Amanda Starc and Thomas G. Wollmann, “Does Entry Remedy Collusion? Evidence from the Generic Prescription Drug Cartel”, March 2022, NBER Working Paper No. 29886, JEL No. L11, L41, L65
Cartels, in which a group of companies conspire to keep prices high, have been viewed by economists as a significant threat to the market economy. When companies cooperate with each other instead of competing against each other, it could have many adverse consequences for consumers. On the one hand, consumers have to pay higher prices for goods and services. It should be noted that cartels keep prices high by limiting the supply of their production. In addition, in the absence of a competitive threat, cartels also have very little incentive to innovate or better serve consumers. In other words, they essentially act like a monopoly. The Organization of the Petroleum Exporting Countries (OPEC) is the most prominent international cartel affecting the price of oil worldwide through coordinated efforts to limit supply.
Can cartels survive?
The usual recommendation for dealing with the threat of cartels today is to enact strong antitrust laws and create a powerful antitrust agency to actively prosecute cartels. In a way, cartelization is seen as a natural phenomenon in a market economy that must be combated through active government intervention. However, some economists believe that antitrust agreements are inherently prone to failure. They argue that while a certain group of companies prefer colluding to keep prices high, there is always an incentive for other companies outside the cartel to undercut the cartel’s efforts. When a cartel keeps a product’s price high, the returns that a potential new entrant into the industry could make are also high. This attracts new entrants into the industry and helps undermine the cartel. The prerequisite for this, however, is that there are no entry barriers that prevent competitors from entering the industry. If there are barriers to entry, cartels can be long-lasting and contrary to consumer interests. It should also be noted that members of a cartel tend to cheat on their agreement. For example, a cartel member wants to make bigger profits by investing more capital to increase production.
In “Does Access Eliminate Collusion? Evidence from the Generic Prescription Cartel” economists Amanda Starc and Thomas G. Wollmann examine the impact of competitor entry on a cartel. You are trying to understand how effective the entry of competitors is to combat the pricing power of cartel agreements. In particular, they are investigating the 2013 generic prescription drug cartel led by Teva Pharmaceuticals, which is described as “the largest price-fixing case in US history.” They found that after the cartel formed, the cost of single generic drugs in the US increased and total healthcare spending by governments and individuals also increased by billions of dollars.
It has been found that generics, which essentially copy the formulation of branded drugs after patents expire, help reduce the cost of essential drugs. In fact, it is said that the introduction of generic versions of a drug formulation helps reduce the price by as much as 80% in just a short period of time. In the case of the generic drug cartel led by Teva Pharmaceuticals, economists noted that the cartel attracted new entrants and that prices fell as new entrants undercut the cartel. However, it should be noted that bringing generic drugs to market can involve significant delays and regulatory costs. Starc and Wollmann found that regulatory approvals delay the entry of most competitors by approximately two to four years and that the entry process also entails significant costs associated with regulatory compliance. They estimate that consumers could save between $597 million and $1.52 billion just by reducing regulatory delays on their medical bills. Faster generic entry could save many lives that would otherwise be lost to unaffordable medical bills.
