Pharmaceutical innovation and parallel trade

- A drug manufacturer in the North may export its good to a price-regulated South.
- We discuss the impact of the international exhaustion of IPRs (parallel trade).
- When the South is large, it does not regulate and R&D increases under parallel trade.
- When the South is small, there is regulation and R&D decreases under parallel trade.
- Under parallel trade, the North benefits either from higher quality or lower prices.

This paper proposes a North-South model to study the interaction between price regulation policies and parallel trade, with a particular focus on the pharmaceutical sector. We show that, under parallel trade, R&D investment can rise only when the South government takes into full account its impact both on investment and on the firm's decision to supply the regulated country. This arises because of a complete withdrawal from price regulation. When policy choices are endogenized, indeed the South wants to achieve this level of full commitment when it is large in size. When instead it is smaller in size, the South chooses an intermediate form of commitment whereby it anticipates its effect only on local distribution and delivery, but not on global R&D investment. As a response to these credible levels of price control commitments, the North reacts by allowing parallel imports from the South.