China's Anti-Corruption Crackdown Closes In On GlaxoSmithKline Exec For Bribery And Price Surges

Chinese President Xi Jinping’s widening crackdown on corruption, which snared a GlaxoSmithKline (LON:GSK) executive on Wednesday, is yet another sign that foreign companies’ biggest risk in the country may be insisting on high prices for their products.

Chinese authorities announced on Wednesday that an investigation of Mark Reilly, the British drugmaker’s senior vice-president of pharmaceuticals for China and Hong Kong, found that he was operating a “massive bribery network,” according to Chinese police officials.

According to Gao Feng, the deputy director of the Ministry of Public Security’s economic crimes unit, Reilly’s bribery scheme began in 2009 when he had his local sales teams bribe doctors, hospital officials and other health care-related figures to use Glaxo products over other brands. The bribes were effective, reportedly resulting in billions of yuan in “illegal revenue” for the company, Gao said in a press statement. While dozens of others have been implicated in the bribery charges, Gao did not offer the names or details of other individuals investigated as part of the probe.

China’s medical industry is a breeding ground for widespread corruption. According to a report by the South China Morning Post, doctors and hospitals routinely accept illicit funds from patients and medical goods suppliers to cover budget gaps and pay for staff salaries. Hospitals also reportedly push certain drug prescriptions over others by assigning sales quotas to employees. In Glaxo’s case, Gao says that bribes in hospitals were able to increase drug prices for the company's medications by up to seven times what they cost in other countries.

Similarly, another foreign drug-maker, AstraZeneca (LON:AZN), announced last July that one of its salespeople was being investigated by Chinese authorities, in what might also be an anti-graft probe.

The real reason for the investigation of Glaxo may have to do with the prices of the drugs it sells in China. The focus on Glaxo and other foreign players in the health care sector by Chinese authorities and media may be tied to a larger issue in the country -- the dismal state of the government-run medical industry, which is often the target of public criticism. People are unhappy about the high prices and low quality of care in many of China’s underfunded hospitals, which are strapped for cash as result of uneven distribution of public funds, particularly in smaller cities. Cases of violence in hospitals against doctors and other medical professionals highlight widespread discontent with the quality of care. A survey released by Horizon Research Consultancy Group last October found that 95 percent of those surveyed said health care was expensive, with 87 percent saying costs were higher than they were four years earlier.

According to a research note from Deloitte on the corruption risk in China’s pharmaceutical market, the crackdown launched by the president as part of a larger anti-corruption drive has larger political implications. “The potential political fallout if the initiative is seen to be ineffective, and the significant sums of money involved, means that addressing graft in the health care industry is a key component of China’s nationwide anti-corruption drive,” the report said. According to Deloitte, the National Development and Reform Commission is looking into potential overpricing by 60 pharmaceutical companies.

In the mineral extraction industry, Rio Tinto Ltd (ASX:RIO) faced similar scrutiny for driving up prices in the mid to late-2000s, in an industry equally crucial to China's economy. China’s local steel industry criticized the British-Australian metals and mining corporation for driving up the prices of iron ore in 2007 and early 2008. Chinese steelmakers publicly expressed concern that Rio Tinto was purposefully manipulating prices because China relied on such resources to fuel the nation’s construction boom.

Four Rio Tinto employees were eventually prosecuted and found guilty on other charges, including accepting millions of dollars in bribes and stealing industry secrets.