1. Entry and Regulation – Evidence from Health Care Professions
Prof. Frank Verboven
Presentation at DG-Competition
13 December 2006
“The Economic case for professional services reform”

2. Background to this study
Academic research paper
Joint work with Catherine Schaumans, doctoral student at K.U.Leuven
Financed by K.U.Leuven and Fonds Wetenschappelijk Onderzoek (Flemish Science Foundation)

3. Health care markets Complicated markets (like many markets …)
Demand side: patients need
Medical diagnosis
Medical treatment, including drugs
Supply side
Pharmaceutical companies investing in R&D
Physicians treating patients
Government: broad access to medical care
Offer high reimbursement
Guarantee sufficient geographical coverage

4. Implications of high reimbursement policy
Agency problem
Physician has an incentive to prescribe too many drugs
Common solution
Separate physician and pharmacy ownerships
Competition problem
Pharmaceutical companies and pharmacies may have an incentive to charge too high prices
Regulate prices, including pharmacy gross margins

5. Broad geographic coverage policy
Combine:
relatively high regulated gross margins
geographic entry restrictions
to guarantee:
sufficient entry in the unattractive areas
without triggering excessive entry elsewhere
Such policies have been followed in many European countries, including Belgium, France, Italy, etc.

6. The Establishment Act in Belgium
In every municipality, the number of pharmacies is restricted based on population criteria.
The population criteria are modified depending on
the number of pharmacists within a pharmacy
the distance between two pharmacies

7. The scope of our study
Estimate an econometric model of entry and competition with geographic entry restrictions
Evaluate the policy of
relatively high regulated gross margins
combined with tight entry restrictions.
Is it indeed in the public interest (ensure sufficient geographical coverage)
or is it rather in the pharmacies private interest?

8. General intuition of the entry model
We observe the number of pharmacies (and physicians) per town
We relate these to demographics, including population size.
Interpretation of results
If population size needs to increase disproportionally to sustain an additional pharmacy,
then entry implies enhanced competitive behavior.
If predicted number of sustainable firms would be higher than what is legally allowed, then there is room for additional entry.

9. Data on 847 small Belgian towns
Demographics (NIS, Ecodata)
Number of firms (RIZIV)
Variable
Description
Mean
Std. D.
# pharmacies
Number of pharmacies
1.76
1.81
# physicians
Number of physicians
4.93
4.62
ln(population)
Logarithm of number of inhabitants
7.91
1.13
% young
Fraction of population, 17 years or younger
0.22
0.02
% old
Fraction of population, 65 years or older
0.16
% foreign
Fraction of population with foreign nationality
0.04
0.06
% unemployed
Fraction of population between 17 and 65, that is unemployed
0.03
Flanders
Dummy variable, 1 for region of Flanders
0.39
0.05
mean income
Mean Income (/10,000)
2.47
0.40
I INCLUDE THIS TABLE FOR REFERENCE BUT WILL NOT DISCUSS IT IN THE PRESENTATION
Source: NIS, Ecodata

10.  Number of pharmacies
Total
Total,
restricted entry
restricted entry (%)
246
199
80.9 1
219
179
81.7 2
146
109
74.7 3
102 85
83.3 4 70 61
87.1 5+ 64
100
847
697
82.3

11. Uncensored bivariate ordered probit Censored bivariate ordered probit
General model with strategic complements
Pharmacies’ payoff equation
Constant
(1.18)
(3.40)
(1.82)
ln(population)
(0.06)
(0.12)
(0.13)
% young
(2.48)
(9.18)
(4.26)
% old
(2.43)
(5.20)
(3.54)
% foreign
(0.94)
(0.96)
(1.08)
% unemployed
(2.22)
(4.85)
(4.40)
Flanders
(0.14)
(0.34)
(0.25)
Income
(0.14)
(0.18)
(0.19)
(0.11)
(0.18)
(0.23)
(0.13)
(0.20)
(0.30)
(0.15)
(0.22)
(0.35) -
(0.29)
I INCLUDE THIS TABLE FOR REFERENCE BUT WILL NOT DISCUSS IT IN THE PRESENTATION

12. Physicians’ payoff equation
Constant
(0.94)
(1.12)
(0.98)
ln(population)
(0.07)
(0.08)
(0.07)
% young
(2.08)
(2.25)
(2.15)
% old
(1.84)
(1.90)
(1.89)
% foreign
(0.73)
(0.69)
(0.72)
% unemployed
(1.83)
(1.98)
(1.89)
Flanders
(0.12)
(0.13)
(0.13)
Income
(0.11)
(0.12)
(0.11)
(0.10)
(0.10)
(0.10)
(0.12)
(0.12)
(0.13)
(0.13)
(0.13)
(0.14) -
(0.19)
(0.29)
(0.83)
(0.83)
corr
(0.03)
(0.07)
(0.09)
Log Likelihood
-2,255.6
-1,761.5
-1,740.6
I INCLUDE THIS TABLE FOR REFERENCE BUT WILL NOT DISCUSS IT IN THE PRESENTATION

13. Summary of empirical findings
Profitability is positively affected by
town size (population)
% old and % unemployed.
Additional entry by pharmacies reduces profits, but this:
is only due to reduced sales;
is not due to enhanced competitive behavior.
The entry restrictions are strongly binding, i.e.
at regulated profit margins more pharmacies want to enter.

14. Policy simulations What is the combined impact of on
reducing the profit margins
loosening the entry restrictions on
total number of pharmacies
number of towns without pharmacy?
This enables us to evaluate the public interest view of the current regulation, i.e. the guaranteeing of broad geographic coverage.

15. No change in entry restrictions Full free entry in pharmacy market
Net markup change
No change
-50%
No change in entry restrictions
Number of pharmacies
1455
1191
Number of towns without pharmacies
250
279
Full free entry in pharmacy market
3035
1836
104
200

16. Additional policy experiments
Introducing free entry and lowering regulated profit margins,
such that the total number of pharmacies across all towns remains constant, leads to:
large markup reductions (tax savings)
net margin drop by about 62%
gross margin drop in the range of 10-18%
no significant loss in geographical coverage (-0.8%).
No public interest motivation for the current regime.

17. What next in Belgium and elsewhere?
Gradual erosion of profits due to a ceiling on the regulated profit margins
 Ultimately entry restrictions may become redundant.
Can profit margins themselves be deregulated?
 May require rethinking of reimbursement policies.
What market failures motivate the many other restrictions in the establishment Acts?

18. What next in Europe?
Similar or other restrictions apply in many other countries
Urgent need for more independent economic research