By James Shen

After a year of stunning growth in 2007, the pharmaceutical industry in China delivered another impeccable performance in 2008. Revenues of the Chinese pharmaceutical manufacturing sector rose 28.8% while its total profits jumped 39.8% in the first eight months of 2008.

As the world embraces a sharp global economic downturn and epidemic financial turmoil, it is inevitable that China will be affected adversely, given the fact that the country’s past economic miracle has largely been built on strong exports. Already, Chinese economists have been talking about slower economic growth in 2009 with expected GDP growth rates falling into the single-digit range.

Understandably, the Chinese pharmaceutical sector will not be spared by the current debacle. Southern Medicine Economic Institute (SMEI), China’s leading pharmaceutical market research institution, recently lowered its estimated growth for the 2009 Chinese pharma industry.

Provided that China’s GDP does not fall under 8%, the country’s pharmaceutical export growth does not drop below 25%, and healthcare reform is implemented smoothly, SMEI forecasts the total output value of the overall Chinese pharmaceutical industry to grow around 23.2%, reaching 1 trillion CNY (Chinese Yuan Renminbi [a currency unit]) in 2009. Under the same assumptions, the total output value of pharmaceutical formulations subindustry is forecasted to reach 270 billion CNY with an annual growth rate of around 20%.

Going forward, it is evident the Chinese government will have to rely on expanding its domestic market to drive the country’s future economic growth. The current global economic slowdown is forcing the Chinese government to move faster on this front. Furthermore, the country’s healthcare reform (i.e. increased government healthcare investments, improved medical access and security, raised consumer confidence) has been viewed as a major step toward boosting the domestic market.

Current State Of Healthcare In China
China is now the fourth largest economy in the world, but in 2005 it ranked the fourth from the bottom among the 191 members of the World Health Organization (WHO) in terms of healthcare financing and fairness of healthcare fund allocation. Despite China’s fast economic growth in the past three decades, the past healthcare reform that started in the early 1980s has failed, so far, to build a new system that is able to translate this growth into better and fairer healthcare for its people. Instead, a matrix of structural flaws has been created in the country’s present healthcare system along with skyrocketing medical expenditures and poor operation/investment efficiency. Low government investment into the healthcare sector has led to heavy reliance of medical institutions on drug sales revenues, lower quality healthcare services, irrational allocation of healthcare resources overemphasizing urban areas, and worse medical access/provision in rural and suburban areas.

While past healthcare reform was largely unsuccessful, one area of progress achieved in recent years involved structuring the country’s state medical insurance program. Former state free medical care programs were successfully converted into the urban employee basic medical insurance program in 1998 as a part of China’s new social security net. The program is designed to provide basic medical coverage, and it is supplemented by various other state-funded programs as well as commercial health insurance. In July 2007, the State Council approved a plan for the new urban resident basic medical insurance program to be put in trial in 79 Chinese cities. The new program is designed to cover all urban residents who are not covered by the existing urban employee basic medical insurance program.

In addition, the rural cooperative medical scheme, which was very successful in the past but almost abandoned in the early years of China’s economic reform, was revived and has been heavily promoted since the late 1990s. By the end of 2007, 223 million urban Chinese residents were covered by both urban basic medical insurance programs, while 726 million rural residents were covered by rural cooperative medical scheme.

Healthcare Reform Imminent
A public review of China’s past healthcare reform began in May 2005 following the publication of a controversial government report, which concluded that the country’s reform in the healthcare sector in the previous two decades had been largely unsuccessful and a new reform was needed for the flawed healthcare system. The conclusion won popular support in the country.

Subsequently, the direction and components of China’s future healthcare reform became a subject of heated debates among all stakeholders, including the public, healthcare policy experts, various central government agencies, and healthcare-related industries. Although relevant officials and healthcare experts have been deadlocked over the reform direction in certain strategic areas, including the public hospital reform and its financing model, the fundamental principles of the future reform (i.e. healthcare should not be market-driven, and the state should play a leading role in healthcare) have been largely accepted by most parties involved.

The Chinese government subsequently entrusted nine external Chinese and international organizations, including the WHO and McKinsey, to help develop its national healthcare reform plan last year. The proposals from these parties were presented to the government in mid-2007, and it was believed they drew various references from the healthcare models in the United Kingdom, Germany, and the United States.

A draft healthcare reform plan was finally published in October 2008 for public comments. The draft plan calls for government leadership and sharply increased government investments in public health and healthcare. The plan also calls for development of a universal basic healthcare system for all, strengthened roles of prevention and primary medical facilities in urban and rural areas, a government-administered essential drug system, and reform of medical institutions and healthcare financing.

Impacts Of The Ongoing Healthcare Reform On The Pharma Sector
The following bullets detail why China’s healthcare reform has been cheered by many in the pharma sector.

• Improved overall market environment — A more streamlined, transparent, and better-regulated healthcare system and hospital financing model will help release the currently suppressed demands for drug products, especially for innovative new drugs, and support long-term sustainable growth of the pharma sector.
• Market expansion — Overall, the increased Chinese government investment in healthcare and continuous expansion of basic medical insurance coverage are expected to boost the domestic demand for drug products. Government funding will be directed primarily to rural healthcare with the hope to close the gap between urban and rural basic medical insurance coverage. When this happens, the Chinese pharmaceutical market will be significantly expanded.
• Emerging new opportunities and frontiers — The restructure of the Chinese healthcare system will create new opportunities for local and multinational drug companies in areas such as vaccines, generic drugs, self-medication, and community healthcare. 
• Improved margins and reduced expenditures — A streamlined healthcare system is likely to reduce pharmaceutical companies’ expenditures for marketing, sales, and distribution of their products, thereby increasing profit margins.
• Strengthened roles of commercial insurance and private medical institutions — The reform is likely to transform commercial health insurance and private medical institutions into high-end supplements to the state basic medical insurance programs and public hospitals. This trend will benefit innovative drug companies with products that are usually more expensive and not covered by basic medical insurance programs.

Uncertainties Cloud The Future
Despite anticipated upsides of the healthcare reform, don’t underestimate the uncertainties and challenges ahead. Following its publication, the draft healthcare reform plan has drawn many criticisms from the public and triggered another round of intensive debates among stakeholders. The draft plan was rebuked by the public for its bureaucratic language, ambiguities, embracement of too many different ideas, and absence of a clear road map. In the meantime, stakeholders and policy experts reiterated their debates on different reform areas centering on public hospital reform and the government’s role in essential drug production and distribution.

In the face of continued disagreements, relevant central government agencies agreed to move the reform forward by temporarily putting aside their differences and initiating experiments of various healthcare reform measures in these disputed areas. It is hoped that a consensus will be reached following completion of these experiments. Meanwhile, a number of local governments are taking the lead to initiate healthcare reform in their own territories before the availability of an overall healthcare reform plan from the central government.

What Does Reform Mean To The Pharma Sector?
There have been almost constant regulatory turbulences and government policy changes in the Chinese pharma sector during the past decade. It will be a nightmare relived for the pharma sector if the healthcare reform is implemented in piecemeal and sporadic ways.

With different central government agencies and local governments rushing to independently test their own ideas and models, it is almost certain that China’s healthcare reform will not be a smooth and straightforward process. The pharmaceutical industry will be among the biggest casualties of such a process in the short term.

In the interest of long-term prospects, however, the pharmaceutical industry in China will have no choice but to weather some short-term turmoil resulting from the upcoming sporadic healthcare reform experiments nationwide and the absence of a clear road map for reform. The healthcare reform will have far-reaching impacts on China’s pharmaceutical sector, and companies will need to prepare, restructure, and reposition themselves to embrace upcoming changes in the marketplace.