An empirical analysis of the multimarket contact theory in pharmaceutical markets

Multimarket contact theory predicts that firms will optimally reduce prices in markets where collusive prices are sustainable and allocate the slack of the corresponding incentive compatibility to increase prices in markets where collusion is not sustainable. Binding price caps in collusive markets will have different effects over the multimarket contact mechanism depending on the severity of the cap. Setting a price cap close to the unregulated case will increase the size of the redistribution of market power whereas stronger regulation will even reduce prices in unregulated markets. Therefore, price regulations aiming at capping prices in a specific market will also affect markets that are not subject to specific mandatory price regulations. We find evidence of the theory predictions using information for nine OECD countries for pharmaceutical markets. Unregulated US markets are shown to respond to the redistribution effect; Canadian markets, known to be subject to soft price regulations, with respect to the former, are shown to be consistent with a stronger redistribution effect. EU markets and Japan are either consistent with the effect of a medium regulation or strong regulation. In this last case multimarket contact cannot explain prices, and these are expected to be lower compared to the unregulated benchmark.