Socially Optimal Solutions

Congestion is a problem of bad economics, not bad engineering.

I’ve heard this said a few times and I think it’s worth repeating. Another way of putting this is that our current economic framework does not result in a “socially optimal solution”.

Economists define a “socially optimal solution” as “the optimal distribution of resources in society, taking into account all external costs and benefits as well as internal costs and benefits.

It’s what we should be trying to get as close as possible to when setting up the economic framework in which our transport systems exists. Our current framework was introduced in the 70s and is largely unchanged since then. At the time it was seen as a massive step closer to a “socially optimal solution” than what we had previously, mainly because it introduced an element of user-pays. Previously transport infrastructure had been funded from general taxation. Now a reasonable chunk of it would come from users in the form of fuel excise and vehicle registrations.

But it’s definitely sub-optimal. It still sucks out massive subsidies from rates and general taxation, as well as imposing big externalities on society. I remember in 2017 when the Auckland regional fuel excise was being debated, someone asked Bill English why his nominally “centre-right” party didn’t support this small step closer to a user-pays system, and he said “we already have a user-pays system”. I wasn’t sure if it betrayed a dishonesty from Bill, or was just a reflection of how poorly New Zealanders understand how transport funding works here, even the politicians supposedly running it.

Despite being a step forward from what we had, our current system is a very long way away from being truly user-pays, and a very long way from being a socially optimal solution.

I’ve pondered a lot about what a socially optimal solution system might look like.

A socially optimal solution should be as close as possible to user-pays, accounting for both internal and external costs.

If we had a pure user-pays system, then:

  1. Costs of driving on rural local roads would roughly double (capital and maintenance costs of rural local roads are subsidised roughly 50% by rates).
  2. Costs of driving on rural state highways would stay roughly the same (capital and maintenance costs of state highways are not subsidised).
  3. Costs of driving on urban state highways would increase subtantially, probably several-fold at peak times. Although capital and maintenance costs are not subsidised, land costs are (which are much more significant in urban areas). Also the external costs of each car are far greater – the negative impacts of delays to everyone else trying to use road space, noise, vibration, pollution, safety, amenity, land values, public health etc.
  4. The costs of driving on urban local roads would increase the most, again probably by several times over at peak times. For the same reasons as point 3 above, plus having to double to cover the full cost of maintenance and capital.
  5. On average public transport costs would roughly double (services are generally subsidised around 50%). But this would vary wildly between routes. High-patronage routes would increase by only a small amount, or could even reduce in price. In contrast, low-patronage routes would increase by more than double. Also off-peak prices would likely plummet to almost nothing, while peak prices would spike.
  6. Costs of parking would generally increase, particularly in cities.
  7. All petrol/diesel vehicles (private and public) would cost significantly more to account for their carbon emissions and pollution.
  8. Costs of cycling would increase (from nothing at the moment). But it would be an extremely small increase given their negligible maintenance costs, tiny footprint and almost non-existent externalities (delays, noise, vibration, pollution etc).
  9. Similarly the costs of walking would increase (from nothing at the moment), but it would also be an extremely small increase.

It’s notable that every single type of travel would increase in cost. Or to put it another way, all travel is subsidised under our current framework.

To me this is a huge problem. It’s no wonder we are constantly battling congestion, over-crowding, lack of infrastructure, and lack of funding, when we as a society are subsidising everyone to travel lots more than they otherwise would.

I’d like to see the prices of travel increase to reflect their true costs. Obviously this means we could have corresponding decreases in rates and general taxation. But more importantly it means we wouldn’t need to spend nearly so much on over-the-top transport infrastructure that doesn’t actually make economic sense, meaning even further decreases in rates and taxes. It would also completely change the shape of our cities – there would be higher demand for walkable neighbourhoods and central city living, and lower demand for stand-alone houses in far-flung auto-dependent suburbia.

The mechanisms for this pricing will soon be with us. The people I’m talking to are saying that within 10 years the whole vehicle fleet in NZ will have GPS units that will charge for driving based on distance, time and location. This will make it easy (from a technological point of view anyway) to price driving at its true cost. We already charge fares for public transport, so doubling these is extremely easy. Walking and cycling are trickier to charge for as there is currently no mechanism to do so. Also, the charges would be so miniscule that any system we were to implement would probably cost more than the tiny amount of revenue you’d collect. So in reality we’ll probably always have to keep walking and cycling free of charge.

The only real problem I can see with moving to a socially optimal solution is the equity impacts. Although as a society we’ll be far better off overall, there will be a small number of people within society who end up worse off. I think this could be quite easily dealt with though, by providing discounts or free travel for certain groups (e.g. people on benefits, people with community services cards, mobility cards, the elderly, children, students etc.). Alternatively we could use some of the revenue collected to help these people through higher welfare payments, or lower income taxes for low earners. It’s far better to have sensible pricing combined with targetted benefits for those who need it, than to wontonly subsidise everything for everyone, as we do now.

Would you like our transport systems to move towards a socially optimal solution, or are you happy with our socially sub-optimal state of affairs?

12 thoughts on “Socially Optimal Solutions

  1. Nice one, Chris. I’m looking forward to parts 2 (Socially optimal solutions for freight transport) and 3 (Socially optimal solutions for rail transport).

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    1. I’m less familiar with how rail funding works. Operationally I think it’s subsidised similarly to buses so I guess it would roughly double. But in terms of capital and maintenance expenditure I don’t really know how that works, and what the relationship is between freight and passenger rail funding.

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  2. Regarding equity impacts, I argue that our existing system already creates huge equity impacts. We have created a car-centric transport system where a lot of people have no alternative to driving. They can’t take public transport (because it doesn’t exist or provides too poor a level of service) or can’t ride a bike (because it’s too scary) or won’t let their children ride (no responsible parent would do that, eh?). So they have to drive themselves, and their children, to wherever they need to be. And that is not necessarily the most equitable way it could be. Forcing people into car-dependency is inequitable. Having socially optimal solutions, no doubt, will also result in some inequality. But the problem should be far less than it currently is.

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  3. No car centric city has imposed congestion pricing. Only cities like Singapore, London and Stockholm with good alternative transport modes have achieved this more socially optimum transport pricing system.

    In the US surveys indicate increased public transport provision would be the more popular first step.

    Ideally any funding congestion pricing generates should go towards compensating the losers especially if their are regressive income effects. This could be in the form of a public transport grant for low income groups. Which would hopefully help expand the public transport network.

    The policy implications of this is that good alternative transport modes need to be provided first and then road pricing can be implemented.

    It would be good to also price other externalities like safety/accidents. Climate change. Wear and tear on roads by axle weight…..

    P.S isn’t the least subsidized road the one with the largest volume of traffic just below the congestion point?

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    1. (a) I suspect the advent of electric vehicles and the GPS fleet will completely change public perception on congestion charging. If we have already switched to charging every vehicle per km rather than per litre, then altering the per km rate by location and time isn’t that big a step.
      (b) But agree that timing and staging is very very important to get right.
      (c) Fully agree that we should properly price all externalities. most of them we do price partially (ACC levies for safety, ETS for climate change) but I don’t think it’s enough.
      (d) I haven’t heard that before but it sort of makes sense – under the purest user-pays system the most expensive travel would be either on roads that carry almost nobody (all their costs have to be borne by only a few people), or roads where demand significantly exceeds supply (e.g. motorway into Auckland at rush hour). I guess you can look to the airline industry for clues – the cheapest flights are usually on busy routes but at unpopular times. Quiet routes are expensive all the time, as are the busy routes at busy times.

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  4. Great article.

    Biggest other issue is that land use is not elastic in NZ and not able to respond quickly (transport is just the derived demand of spatial land use allocation.) to the change in transport costs socially optimal costs would mean.

    The RMA would need to be completely freed up (no zoning, no density restrictions, effects based only) at the same time.

    The immigration rate would also need to be managed at a sustainable level (mainly Auckland) so that additional land use development can be added at a rate that is physically possible to implement.

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    1. Agree the RMA needs changes you make land use more adaptable- not sure what the best way to do that is though.
      Not so sure about immigration… personally I think that, like trade, as borders become more open everyone gets better off. There’ll be some localised temporary pain for some people but i wonder if we just need to push through that and we’ll come out the other side better off.

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  5. Chris, I’m confused. What costs are you talking about? How could, for example: “Costs of driving on rural state highways would stay roughly the same (capital and maintenance costs of state highways are not subsidised).” and “Similarly the costs of walking would increase (from nothing at the moment), but it would also be an extremely small increase.”

    It seems you’re not including the costs on public health, environment, climate, etc…

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    1. In theory it should include all costs. I just didn’t mention ones I thought were not so significant. Emissions are included but I put them further down as a separate thing. You could probably argue that rural driving should have some sort of extra charge because it reduces public health. So yea maybe the cost of rural driving would actually go up a little.

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      1. Climate change and public health would be big. Might be worth looking at the European study that found they’re subsidising driving to the tune of 500 billion euros a year.

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