Has the shortened drug distribution chain cut drug prices? Evidence from the Two-Invoice System in China

Global concerns over rising drug prices have led to regulatory efforts in the pharmaceutical industry targeting price transparency and distribution efficiency. This study examines the impact of China’s Two-Invoice System (TIS), a 2016 reform aimed at reducing drug costs by streamlining the pharmaceutical distribution chain and enhancing price transparency. With a theoretical model, we examine the decision-making for pharmaceutical manufacturers and distributors on pricing and promotion activities. We predict competing effects on drug prices: while intermediary markups inflated by double marginalization are reduced, the removal of efficient distributors may elevate supply chain expenses. Using a staggered difference-in-differences approach with procurement data from 2015 to 2019, we find that the implementation of TIS led to a 1.9% increase in average drug prices, contrary to policy expectations. Price increases were more pronounced for lower-priced drugs and in wealthier regions, for which the supply chain markups are limited and the effect of efficiency disruption might dominate. We also document a significant increase in sales and marketing expenses of the manufacturers, who are supposed to have absorbed a considerable amount of promotional costs previously borne by distributors. These findings underscore the unintended inefficiencies of regulatory reforms, highlighting the need for a balanced policy design that considers both cost control and market dynamics in healthcare.