Strategic Responses to Parallel Trade

High prices for patented pharmaceuticals have prompted many governments to consider allowing competition from "parallel imports," or products first sold at lower prices in other countries. This paper examines how pharmaceutical firms have responded to changes in intellectual property rights and trade barriers that legalized parallel imports within the European Union (EU). The threat of arbitrage by parallel traders reduces the ability of firms to price discriminate across countries. Due to regulations on price and antitrust law on rationing supply, pharmaceutical firms may rely on non-price responses. Such responses include differentiation of products across countries and selective "culling" of product lines to reduce arbitrage opportunities, as well as raising arbitrageurs' costs through choice of packaging. Using a dataset of drug prices and sales from 1993-2004 covering 30 countries, I find evidence that the behavior of pharmaceutical firms in the EU with respect to their product portfolios is consistent with attempts to reduce parallel trade. This may at least partially explain why parallel trade has not yet resulted in significant price convergence across EU countries. Accounting for non-price strategic responses may therefore be important in assessing the welfare effects of competition from parallel imports.