Vaccines: How to Use Market-Based Incentives to Ramp Up Production

The EU’s procurement strategy is clearly failing. A major supplier, AstraZeneca, has just announced major delays in its delivery schedule while the pandemic continues unabated. How did it come to this?

The EU negotiators made two mistakes: first, they concluded their contracts much later than other large buyers, for example three months after the UK in the case of AstraZeneca. The early orders meant the company could confidently start to prepare for increased supplies to the UK, long before beginning its preparations to supply the EU. Moreover, the EU haggled for a low price, creating an incentive for companies to serve first those who ordered first (and paid more).

The EU’s second mistake was to conclude contracts with vague delivery targets specified in quarters, if not years. It is understandable that the companies themselves could not accept binding targets of delivery for a totally new product. The contracts thus specify only that the companies should make “best efforts” to deliver on schedule. The Commission has published a redacted version of the contract with Curevac that mentions an “estimated delivery schedule” by quarter, albeit with the exact time line redacted. This “estimated” delivery schedule is anyway of little value, since paragraph 1.12.2 states that in the event of a delay, all the company must do is to explain the reasons for the delay and submit a revised delivery schedule. In addition, the contract states that “the Parties agree that doses will be delivered if and when lots are released and not necessarily at the end of a quarter.” The contract with AstraZeneca contains even fewer provisions pertaining to delivery delays. This is not surprising, since it was agreed with AstraZeneca that the company would be reimbursed only for the cost of the vaccinations. One should not expect too much from a company that cannot make any profit on a service. Given the huge disadvantages for society that a delay of one or two months entails, such vaguely worded agreements are clearly inadequate.

Economic Explanation for the Behavior of Suppliers

This lack of enforceability in the delivery schedule or of economic incentives to deliver early has an important implication: with a constant price per dose, the companies have no incentive to ramp up production as quickly as possible given that they would not be compensated for the additional costs. In a standard adjustment cost model, which usually assumes that the cost of ramping up production quickly increases more than proportionally (quadratic adjustment costs), a company looking to maximize profit would opt for a constant increase in production capacity. A linear increase in production (per unit of time) will then result in delivery delays. The rate of increase the company chooses will of course depend on the delivery schedule. The more elastic the delivery schedule, the slower will be the increase in production capacity. As the delivery schedule for the EU is non-binding, it is not surprising that companies are finding reasons to slow down the increase in production. As the contracts stand, it is more profitable for companies to deliver late. There is no altering the fact that the EU is now sitting on poorly drafted contracts that specify a low price for a large quantity; but only “best effort” promises on timely delivery.

However,  policymakers still can and should take urgent steps. 

Premiums as a Proposal to Solve the Problem

The EU should offer to pay AstraZeneca or Pfizer/Biontech an additional premium for any additional doses delivered early. Given the extraordinary cost to society of the continent-wide pandemic and lockdowns, this premium should be very high. A dose delivered three months early could well be worth hundreds of euros to society, even though the cost is much lower. According to a recent study, the pandemic reduces global economic output by some EUR 420 billion each month. Every additional dose of vaccine delivered in 2021 has a value to society of roughly EUR 1,500[1]. It would be worth offering the companies much more than the EUR 15 euros (in the case of Pfizer/Biontech) or even less (in the case of AstraZeneca) they get today [2]. If the premium is offered only for deliveries before a fixed deadline of, say, the start of April or May 2021, companies might hesitate to take the risk of trying to quickly build up new production capacity. But there are ways to address this problem: a new sliding price scale, starting at a multiple of the original price but going down over time, would reduce the risk of missing a fixed deadline and give the companies a strong incentive to ramp up production. The additional funding would also allow the companies to contract other pharmaceutical companies to use their production capacity and their qualified personnel. This would reduce risk and make good use of all available specialized resources.

Economic incentives to accelerate production would be much more productive than the empty threat of suing AstraZeneca. The additional cost for boosting vaccine supply for Europe might run into a couple of billions of euros, but this would be a lot less than the cost of prolonged disruption to the economy and society, let alone the lives lost.

[1] See Ahuja et al (2020): Preparing for a Pandemic: Accelerating Vaccine Availability, Becker Friedman Institute Working Paper No 2021-08.

[2] See https://observer.com/2020/11/covid19-vaccine-price-pfizer-moderna-astrazeneca-oxford/