Risks of Technical Regulation in Market Failures: Analysis

This report delves into the critical analysis of regulation, regulatory frameworks, and the inherent risks associated with market failures, particularly within the pharmaceutical industry. The study begins with an introduction to the concept of regulation, defining its role and importance in guiding business operations and ensuring societal well-being. The discussion then transitions to an exploration of regulatory risks, market failures, and their implications, using the pharmaceutical sector as a key example. The report examines how regulatory frameworks impact pharmaceutical companies, highlighting the need for compliance and risk mitigation. Furthermore, it provides an overview of accountability frameworks and offers recommendations for both companies and regulators to maintain a sustainable regulatory environment. The analysis covers regulatory burdens, standard-setting, behavior modification, and information gathering. The report also explores the advantages and disadvantages of regulation, different paradoxes, and the role of government intervention in the pharmaceutical industry, with a focus on market failures, information imbalances, and competition failures. The conclusion summarizes the key findings and emphasizes the need for balanced regulatory approaches to promote both industry efficiency and public interest.

DANGERS IN SEEING REGULATION AS AN ESSENTIALLY
TECHNICAL MATTER DESIGNED TO ADDRESS MARKET FAILURES

Table of Contents
1.0 Introduction..................................................................................................................3
2.0 Discussion...................................................................................................................5
2.1 Overview of Regulation............................................................................................6
2.2 Regulatory Risk......................................................................................................10
2.3 Risk Management in Regulations..........................................................................12
2.4 Regulations in Pharmaceutical Industry.................................................................13
2.5 Regulatory Risks and Failures in Pharmaceutical Industry...................................15
2.6 Accountability Framework......................................................................................20
2.7 Recommendations and Suggestions.....................................................................22
3.0 Conclusion.................................................................................................................24
References.......................................................................................................................26
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1.0 Introduction
The concept of regulation has always been a critical success factor (CSF) in the study
of business as the regulatory framework provides a backdrop against which business
performs its activity. The regulation may be defined to be a set of rules of directive
made by the relevant authority which is responsible for providing a controlled
environment wherein the business will operate. Regulation in business context may be
conceptualized to be a set of rules and policies that may bind an organization and its
management to perform its activity in socially viable manner in order to bring
sustainability in its operation in the long run not only for the customers or other
stakeholders associated with the business but also for the society as a whole1.
Different industries have to abide by different sets of regulations and the pharmaceutical
industry operates in one of the most regulated environments across the world 2. Since
pharmaceutical industry deals with life-saving drugs and critical medicinal products
elements which are necessary for a human being and a sustainable living for a society,
it is imperative for the government to device regulatory framework in which operation of
the country will be not only socially acceptable but also ethically and morally viable3.
In order to maintain a license to operate and perform the business, pharmaceutical
companies may need to comply with a complex set of rules and regulations and
therefore it will be interesting to assess regulatory framework in the backdrop of the
pharmaceutical industry4.
1 Demortain, D. (2017). Expertise, regulatory science and the evaluation of technology and risk: Introduction to the
special issue. Minerva, 55(2), pp.139-159.
2 Alves, T. L., Lexchin, J. and Mintzes, B. (2019). Medicines information and the regulation of the promotion of
pharmaceuticals. Science and engineering ethics, 25(4), pp.1167-1192.
3 Levaggi, R., Moretto, M. and Pertile, P. (2017). The dynamics of pharmaceutical regulation and R&D
investments. Journal of Public Economic Theory, 19(1), pp.121-141.
4 Alves, T. L., Lexchin, J. and Mintzes, B. (2019). Medicines information and the regulation of the promotion of
pharmaceuticals. Science and engineering ethics, 25(4), pp.1167-1192.
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It has often been observed that a set of rules and guidelines may consist of its inherent
drawbacks and flaws as well and regulation is no exception to the same. There have
been instances where regulation risk arises and businesses fail to mitigate such risks
and failures and therefore collapse5. On the contrary, a stringent set of rules and
policies may affect business operations in an adverse manner and therefore regulators
may also need to be careful to devise sets of policies that will be actionable by the
companies as well6. In short, regulation should act as a double-edged sword which
should be in line with the broader objective of the government in the long run.
Therefore, it may be stated that the regulations will be acceptable not only for the
company but also for the society and regulators as well.
In the given paper, the researcher has aimed to provide a brief discussion as to the
regulation, regulatory framework, and regulatory risk and market failure arising out of
the same in the context of the pharmaceutical industry.
At the very outset of the study, the researcher provides a brief introduction to the theme
of the paper supported by the detailed discussion on the given topic. In the subsequent
sections of the paper, the researcher has provided an analysis of the theme in a step by
step manner defining a regulatory framework and regulatory framework and also risk
management approach in a regulated framework as set by the government. Also, the
discussion has involved regulation in the pharmaceutical industry and how a
pharmaceutical company operates in a given regulatory framework and thereby
5 Apps.who.int. (2020). Public-Private Roles in the Pharmaceutical Sector - Implications for Equitable Access and
Rational Drug Use - Health Economics and Drugs Series, No. 005: 2. Pharmaceutical markets: structure and
performance: 2.3 Pharmaceutical market failure. Available at:
<https://apps.who.int/medicinedocs/en/d/Jwhozip27e/6.3.html> [Accessed 16 April 2020].
6 Schiel, C. R. (2018). Leveraging Pharma to Lower Premiums: Medical Loss Ratio Regulation in the Pharmaceutical
Industry. BYU L. Rev., p.205.
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mitigates the regulatory risk and market failure. While performing the discussion, the
researcher has also attempted to provide an overview as to the accountability
framework followed by a corresponding recommendation and suggestion as to what
needs to be done by both ends, that is company as well as regulator, to maintain a
sustainable regulatory framework in which the industry may operate in most optimum
manner and regulators objectives may also get fulfilled. Finally, the researcher has
concluded the paper by way of a concluding note
2.0 Discussion
Government intervention in the pharmaceutical industry has been traditionally an
extensive affair to provide a regulatory framework. Since the industries deal with
medicinal products that are necessary for a sustainable living for the society, it becomes
critical for the government to closely monitor, control and supervise the operation of the
industry7.
As per the economic theory, a market failure suggests a concept of failure of the
industry due to the market externalities affecting the business operation and thereby
sustainability in the long run. In a 'perfect market', was coined in the economic theory,
where buyers and sellers transact with each other in a most optimum and reasonable
manner, may not be available in every industry context under a given regulatory
framework8. Since the pharmaceutical industry is a highly regulated one, there have
been cases of market failure that are directly related to regulatory risks as well.
7 Demortain, D. (2017). Expertise, regulatory science and the evaluation of technology and risk: Introduction to the
special issue. Minerva, 55(2), pp.139-159.
8 Alves, T. L., Lexchin, J. and Mintzes, B. (2019). Medicines information and the regulation of the promotion of
pharmaceuticals. Science and engineering ethics, 25(4), pp.1167-1192.
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Information imbalance, failure of competition, market externalities, etc are some of the
factors of pharmaceutical market failure where regulation has been a critical
component. The subsequent section of the paper will discuss in detail how market
failure can be witnessed through a regulation risk and regulatory failures.
However, before beginning with such discussion, it will be necessary for the researcher
to provide a brief background as to the concept of regulation in terms of its theory,
practical use, the strategic horizon as well as importance and impact on the society as a
whole. Gradually, then the researcher will enter into the risk horizon related to
regulations where the regulatory risks will be discussed in the context of pharmaceutical
market failure9.
2.1 Overview of Regulation
The regulation may be defined to be a set of norms, rules, and practices imposed by an
authority on society and players in a given field operating and acting towards the
achievement of a common goal for the greater public interest. Different researchers
have argued that regulation may be defined as an intervention that may be direct or
indirect; there should be an explicit presence of intention and such intentionality is
portrayed as an inherent feature of a regulation. Such intervention can be economic as
well as non-economic, incentive-based or punishment-based10.
In the opinion of Koop and Lodge (2017), the primary motive of setting a regulatory
framework may be considered to be manifold. For example, a business may be needed
to be regulated so that the operation is socially viable, or environmentally sustainable.
9 Levaggi, R., Moretto, M. and Pertile, P. (2017). The dynamics of pharmaceutical regulation and R&D
investments. Journal of Public Economic Theory, 19(1), pp.121-141.
10 Koop, C., and Lodge, M. (2017). What is regulation? An interdisciplinary concept analysis. Regulation &
Governance, 11(1), pp.95-108.
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Besides, it may also be noted that the stakeholders' interests may need to be retained
and kept intact and that is the reason regulatory authorities and bodies may play a
significant role in ensuring such interest of the stakeholders11.
Researchers put the argument for the rationale of regulating an activity from the context
of market failure. It has been observed that an uncontrolled marketplace may fall or
experience failure without proper supervision, monitoring and follow up mechanisms.
This is especially applicable in monopolistic nature of market where one player primarily
dominates the market, set prices, rules and dictates the purchase decision and
influence the entire market dynamics for own interest.
In this context, it will be interesting to discuss a regulatory burden that may be
considered to be an obligation for the ones with whom the burden is being imposed.
Since a complex set of rules may force the players in a market to act in a certain and
prescribed manner, the same involves both cost implication as well as time involvement
12.
Regulations may impact private as well as corporate life and significantly influences the
life of not only individual public, but also the organizations, nursing homes, schools,
small and big sized non-profit organizations, manufacturers, pharmacies, retail shops,
etc. The researchers have identified three key aspects of the regulatory burden that are
noted below:
 Standard-setting: The "rule" itself is a typical feature of regulation that directs a
group of people or organizations to act in a specified manner and choices or
11 Koop, C., and Lodge, M. (2017). What is regulation? An interdisciplinary concept analysis. Regulation &
Governance, 11(1), pp.95-108.
12 Alves, T. L., Lexchin, J. and Mintzes, B. (2019). Medicines information and the regulation of the promotion of
pharmaceuticals. Science and engineering ethics, 25(4), pp.1167-1192.
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preferences may get limited. No such rule is being imposed by State-based
regulatory authority for a self-regulatory body and such variation of the nature of the
regulator may, in turn, significantly impacts the stakeholders of regulation and
compliance framework.
 Behavior modification: In the opinion of Karas, Feldman, Bai, Kang and Anderson
(2019), this is another critical component of the concept of regulation since non-
compliance of a given rule and requirement set may attract punishment in the form
of penalties, fines, withdrawal, non-approval, and cancellation, etc, there may prevail
a sense of threat or fear of such punishment which, at times, may adversely impact
the operation of the industry13. It is needless to mention that such an impact may
vitiate the very basic purpose of setting up the regulation in the market14.
 Information gathering: As per Alves, Lexchin and Mintzes, 2019), the regulators
need to know what they need to regulate and therefore it is critical for the regulatory
bodies to have detailed know-how and database about the market which needs to
be regulated. As a result, the information gathering process is a critical factor in
regulation setting a process15.
Researchers have opined that regulations have been two-fold in terms of achieving its
objective. There have been instances where regulations have been successful and
there is a number of cases where regulations and regulatory framework have been
proved to be unsuccessful. For example, the Environmental Protection Agency (EPA) in
13 Karas, L., Feldman, R., Bai, G., Kang, S. Y. and Anderson, G. F. (2019). Pharmaceutical Industry Funding to Patient-
Advocacy Organization: A Cross-National Comparison of Disclosure Codes and Regulation. Hastings Int'l & Comp. L.
Rev., 42, p.453.
14 Karas, L., Feldman, R., Bai, G., Kang, S. Y. and Anderson, G. F. (2019). Pharmaceutical Industry Funding to Patient-
Advocacy Organization: A Cross-National Comparison of Disclosure Codes and Regulation. Hastings Int'l & Comp. L.
Rev., 42, p.453.
15 Baldwin, R., Cave, M. and Lodge, M. (Eds.). (2010). The Oxford handbook of regulation. Oxford university press.
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the USA has failed miserably during the '70s and 80's to control air and water pollution.
However, the EPA invested their effort and millions of dollars to prevent such pollution16.
The theorists have proposed different paradoxes that may exist in a regulatory
framework few of which are mentioned herein.
Paradox one: over-regulation creates under regulation
It has been observed that an aggressive and stringent statutory policy may vitiate the
basic purpose of regulation and therefore the private players and market may not be
able to cope up with such stringent rules and policy sets and therefore a sense of under
regulation prevails throughout the market.
Paradox two: strict regulation may generate and increase the risk level
It is observed that imposing strict regulations may restrict new entrants into the market
and therefore it is a kind of discouragement for the players with innovative ideas and
newer sources and resources17.
Paradox three: Adopting best available technology will discourage innovation
In the US context, it has been observed that the government or EPA environment
protection agency is advocating for Best Available Technology (BAT) to be implemented
by the industry players; however, such proposition may restrict the scope to invent or
innovate with the existing technology18. As a result, the market gets fully clumsy with
new technology without sufficient resources back up to be utilized to run and use such
technology to its fullest extent.
Advantages
16 Sunstein, C. R. (1990). Paradoxes of the regulatory state. The University of Chicago Law Review, 57(2), pp.407-
441.
17 Sunstein, C. R. (1990). Paradoxes of the regulatory state. The University of Chicago Law Review, 57(2), pp.407-
441.
18 Parker, D. (2012). THE OXFORD HANDBOOK OF REGULATION edited by Robert Baldwin, Martin Cave and Martin‐
Lodge. Public Administration, 90(2), pp.563-564.
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 Helps the government or the regulatory agencies or the bodies to effectively
control the market
 The regulation also helps the authorities to reduce the information asymmetry
that may be prevailing within the market 19
Disadvantages
 Compliance with regulations may prove to be a costly affair at times.
 Regulations may prevent the operations of price mechanism at times and hence
the market corrections and dynamics may get adversely affected20.
2.2 Regulatory Risk
The reason for regulatory failures may be explained from two approaches namely
rhetorical and analytical. Rhetorical approach states that regulatory failure may occur in
three different ways:
 Futility: The researchers have stated that irrespective of regulatory effort, the
present situation may not be changed and that may be denoted with the example
that the behavior of people will remain the same regardless of the regulated
intervention21.
 Jeopardy: The approach states that the implementation of certain rules and policies
sets in one aspect will invite complexities and cost implications in another aspect.
For example, the adoption of a particular safety standard may involve serious cost
19 Levaggi, R., Moretto, M. and Pertile, P. (2017). The dynamics of pharmaceutical regulation and R&D
investments. Journal of Public Economic Theory, 19(1), pp.121-141.
20 Getrevising.co.uk. (2020). Government Regulation. Available at:
<https://getrevising.co.uk/grids/government_regulation>[ Accessed 16 April 2020]
21 Karas, L., Feldman, R., Bai, G., Kang, S. Y. and Anderson, G. F. (2019). Pharmaceutical Industry Funding to Patient-
Advocacy Organization: A Cross-National Comparison of Disclosure Codes and Regulation. Hastings Int'l & Comp. L.
Rev., 42, p.453.
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implications in terms of setting up necessary resources to be used in order to comply
with the standard22.
 Perversity: As per Demortain (2017), it means that regulatory interventions produce
exactly the opposite of the intended outcome; for example, the prohibition of a
certain medicine on the precautionary grounds may cause death or fatal injuries of a
patient23.
The analytical approach of regulatory failure is linked to the concept of bounded
rationality that significantly may impact individual as well as an organizational decision-
making process. Since the information is costly and capacity of an individual or an
organization to process the information for the purpose of decision making within a
given time frame and cost consideration is limited, there arises the concept of bounded
rationality that may raise question on the impact or the effectiveness of regulation
because of the ambiguity as to the cause effect relationship of regulatory instruments.
2.3 Risk Management in Regulations
Risk management may be defined to be a structured and methodological process of
eliminating or reducing risk by adapting an efficient mechanism. Risk management is an
approach whereby the risks are avoided or mitigated with the help of different tools
available for the purpose24. The risk management may consist of five different steps. In
the initial phase, the risks are being identified and then it is measured in terms of its cost
implication and timeliness. Then the probable solutions are examined and different
22 Karas, L., Feldman, R., Bai, G., Kang, S. Y. and Anderson, G. F. (2019). Pharmaceutical Industry Funding to Patient-
Advocacy Organization: A Cross-National Comparison of Disclosure Codes and Regulation. Hastings Int'l & Comp. L.
Rev., 42, p.453.
23 Demortain, D. (2017). Expertise, regulatory science and the evaluation of technology and risk: Introduction to the
special issue. Minerva, 55(2), pp.139-159.
24 Herrera, M. (2013). Four Types of Risk Mitigation and BCM Governance, Risk and Compliance. [online]. MHA
Consulting. Available at: <https://www.mha-it.com/2013/05/17/four-types-of-risk-mitigation/> [Accessed 16 April
2020]
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alternatives are being placed for decision making purposes. Out of those alternatives,
one best alternative is being chosen and finally the same is being implemented to
manage risk in the most optimum manner25. At the last, the result is being strictly
monitored and followed up and any deviation from the standard is being taken up for
further consideration26.
The theories of risk management may show that there are a number of ways in which
may be managed. One can avoid the risk by completely eliminating the same, or the
risk may be mitigated that means that the likelihood of the impact of risk is being
reduced to a certain extent. Thirdly, the risk may be transferred if at all it cannot be
eliminated or mitigated and such transfer is being made to a third party through mutual
negotiation and dealings27. Finally, the risk may be accepted if there is no chance of
transferring or reducing and mitigating the risk28.
2.4 Regulations in the Pharmaceutical Industry
Before discussing the regulatory framework in the given sector, it will be wise to discuss
the industry sector in brief so as to have an overview as to the growth prospects and
size of the industry. Such discussion will be helpful for the readers as well to
comprehend the regulatory contexts subsequently in a more detailed manner. The
industry has been one of the most regulated industries across the world and sizably big
25 Levaggi, R., Moretto, M. and Pertile, P. (2017). The dynamics of pharmaceutical regulation and R&D
investments. Journal of Public Economic Theory, 19(1), pp.121-141.
26 Karas, L., Feldman, R., Bai, G., Kang, S. Y. and Anderson, G. F. (2019). Pharmaceutical Industry Funding to Patient-
Advocacy Organization: A Cross-National Comparison of Disclosure Codes and Regulation. Hastings Int'l & Comp. L.
Rev., 42, p.453.
27 Banta, C., 2016. Risk Tolerance: To Avoid, Transfer, Mitigate Or Accept—That Is The Question!. [online] Pivot
Point Security. Available at: <https://www.pivotpointsecurity.com/blog/risk-tolerance-in-business/.> [Accessed 16
April 2020].
28 Rowe, C. (2016). The 5 Step Risk Management Process [Updated for 2018]. [online]. Clearrisk.com. Available at:
https://www.clearrisk.com/risk-management-blog/bid/47395/the-risk-management-process-in-5-steps [Accessed
16 April 2020].
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