Incentivizing Capacity Investments for Global Health Products

Abstract

We study mechanisms that encourage manufacturers of global health products to build production capacity. This is particularly important for health products manufactured for low- and middle-income country (LMIC) markets where willingness to pay is lower and demand risks are greater. As a result, manufacturers can be hesitant to invest to serve these markets at an affordable price for those in need. Development finance institutions and philanthropies are beginning to utilize new instruments to incentivize production/distribution for LMIC markets. The goal of this paper is to understand the effectiveness of such mechanisms in different settings, and to translate our understanding into a framework to guide social investors. We examine four instruments – sales subsidy, capacity subsidy, low interest (concessional) loan, and volume guarantee – and obtain the following results: A capacity subsidy is less costly than a sales subsidy, but a sales subsidy is viable at lower levels of capacity and is less susceptible to moral hazard. A concessional loan has a payment structure similar to a capacity subsidy but has an important difference: while manufacturer savings and social investor cost are the same under a capacity subsidy, these values are linked to the costs of capital under a concessional loan and can be substantially different. A volume guarantee targets manufacturer’s risk rather than relying on the manufacturer’s private cost information. It becomes especially attractive in settings where the social investor has a more favorable and accurate view of the market and where uncertainty around the manufacturer’s cost structure is high.