument with which the Health Ministry has sought to reign in mushrooming health care expenditures. By maintaining the trade-off between pharmaceutical prices and medical fees, the government effectively pitted two powerful health care lobbying groups, drug companies and physicians, against one another.

[Insert Table 9 about here]

Nevertheless, some argue that slashing drug reimbursement prices is a form of industrial policy designed to promote new drug innovation (Reich, 1990). Even though the reimbursement prices have been cut over the years, MHW's pricing system tends to award higher prices for new drugs in the apparent hope of stimulating greater innovation. However, a substantial share of the new drugs introduced in Japan are so-called "me-too" products (shin zoro), produced by Japanese pharmaceutical companies in order to reap the relatively higher prices for new drugs. Indeed, companies are able to effectively market these drugs in Japan because of the perverse incentives produced by the pharmaceutical pricing system and the rewards reaped by physicians and hospitals as a result the doctor's margin. There is a strong incentive for pharmaceutical companies to compete to obtain higher government-set prices, rather than to produce truly innovative products that might gain appeal in overseas markets.

This marketing competition over high-priced me-too products has resulted in over-employment in drug marketing which siphons resources away from efforts at truly innovative R&D. It is estimated that there is one pharmaceutical sales representative per every four doctors in Japan, compared with one per every 40 doctors in the United States (Morohashi, 1995). If one includes the 25,000 marketing representatives working for Japanese drug distribution companies, the result is one sales/marketing representative per every 2.5 doctors. Moreover, total wages and salaries for these sales/marketing representatives is estimated to be about ¥100 billion, twice the amount of the total research spending for Japanese pharmaceutical companies (Takegami, 1993).

Despite the fact that the Health Ministry has cut drug reimbursement prices regularly for many years, the ratio of spending for pharmaceuticals to total medical spending -- the pharmaceutical ratio -- has remained nearly constant. As a result of dramatic reductions in 1981 and 1984 (18.6 percent and 16.6 percent, respectively), the pharmaceutical ratio dropped from 38.7 percent to around 30 percent. Since then, however, the ratio has hovered around 30 percent. One reason for this is that drug makers offset the lower prices for older products by producing high-priced me-too products.

Although Japan has a universal health insurance system that consumes less than half the share of GNP that the fractured American system does, the Japanese spend an abnormally large amount of money on pharmaceuticals. According to the Nihon Keizai Shinbun (6 April 1995), Japan's spending for pharmaceuticals amounted to 29.5 percent of national medical expenditures in 1993, as opposed to 19.9 percent in France and 17.1 percent in Germany. And, it should be noted, the doctor's margin overstates the share of health care spending devoted to pharmaceuticals. Using the high ratio as a justification, MHW has aggressively introduced measures to fundamentally reform the pharmaceutical market (Arioka, 1995). For example, in a major departure from its fee-for-service medicine, the Health Ministry recently introduced capitated fees for geriatric patients, which eliminates the doctor's margin and, thus, offers no incentive to utilize expensive medicines. Significantly, MHW released a survey of six hospitals showing that spending on pharmaceuticals dropped by 35.7 percent under this flat-fee payment system.



Source: Shakai Iryo Shinryo Kouibetsu Chosa Hokoku.
Website - http://ciber.gatech.edu/workingpaper/1997/woodall.html

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