Millions of people die each year from infectious diseases like malaria, TB, HIV and diarrhoea, many of which have drug therapies. We need effective medicine to confront the alarming burden of infectious disease in the developing world. However, many of the drugs for sale in developing countries are of poor quality. Counterfeiters sell ineffective products that imitate the appearance of established brands, while small manufacturers make and distribute substandard versions of common generics.

A recent meta-analysis found that 28.5% of the drugs sampled in 25 primarily low-income countries were either counterfeit or substandard (Almuzaini et al. 2013). Poor-quality drugs are harmful because they deny therapy to patients and foster drug resistance.

Why do markets in developing countries contain low-quality drugs? Although everyone would rather take drugs that work, poor consumers in developing countries may prefer to take their chances if low-quality medicine is cheaper. In other words, drug quality may be a ‘normal good’ for which demand increases with income. Wealthy people may consume better medicine just as they consume better housing, transportation, and food. By creating demand for high-quality medicine, economic growth should improve drug quality along with the quality of other goods.

The difficulty of observing drug quality

An important caveat to this simple argument is that drug quality is difficult to observe. Outside of a chemistry lab, an antimalarial tablet looks just as effective as a sugar pill. Consumers have some information – the brand, the expiry date, and reputation of the seller – but it is unclear how informative these signals are. Just as the unobservable quality of used cars may create a ‘market for lemons’, pharmacies have little incentive to screen for, stock and sell high-quality medicine if consumers can’t observe quality. Moreover, income growth may not lead to higher quality if quality improvements do not attract more business.

When quality is difficult to observe, regulatory and legal institutions can greatly enhance market functioning. However, poor countries typically have weak regulation. For example, India’s Drugs Control Administration has a reputation as an ineffective regulator because it has frequently failed to detect substandard medicine. In one instance, it audited pharmacies but did not test the samples for 14 months, by which time many samples had expired (Mahesh 2010). Because quality is difficult to observe, unregulated drug markets may struggle to improve quality, even as incomes rise.

Fortunately, even with weak regulation, economic growth can foster changes in industry structure that lead to higher drug quality. Larger markets allow firms to reorganise production and invest in technologies that reduce the marginal cost of quality. In the status quo, many independent mom-and-pop pharmacies in India purchase medicine from a convoluted wholesale market. In addition to carrying national brand drugs, these retail shops stock a multitude of nearly indistinguishable ‘local’ brands whose quality varies widely. The shops usually lack air conditioning (an important quality determinant in the tropics) and do not employ licensed pharmacists.

Recently, chain pharmacies have expanded rapidly in Indian cities. Chains can improve quality by purchasing in bulk from trusted manufacturers, establishing independent distribution networks, employing licensed pharmacists and advertising to raise consumer awareness. These investments aren’t necessarily economical for mom-and-pop stores but make sense for a chain with hundreds of shops. Growth in consumer demand enables this process by creating markets that are big enough to cover the fixed costs of these organisational changes and quality controls.

The impact of chain pharmacies on drug quality

Our recent field study in India examines the market-wide impact of chain entry (Bennett and Yin 2014). We collaborated with MedPlus, a new chain that operates several hundred pharmacies in southern India, and examined how entry affected the prices, quality, and performance of mom-and-pop incumbents. We sent mystery shoppers to these stores to buy two common off-patent antibiotics, and send these samples to a lab. We also interviewed pharmacists and consumers, and counted the number of customers at each shop. We carried out this survey before and one year after entry in 20 markets in Hyderabad.

At baseline, we found that 6% of our samples fell below pharmacopeia standards. Quality was higher among established brands than among so-called local brands, which failed 22% of the time. This failure rate is worrisome for public health, since even modest quality deviations may have clinical effects for some patients.

We found that the chain improved quality both directly and indirectly. By selling high-quality medicine, the chain created better access to effective drugs. Chain entry also improved quality indirectly through competition, leading incumbents to both raise quality and lower prices. The price response was reasonable, since MedPlus generally undercuts its competitors’ prices by 5–10%. The quality response was not necessarily what we expected. After all, incumbents might find it easier to cut both prices and quality to avoid direct competition with the chain. The quality response suggests that, despite our concerns, consumers do have enough information to reward firms that improve quality.

Who benefits from chain entry? We worried that shops might discriminate against poor customers, and so we designed the study to investigate this possibility. We stratified the pharmacy audits by deploying both wealthy and poor mystery shoppers, which shopkeepers could observe based on their appearance and speech. In fact, we found no differential effects by the socioeconomic status of shoppers, nor among shops catering to relatively wealthy or poor clientele. By raising quality and lowering prices throughout the market, the chain appeared to improve consumer welfare for all consumers.

Our results suggest that chains will continue to thrive in India. Although incumbents match the chain’s level of quality, they do not match its prices. This pattern suggests that chains have a lower marginal cost of quality than independent stores. A cost advantage may eventually allow chains to dominate pharmacy markets in India. Although the welfare implications of this transition are ambiguous, we are hopeful. Chains apply an organisational approach that is conducive to offering good medicine. In developed countries, chains compete aggressively, margins are slim and quality is generally high.

Published in collaboration with Vox

Authors: Daniel Bennett, Economist at the Harris School of Public Policy, University of Chicago and Wes Yin, Associate Professor at the School of Public Policy and Anderson School of Management, UCLA

Image: A woman sells medicine in a market in Korhogo, northern Ivory Coast. REUTERS/Luc Gnago