Quality Regulation and Competition: Evidence from Pharmaceutical Markets

Abstract

Quality regulation attempts to ensure quality and to foster competition by reducing
vertical differentiation, but may also have unintended consequences through its effects on
market structure. We study this trade-off in the context of pharmaceutical bioequivalence,
which is the primary quality standard for generic drugs. Exploiting the staggered phase-in of
bioequivalence requirements in Chile, we show that stronger regulation decreased the number
of drugs in the market by 25% and increased average paid prices by 9%. These adverse
effects were concentrated among small markets, suggesting that compliance costs played an
important role. We estimate a structural model with endogenous entry and certification to
study the role of drug quality, aversion against generics, and certification costs in shaping the
equilibrium effects of quality regulation. We find that quality regulation increased consumer
valuation of generic drugs through reducing asymmetric information and aversion against
unbranded generics, which induced entry of high-quality products in place of low-quality
products. Consumer welfare increased despite higher prices and a lower number of firms.

Keywords: quality regulation, competition, bioequivalence, generic drugs

JEL Classification: I11, L11, L15