Commentary

In the post-pandemic era, Chinese local governments have actively issued

policies to support the development of new drugs against the new crown. In 2022, the
Jinan Municipal Government announced that if an enterprise newly obtains a national
first-class new drug production approval number, each product will receive a one-time
reward of 20 million yuan from the municipal government; In the year when the new
drug is approved, the total cumulative reward given by the government to the
enterprise is the highest. 100 million yuan.What’s more it also reflects the role of
government intervention in creating additional social welfare.

New drugs developed by pharmaceutical companies create externalities that have a

positive impact on the rest of society. This kind of innovation not only enables
companies to gain profits and develop technology, but also protects the health of other
members of society and mitigates the spread of the new coronavirus. Third parties
actually enjoy more advanced drugs and medical conditions. Therefore, private
spending in the market will be lower than socialspending.

FIGURE 1

Figure 1 demonstrated how such scenario affected the market.Under the premise of no
market intervention, the best position of the market lies at the intersection of marginal
private cost of developing new drugs and marginal social benefit of technological
innovation. Also the market gives rise to the price and quantity at optimum level at
this point .On this basis, each new drug of a pharmaceutical company will make a
contribution to the technological development of society and the medical
environment, which is regarded as an external benefit in the figure. However, the
equilibrium position of the market (the intersection of MPC and MPB) is to the left of
the optimal position, which means that the resources in the market are not being used
most efficiently to maximize the production of new drugs.The market price of the
drug is significantly higher than the optimal price and the quantity produced is far less
than the optimal quantity.what's more, the overall welfare of society will also be
missing to a certain extent: the level of medical technology in society should have
reached a higher level.

Therefore, when the free market itself cannot effectively regulate the relationship
between supply and demand, government intervention can be used here as a "visible
hand" to artificially make market production reach the best position.

In order to maximize social welfare, the Jinan government solves this externality
problem through subsidies which the government provided to reduce the cost of
pharmaceutical companies in order to reduce the market price of their products.

FIGURE2
In the graph, if government applies certain amount of subsidy per unit good to the
pharmaceutical company, it can reduce the firm’s marginal private cost. Thus, the
MPC line will shift downwards vertically, which increase the quantity produced and
decrease the market price. Since both the market price and quantity produced are
closer to the optimum level. The size of welfare loss in the society will shrink its size
and the problem of underallocation of resources will be partly alleviated.

Although in this case, government can theoratically increase the social welfare and
make the market functions efficiently,there still many problems hidden inside of it.

The money utilized to subsidize the firm can actually have other uses, invest the
infrasturecture and healthcare service in Jinan can also helped people in pandermics
which are comparatively less risky. Since the failure is inevitable in technological
development. The government should consider the opportunity cost of such
expenditure.Furthermore if the investment is a loss, the sensitive topic of loss of state
capital can be involved.

As a means of administrative intervention, government subsidy damages fair

competition in the market. Since some pharmaceutical giants may posses more
advanced technologies and long experience, the monopoly may happen after the
government intervention. At that point, the small firms may face high threshold of the
industry.Thus, it is hard for Jinan governments to choose which one to subsidize.

Moreover, the size of the subsidize can be another major problem. If it is too small,
the firms may not be able to decrease its cost of production effectively. On contrast, if
the size is much larger than the external benefit, the firm may spend money in oher
area in operation rather than thdrug and therapy development. Therefore,the Jinan
government should keep the subsidy in a moderate range.

Overrall, although the Jinan government's funding activities can partially promote the
development of new crown drugs by local pharmaceutical companies, more
consideration should be given to the funding itself.