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Using Technology to Fight Corruption in Pharmaceutical Purchasing: Lessons Learned from the Chilean Experience February 20, 2001 Jillian Clare Cohen and Jorge Carikeo Montoya I

Introduction

Medicines are fundamental inputs in any public health system and often the most costly. WHO reports that public spending on pharmaceuticals in developing countries represents the largest health expenditure, after staff salaries.1 Equally noteworthy, pharmaceutical expenditure is often wasted, particularly when drugs are procured because in many developing countries, drug procurement procedures are inefficient, non-transparent, and corrupt. 2 Identifying what constitutes corruption can be elusive. Oftentimes it is complicated to disentangle inefficient behaviour from corrupt behaviour, particularly in the pharmaceutical sector. In Latin America and the Caribbean, as in many regions around the world, examples of unethical procurement practices are common for these reasons and more. In a Central American country, inventory records revealed that stock levels of oral ampicillin, antibiotic eye treatment, and other products, were oversupplied because government purchasers received special commissions for their purchases.3 A recent study on public hospitals in Bogota, Colombia found that when bidding processes were not used, drug prices were consistently higher.4 And in Brazil, a municipal government was purchasing medicines from a local private pharmacy, at excessive prices because the mayor was friendly with the pharmacy owner.5 These practices are damaging not only for pharmaceutical purchasing but more widely for the success of health reform efforts in Latin America and the Caribbean. As governments seek to reduce health expenditures, ameliorate the quality of care, and to respond more effectively to patient’s needs, pharmaceutical purchasing systems must be able to contribute to the efficiency and equity objectives of health sector reform. Efforts are already underway in many countries in the region to reform pharmaceutical systems precisely because of this acknowledged need. Chile, the country focus of this article, has developed a transparent, electronic system of bidding for pharmaceutical purchases that has led to tremendous savings and helped increase access of the poor to essential medicines and shown how information technology can put the government at the service of the public6.

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WHO Medicines Strategy: Framework for Action in Essential Drugs and Medicines Policy 2000-20003, WHO, Geneva, 2000, p. 8. 2 The World Bank defines the term corruption as “… behavior on the part of officials in the public and private sectors, in which they improperly and unlawfully enrich themselves and/or those close to them, or induce others to do so, by misusing the position in which they are placed.” 3 Managing Drug Supply, Second Edition, 1997, Management Sciences for Health., West Hartford, Connecticut, Kumarian Press. 4 Liliana Jarmilla Mutis, Presentation at “The Multisectoral Approach to Improve Ethical Business Practices: A Contribution to Improving Access to Medicines in Latin America and the Caribbean,” Washington, DC, September 2000. 5 World Bank Mission, Bahia: Pharmaceutical System Overview, Back to Office Report, January 2000. 6 World Bank, PREMNotes, (2001), “Technological innovation in public sector reform: Chile’s public procurement e-system,” January, Number 50.

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What makes the Chile case compelling is that it reduces incentives for corrupt behaviour in drug procurement systems. Incentives for corrupt behaviour can be high because pharmaceutical purchasing typically involves large amounts of money, it can be replete with information asymmetries and usually public official salaries are modest so risking punishment for private gain has low costs. Corrupt practices can include collusion between pharmaceutical suppliers so that prices of pharmaceutical products exceed a fair price. The manipulation of contract awards by government officials to favour specific suppliers, is another example. Drugs can be purchased but not delivered to the intended public health facilities. And, payment for drugs procured can also be far greater than the value of the drug, thereby allowing corrupt individuals to “skim-off” public money for private use. We admit openly that the Chilean model cannot eliminate corruption entirely, nonetheless, it is a powerful example of how governments can reduce the risk of corruption with the requisite political will, financial resources, and well designed and executed interventions. It is our intent to show how the right mix of people, strategies and tactics, and resources, can lead to positive results. First, we provide an overview of the core problems in Chile prior to the pharmaceutical purchasing reform, next we provide an overview of the interventions that took place over the course of a five year period (1995-2000), and finally, we provide some of the results that can be attributed to the pharmaceutical purchasing reforms.

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Background

From 1979 until the early 1990s, the public pharmaceutical and medical supply system in Chile operated as a traditional centralised model - known as the central medical store. CENABAST, the supply agency of the National Health Service was the sole institution responsible for purchasing and distributing products to public hospitals,7and primary health centers throughout the country. (Chile has 180 public hospitals, of varying sizes and levels of care, and 300 primary health care facilities, most of the latter are managed at the municipal level). The public drug supply system was inefficient because it was poorly managed and many of the public officials working in the system lacked the know-how to administer a national pharmaceutical purchasing system. For example, there were stock-outs of essential medicines at the same time that there were over-stocks of some products. All too frequently, drug purchases were wasted because of poor storage conditions in the drug warehouses. Exacerbating these conditions, there was no overarching transparency in the pharmaceutical purchasing system, so the public could not monitor if the government was purchasing the best quality drugs at the lowest prices. These inefficiencies and non-transparencies created an environment which advantaged suppliers and disadvantaged the public.

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In 1985, the government had allowed public hospitals to choose whether they would receive their pharmaceutical and medical supplies from CENABAST.

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The Reform

In 1990 the new democratic government of President Alywin pledged to make social justice a priority and to ensure that government services became accountable and responsive to its citizens. The health sector, including the pharmaceutical procurement system, was one of the initial target areas for reform. More specifically, the focus of the pharmaceutical procurement reform was to devise a system of checks and balances in the pharmaceutical procurement system so that it would become transparent and, along with greater transparency, more cost-effective. A number of potential drug purchasing models were considered by the team of government reformers but ultimately the model they chose to implement was novel and hence risky as it had never been tried before. The basic rationale behind the pharmaceutical purchasing and supply reform design was to transform CENABAST from a product supplier to a mediator of pharmaceutical purchases between suppliers and clients. In addition, CENABAST would ease the risk of default payments by hospital providers by acting as a financial guarantor of the transactions that would take place between the hospitals and their pharmaceutical suppliers. Eventually, an electronic bidding system was to be launched that could help hospital buyers use their purchasing power against suppliers in a transparent process.

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Fostering Transparency in Pharmaceutical Purchasing

The reform of CENABAST involved three elements, all designed to make the drug purchasing system more transparent and accountable. The centrepiece of the reform was the creation of an electronic bidding system and the use of the internet for information dissemination.8 First, CENABAST was institutionally reformed. Second, an electronic bidding system was created and CENABAST became a mediator and guarantor of drug purchases. Third, a communications campaign was launched in parallel to the operational reforms. This campaign focused on winning over the main stakeholders in the pharmaceutical sector by ensuring they knew the potential benefits the reform potentially offered to them. Implicitly, the information campaign informed them that pharmaceutical purchasing practices would be under close scrutiny. As part of the institutional reform, CENABAST’s responsibilities, such as purchasing, and others like the storage and transport of drugs was delegated to other health agencies and the private sector. Thus, the potential for monopoly and collusion was mitigated. In addition, all steps in the drug purchase and supply chain would be monitored by an information technology system that could keep a record of the types, prices, and suppliers of drug purchases. The second major element of the reform, the electronic bidding system, helped reduce the likelihood of collusion by subjecting suppliers to a competitive bidding process by making drug prices common information to all suppliers and their clients. The bidding system operates as follows. Participating drug purchasers (hospitals) submit their •

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For a more detailed discussion of the reform, please see “The Pharmaceutical Supply and Distribution System: The Chilean Experience, ” Jillian Cohen, Sandra Rosenhouse, Julio Sanchez Loppacher and Jorge Carikeo Montoya. Montoya. World Bank , IESE and World Bank (2000), prepared for Europe and Americas Forum on Health Sector Reform, Costa Rica, 2000.

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projected drug needs for a six month period to CENABAST. Following this, CENABAST compiles a list of all drug products needed by those hospitals that submitted estimates. Drug suppliers are then invited to participate in a price competition at CENABAST’s facilities. Concurrently, drug suppliers submit their proposed prices through a computer network for the specific drug products and quantities. All suppliers are provided with information about the lowest bid made and are able to reduce the prices they originally offered in view of the new information on their competitors prices. This bidding process continues until an equilibrium has been reached; that is, an agreed price is reached upon by CENABAST and the supplier. CENABAST, in addition, provides incentives for drug suppliers to participate in this drug bidding system because it agrees to act as a financial guarantor of the drug purchases made. The third component of the reform is an information and communication campaign. CENABAST regularly informed suppliers and purchasers about the process of reform and appealed to the self-interest of managers by emphasizing how they could gain benefits from participating in the new purchasing system. In particular, CEOs of pharmaceutical firms were targeted. Their endorsement was critical insofar as they helped the government reformers overcome resistance to change from the mid-level managers of pharmaceutical firms. The latter were generally reluctant to participate in the new purchasing system as many viewed the reforms as a threat to their job security. Additionally, for some dishonest managers, they resisted the reform because they perceived, rightly so, that their capacity to exercise influence and make private gains, would be severely curtailed with the improved transparency of the new system.

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The Impact

The new Chilean pharmaceutical purchasing system offers hospitals choice. The only mandated edict hospitals are subject to is to compare the costs of products and services with CENABAST to those obtained directly from suppliers. One-third of the total number of hospital purchases have been made through the CENABAST system since its inception. This figure reveals that the bulk of drug purchases are still made directly between the hospital and the supplier but also promises expansion. However small, the presence of a transparent system helps consumers and purchasers determine what are fair practices and prices in the purchase of medicines. Presently, CENABAST uses the intermediary model, discussed above, for most of its product portfolio. Data processing and communication support has been developed. Almost all of the 180 hospitals in the public health network are using CENABAST as a mediator, as well as the health care centres which are located in the central region of Chile. The new model has resulted in an increase in CENABAST’s transactions, as well as in the share of the National Health Service spending (S.N.S.S).(as conveyed in Table 1):

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Table 1. S.N.S.S. Expenditure on Pharmaceutical Products and Medical Supplies (in thousands of dollars). YEAR CENABAST S.N.S.S. hospital CENABAST’s share (%) spending expenditure in S.N.S.S spending 1994 23, 143 101, 456 22.8 1995 23,766 92, 275 25.7 1996 29, 472 111,052 26.5 1997 35,108 124,979 28.1 Source: CENABAST, Fonasa CENABAST’s new operational design and mediating role have become well-known to suppliers. Although some continue to sell their products through the “old” CENABAST’s system, they are increasingly using the electronic bidding systems because of growing demand from their customers for cost-effective medicines. The economic arguments are strong: CENABAST’s new model has resulted in significant savings for the public sector in terms of its drug budget. In 1997, the group of hospitals saved an estimated US $4 million in medicines and medical supplies, by using the new system. This estimate is based on the fact that in the bidding processes to date, hospitals have gained savings that vary from 5 to 7%. Also, prior to the new model, CENABAST levied a 14% margin on its operational transactions. This margin is now reduced to 5% or 10%, depending on the volume of pharmaceuticals purchased.

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Discussion

The Chilean model illustrates how creativity can lead to savings in a pharmaceutical supply system. A hybrid procurement model, incorporating positive features from both a decentralised and a centralised model, can achieve accountability and savings. On the one hand, the centralized features of the model allows the public health sector to use its purchasing power effectively to generate savings. And even though a central agency for drug supplies exists, the model is in practice highly decentralised. CENABAST assumes a mediating role between hospitals and drug suppliers when hospitals choose to purchase their supplies through it. Or, hospitals can choose to purchase through the CENABAST or directly from the suppliers themselves. Many choose some mix of the two. The experience in Chile also illustrates how electronic bidding and information dissemination through the internet are useful tools to mitigate against the risk of corruption. These tools can be more robust when they are coupled with parallel efforts, such as ensuring that a wide range of suppliers, both local and international are competing for each drug product that is being tendered. The latter can help foster price competition and mitigate against collusion and or price gouging on the part of the suppliers. However, the pharmaceutical purchasing system needs to ensure fair prices for pharmaceuticals, not only for the consumer, but for the supplier as well so they are induced to participate.

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Before pharmaceutical systems are reformed, policy makers should assess the potential risk of corruption and inefficiency9 of each purchasing model in their country context. Some pharmaceutical specialists preach the decentralisation mantra as the most effective way to mitigate against corruption. They argue that when smaller amounts of money are involved in the transaction, the incentive for corrupt behaviour is not as high. We disagree. Decentralisation cannot solve corruption but simply decentralises it unless certain good procedures and the right incentive structures are in place.

VII

Lessons Learned:

1. The Chilean case illustrates that corruption can be minimized in procurement systems by applying the appropriate supply model and mobilising technology effectively. Good incentive structures, rather than cumbersome rules, that are often easily circumvented, can also foster ethical behaviour and cost-effective purchasing. 2. The electronic bidding system can be a useful tool to fight the corruption in the purchase of pharmaceutical products because it reduces information asymmetries, broadens participation, and provides clear rules-of-the-game. While the Chilean model may not be appropriate for all country settings, its application is attractive to apply when great volumes of medicines are being purchased. Potential suppliers can be “sold” on the benefits of the model because of the volume of the purchase. The purchasers, on the other hand, can be “sold” on the benefits of gaining more purchasing power. 3. Finally, the Chilean case illustrates that not one strategy, but a mix of strategies, can help minimize corruption in pharmaceutical procurement. They include a centralized agency that assumes a role as mediator between suppliers and clients and an electronic biding system that can lead to more cost-effective purchasing. While imperfect, the Chilean experience shows how small but deliberate steps can be powerful in the battle against corruption. It also demonstrates how information technology and good institutional designs can allow governments to become more service-oriented so they perform the job they are mandated to do by the public. Dealing with corruption in pharmaceutical purchasing is challenging but essential for the objective of providing good quality medicines to the population, particularly to those in greatest need.

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Jorge Caríkëo (1999) : “ The Analysis of the Supply System Reforms in the Chilean Health Sector” mimeo, develops this point.

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Bibliography Broun, Denis. (1994). Procurement of Pharmaceuticals in World Bank Projects. HRO Working Papers, Report No. 13525., Washington, DC. Caríkëo, Jorge (1999) : “ The Analysis of the Supply System Reforms in the Chilean Health Sector.” Mimeo. Cohen, Jillian Clare. (2000). Public Policies in the Pharmaceutical Sector: A Case Study of Brazil. LCHSD Paper Series No. 54. Human Development Department, Washington, DC: The World Bank. Cohen, Jillian, Sandra Rosenhouse, Julio Sanchez Loppacher and Jorge Carikeo Montoya. (2000). “ The Pharmaceutical Supply and Distribution System: The Chilean Experience, ” Country Case Study Prepared for Europe and the Americas Forum on Health Reform, San Jose, Costa Rica. IESE and World Bank. Departamento Administrative de la Funcion Publica, Colombia, (2000). Riesgos de Corrupcion en la Administracion Publica, Santa Fe de Bogota, Tercer Mundo Editores. Govindaraj, Ramesh, Michael Reich and Jillian Cohen (2000). “World Bank Pharmaceuticals Discussion Paper,’’Human Development Network, World Bank, Washington, DC. Gray-Molina, George, Ernesto Pérez de Rada, Ernesto Yañes (1999). “Transparency and Accountability in Bolivia: Does Voice Matter? ” Inter American Development Bank Research Network Working Paper #R-381. Kaufmann, Daniel, Aart Kraay, Pablo Zoido-Lobatón (2000). “Governance Matters: From Measurement to Action” Finance and Development, IMF, June, Volume 37, Number 2. Klitgaard, Robert (2000).” Subverting Corruption,” Finance and Development, IMF, 2000, Volume 37, Number 2. ____________. (1990). Tropical Gangsters: New York, N.Y. Basic Books. Klitgaard, Robert, Ronald Maclean-Abaroa and H. Lindsey Parris, (2000). Corrupt Cities: A Practical Guide to Cure and Prevention, Institute for Contemporary Studies and World Bank Institute, Washington DC. Lashman Hall, K. (1986). Pharmaceuticals in the Third World: An Overview. PHN Technical Note 86-31. Washington, DC: World Bank. Management Sciences for Health. (1997). Managing Drug Supply, 2nd Edition. West Hartford, Connecticut: Kumarian Press. Pan American Health Organisation (1998).: Health in the Americas. Washington, DC.

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World Bank, PREMNotes, (2001), “Technological innovation in public sector reform: Chile’s public procurement e-system,” January, Number 50. World Bank, Bahia: Pharmaceutical System Overview, Back to Office Report, January, 2000. World Bank. (1997). Helping Countries Combat Corruption: The Role of the World Bank. Washington, DC: World Bank. WHO. (2000). Medicines Strategy: Framework for Action in Essential Drugs and Medicines Policy 2000-20003, WHO, Geneva, 2000, p. 8.

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