Why Corruption is Inevitable in China’s Pharmaceutical Industry

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Jul. 25 – The Mayor of London, Boris Johnson, famously quipped that his policy on cake is to have it and to eat it. The Chinese authorities have long employed the cake policy on the subject of corrupt practices of foreign pharmaceutical companies.

In the last week, we have seen a growing official condemnation of the activities of GlaxoSmithKline, the British drugs giant. This has now developed into a plethora of foreigner-bashing in the Chinese state-controlled media. The chief investigator in the GSK case has hinted that other foreign companies may also have a case to answer. Meanwhile, the international media coverage of this story has focused on the alleged wrong-doing of GSK and the doctors and officials who have been corrupted. The impression is of a chaotic environment where the authorities have permitted, due to widespread bribery, a system favoring the machinations of foreign-invested pharmaceutical MNCs. What has not been discussed is that corruption in the drugs business is not merely a result of lax regulation and enforcement, but is a direct result of the regulatory landscape. The systems failings are not merely tolerated by the authorities, but are in fact an inevitable result of the regulatory framework controlling the sale and prescription of drugs.

Despite the often-invoked image of China being in the throes of rampant capitalism, it remains a highly regulated market. Drug prices are set by the Chinese authorities and this dictates the margin structure for the state-controlled importers, distributors as well as sub-distributors and hospitals. The fiction is maintained that this structure is realistic. In fact, the official low-margin distribution chain is not observed and drug companies are obliged to find ways to enhance the margins of each participant in this cumbersome process.

Since China’s accession to the WTO, some of the more flagrant barriers imposed against foreign businesses trying to compete on a very uneven playing field have been softened, however it remains highly problematic for many pharmaceutical companies trying to market a portfolio containing both locally-manufactured and imported products. The regulations dictate that imported products may not be promoted by the sales team of the locally-established foreign company affiliate, which should only concern itself with locally-manufactured products. This system drives companies to employ parallel and sometimes multiple sales forces for their product range. These sales forces should be separately managed and administered, and these organizations should even occupy separate specially-approved, and more expensive, premises. The structural inefficiency ensures much time and energy is expended and heavy costs incurred trying to maintain an artificial separation “on the books” for what is, in reality, a single organization. Most foreign companies would not stand up to detailed scrutiny should they be investigated.

The authorities know that they have got the companies just where they want them – forced into transgressing a range of restrictive rules in order to stay in the game. Whenever they feel the need to make an example of a foreign miscreant, they can choose a handy example without much effort.

Meanwhile, in normal business operations, keeping inspectors away from the organization while the status quo of business operations – albeit not fully compliant – can provide another “nice little earner” for officialdom. You rub my back and we’ll rub yours – until the political pressures change. Then, the masseuse becomes the inquisitor, for awhile at least. This is where GSK is right now.

In the Chinese system, doctors, who prescribe the medicines, are the most significant element in the business. “Motivating” doctors to prescribe drugs is a worldwide phenomenon, and pharmaceutical companies have learned how to blur the distinction between blatant inducements and more anodyne assistance with “medical education.” It is a rule of thumb that as countries become more “developed” the means of satisfying the demands of doctors become more sophisticated. In Europe, there is much debate about what is acceptable practice. In China, the situation is refreshingly straightforward – doctors demand money.

It doesn’t matter how good a product is, it may have unique life-saving properties, but it will achieve negligible sales unless doctors get a cut of the action. It should be noted that Chinese doctors do not swear the Hippocratic Oath, and their motivations for professional assistance are financially driven rather than being based upon a moral creed.

One former senior executive with a foreign pharmaceutical company reported attending a focus group in Beijing composed of hospital consultants. Some of the participants had not seen each other for some time and before the technical discussion began, the group chatted amongst themselves. When the conversation turned inevitably to matters material, the executive was astonished to learn of the value of the apartments being bought and large expensive German cars being driven by the panel, as well as the expensive overseas educations being procured for the offspring of doctors officially existing on salaries equivalent to a few hundred dollars per month. Without this effective subsidy, China would be facing an increase in basic doctor salaries of billions of dollars.

All of this means that many foreign companies are obliged to part with a lot of cash just to have a chance of competing in China. Managing large amounts of “black” money can be a major headache. As the organization grows, the sums involved increase and medical representatives face a growing risk in dispensing cash in hospitals. Direct bribery not only presents problems in finding receipts for the money sloshing through the company accounts, but also makes it almost impossible for a company to evaluate how much cash is sticking to the fingers of their own employees. As a way around this, some companies try to channel the inducements through third-party agencies for various services. This naturally incurs further cost, but can be sold to head office as a means of distancing the company to some extent from the dirty deed. The problem with this, however, is that it further empowers the local managers who decide on which agencies will be given these attractive contracts. Naturally, the agencies are obliged to provide inducements to the managers to obtain the contracts.

The Chinese dictum “everybody must eat” could have been coined with particular reference to the sale, distribution and prescription of drugs. The system guarantees that foreign companies are obliged to support a large population of peripheral facilitators as well as subsidizing the salaries of hundreds of thousands of doctors. It is highly agreeable for the Chinese authorities to benefit directly from this process, while retaining the luxury of deploring the corrupting influence of the foreign participants in this bizarre relationship.

It is not clear whether or not GSK were involved in something along these lines, but it is obviously highly embarrassing to some pharmaceutical company senior executives, in company headquarters, to have such matters discussed. In the case of GSK, the response to the revelations has been shocked denial of knowledge of such practices and determination to get to the bottom of the matter. In this, GSK are reacting predictably.

When US and EU regulators introduced global anti-corruption regulations over the last 10-15 years, which allowed the bosses of major companies to be found guilty, and possibly jailed should corruption be proven in any of their overseas affiliates, there was a rapid and undignified race to bring out “codes of conduct” which the senior managers of subsidiaries were obliged to sign. This theoretically placed the responsibility on the local managers and took the heat off the head office. It would be instructive to be able to see the local budgets and sales targets at the time when each such code of conduct was introduced, and to learn whether sales targets were adjusted downwards in recognition that naughty practices were henceforth forbidden. If not, one would have to ask whether any such code was initiated in order to really change the current practices or purely in order to protect managers in HQ.

In the meantime, the China saga drags on. It will of course disappear, and more likely than not the errant foreign pharmaceutical companies concerned will negotiate fines, deplore such activities, and find a few mutually acceptable scapegoats to pin the blame on. Some individual reputations will be tarnished. However, when the system itself is skewed, the question is really how much of this scandal is a real anti-corruption drive and how much of it is a State-sanctioned, politically-motivated, billion-dollar shake down of foreign pharmaceutical investors who actually pay the vast majority of incomes enjoyed by China’s own doctors?

The author of this article is a now retired, foreign pharmaceutical expert with many years’ experience in the pharmaceutical industry in Africa and mainland China. He has requested anonymity for this piece.

The views expressed within are not necessarily those of Asia Briefing Ltd. The company has made a donation of US$1,000 to the Care for Children China charity at the request of the author in payment for this article.

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