China: Big Pharma's new New Jersey

NEW YORK (CNNMoney.com) -- U.S. drugmakers are investing heavily in China, but experts say the People's Republic needs to cast off its image as a maker of toxic recalls before it can rival New Jersey - home of half of the world's top 10 pharmaceutical companies - as a big hub for Big Pharma.

China's strong domestic market for pharmaceuticals has fueled interest from Western investors, who find the allure of cheap labor irresistible. The Chinese drug market is red hot, with sales jumping 12.3 percent in 2006 to $13.4 billion, according to IMS Health. Sales are projected to more than double by 2010.

Western drugmakers and biotechs - Merck (Charts, Fortune 500), Wyeth (Charts, Fortune 500), Eli Lilly & Co., (Charts, Fortune 500) Schering-Plough (Charts, Fortune 500), Novartis (Charts), Sanofi-Aventis, Biomed and Genentech, to name a few - are ramping up investments in China, as well as in India and Singapore, according to a report from PricewaterhouseCoopers analyst Dan Bartholomew.

In addition, China, India and Singapore have their own home-grown industries, while South Korea, Thailand and the Philippines are rapidly increasing healthcare spending.

"The tide towards production in pan-Asia is something that's not going to stop," said Bartholomew. "It's just a question of the measures that are put in place to do it the right way."

But all is not well in the People's Republic. In recent months, "Made in China" has become synonymous with faulty products, including counterfeit toothpaste containing dangerous levels of a chemical found in antifreeze, car tires with a tendency to disintegrate, and toys coated with dangerous lead paint.

U.S. companies have announced the recall of millions of Chinese-made toys, the most recent being Tuesday's announcement of more than 9 million Mattel Inc. (Charts, Fortune 500) toys.

Also this summer, the "Made in China" stamp has been marred by two high-profile deaths: the suicide of Zhang Shuhong of Hong Kong, contract manufacturer for Mattel, and the execution of Zheng Xiaoyu, former chief of China's State Food and Drug Administration, for accepting bribes to approve drugs.

China's State Food and Drug Administration has vowed to invest more than $1 billion through 2010 to strengthen its food and drug safety program. But there's a question concerning whether this is enough.

"The Chinese FDA just doesn't have the infrastructure," said Les Funtleyder, drug analyst for Miller Tabak. "They don't have the hundreds of inspectors who go out [to check factories.] They don't have the training. Until they bring things up to speed, I'm not sure the [U.S.] FDA is going to just accept drugs made in China."

That hasn't stopped Pfizer, Baxter, Bayer and Roche from investing in Chinese manufacturing. Big Pharma is lured by a strong local market and the possibility of cheap manufacturing for eventual export.

Dan Bartholomew of PricewaterhouseCoopers added that much of the recent outside interest in China, such as $100 million investments from Novartis and AstraZeneca, is for research and development because clinical trials are comparatively cheap to run in Asia.

This is despite the region's laissez-faire attitude to patents and intellectual property. Even in China, where "IP" (as the Americans call it) has long been considered a foreign concept, strides have been made to protect the patent-holders.

In 2006, a Beijing court ruled in favor of Pfizer in a patent dispute over Viagra, and this sent a strong positive message to U.S. drugmakers, said Bartholomew. The analyst claimed that R&D investments from Novartis, AstraZeneca and other Western drugmakers are a "huge statement" that their property will be protected.

The investments could be stepping stones to manufacturing, said Bartholomew, who projects that Chinese factories could be making drugs for the U.S. market within five years.

But analysts said this would only happen if aggressive measures are taken - by outside investors - to ensure sound product quality, and also to cut down on counterfeiting. Otherwise, legitimate manufacturers could have their brand-names misappropriated for use on dangerous and illegal copies, as occurred in the recent abuse of the Colgate brand by toothpaste counterfeiters.

But China-U.S.business relations can be notoriously complex, and quality control to meet the standards of U.S. regulators could take a bite out of the benefits of cheap labor.

"The bureaucracy in China is going to be less flexible and more serpentine [than U.S. regulators] and will take longer to get change and cooperation for change to really occur," said Robert Toomey, drug analyst for E.K. Riley Investments. "I think it comes down to economics. Is the need for cheaper labor offset by the need for more oversight of the process?"

The specter of a Vioxx-style recall hangs heavily over the prospect of Chinese-made exports to the U.S., analysts said, and it could spell big trouble for the industry.

"All it will take is one contaminated batch of drugs from China and your pharma company will have really big problems," said Funtleyder of Miller Tabak. "Given the skepticism around China, I'm not sure that a production facility in the continent to ship back here is worth doing."