Britain's drug dependency

The pharmaceutical industry is often held up as the one dynamic sector of British capitalism. In fact, says Debra Warner, it survives on a drip-feed of government stimulants

We've all become familiar with the tragic tale of British industry's decline. News of factory closures and businesses going bankrupt fills the financial pages daily. Even the City of London, pride and joy of British capitalism, has seen better days. But there is one sector of the economy which still puts a twinkle in the eye of the most jaded forecaster. The pharmaceutical industry, according to one excited commentator, is 'the jewel in the UK manufacturing crown' (Guardian, 8 August). Four of the top 20 pharmaceutical companies in the world are British and between them they produce six of the world's top-selling drugs.

Without its 'mother's little helpers', Britain's economy would be a great deal sicker. The pharmaceutical industry produced a trade surplus of £1.1 billion in 1990, climbing to £1.2 billion last year, according to the Association of the British Pharmaceutical Industry (ABPI). Glaxo, with a workforce only one sixth the size of British Telecom, is the world's second most profitable drug company. And amid all the recent doom and gloom about the economy, Smith Kline Beecham announced a growth in profits of 10 per cent over the past half year.

So what makes pharmaceuticals different? Strong management is often cited. There are legendary tales of how Sir Paul Girolami, Glaxo's chief executive, rocked the industry by launching the ulcer 'wonder-drug', Zantac, at way above the market price then watched it grow to become the top-selling drug in the world. Or how John Robb transformed Wellcome from a charitable trust into a stock-market blockbuster.

The drug industry bosses have certainly been ruthless. Behind the recent highly publicised sale of shares to raise £2 billion for the Wellcome Trust's charitable works (and £75m in fees for the City), Wellcome management have cut unprofitable research into such minor ailments as cancer to concentrate on high-profile and highly profitable treatments for diseases like Aids. As a result, Wellcome's pre-tax profits leaped by 28 per cent in 1991 and 35 per cent in the first half of this year.

However, managers have been equally ruthless in other British industries - usually without a corresponding surge in profits. The question remains, what makes drug companies so successful?

The real reason for the success of Britain's pill-pushers is much more straightforward, and one that the industry is less keen to boast about. The secret ingredient in the pharmaceutical industry is good old-fashioned state intervention. This comes in two forms.

The National Health Service comprises 80 per cent of the British market for drugs and consumes nearly 40 per cent of the British pharmaceutical industry's output - a figure which has grown by almost 10 per cent since 1970. Annual NHS expenditure on medicines has risen from £2.78 per head in 1970 to £43.97 per head in 1990. The fact that British drug companies have been guaranteed the largest slice of this expanding cake, paid for out of the public purse, has helped to protect them from competition and downturns in the world market.

Profit protection

The second factor is the Pharmaceutical Price Regulatory Scheme , a watchdog body set up in 1957 by the Department of Health. It is ostensibly aimed at controlling drug expenditure in the NHS by preventing companies from artificially inflating prices. But rather than directly imposing price controls, it places a ceiling on the profitability of each company, measured by the rate of return on their assets. Those companies which exceed their target profit margin (usually 17-21 per cent) can opt to invest in plant or research and development rather than paying the excess to the government or lowering their prices. It is this which has encouraged investment in pharmaceutical manufacturing plant within the UK, at a time when investment in the rest of British industry has been falling. Britain now has 16 per cent of European production capacity, while holding 13 per cent of the European pharmaceutical market. All good news for the ailing balance of trade.

State protection looks set to increase into the 1990s. The industry is currently lobbying the government to extend patent life in order to protect it from foreign imitations of Great British Brands.

The other leading producers of pharmaceuticals, such as the USA, Germany and Switzerland, all use state regulation of one form or another, and all are arguing for longer patent protection. But the essential role of government in propping up the pill-pushers becomes much more transparent in Britain, where strong state involvement has kept alive what is just about the only globally competitive arm of the manufacturing sector.

As the Wellcome experience shows, government regulation does not produce more people-friendly drug companies. It simply protects the profits of the industry against competition from abroad. But in an era when, despite the slump, everyone seems to be worshipping at the altar of market forces, it is worth remembering that even in the one small remaining corner of the British economy that amounts to anything, free market forces don't really work.