Dynamic Bargaining under Ratchet Effects: Evidence from cardiac pacemakers

This paper examines the distortionary incentives created by ratchet-based regulation of medical device reimbursement prices. In Japan, reimbursement rates for devices such as cardiac pacemakers are revised every two years, with adjustments based on transaction prices observed between hospitals and device sellers during designated sampling periods. This retrospective pricing rule gives hospitals and sellers a shared incentive to raise prices during update periods -- an incentive that contrasts with their ordinarily opposing interests in price negotiations. Using a Nash-in-Nash bilateral bargaining model and transaction-level cost data, the study finds that hospitals generally hold greater bargaining power than device sellers. When cost data are unavailable -- as is common in much of the existing literature -- the estimated bargaining parameters differ markedly under conventional cost assumptions. Wholesale prices are higher compared to counterfactuals without the ratchet-based regulation, with distortions more pronounced in less competitive product categories. Although the ratchet mechanism could, in principle, have raised reimbursement prices by more than 20%, our simulations indicate that the actual effect was modest. This attenuated impact is attributable to institutional features of the reimbursement system including the government’s use of a relatively long sampling window and its aggregation of products into broad functional categories. This institutional architecture collectively reduces the scope for strategic price inflation.