A Practical Proposal for Privatizing the HighwaysLet us suppose that our national highway system is a”natural monopoly,” as economists use the phrase. Howcould it be privatized? In particular, how could it beprivatized in a way which would:(a) create private enterprises’ usual incentives to keepprices and costs low and quality high(b) create incentives for innovation(c) keep the low transactions costs of free public provision(d) eliminate any need for continued regulation typical of”contracting-out” schemes(e) be simple enough to win public support?2. An Overly Simple ProposalThe simplest answer would be to simply give every adultcitizen in the country a share of stock in the road system,and then let the Privatized Road Corporation do whatever itlikes. It could charge a flat fee, per-mile charges, tolls, orany other combination. Naturally, the Corporation wouldearn massive monopoly profits, but if everyone in thecountry were receiving a share of them, why should wecare? In fact, if we push the logic far enough, we will notethat if the consumers and the stockholders are the samepeople, then trying to extract monopoly profits would becompletely futile. But on second thought, we should note the strongassumption underlying this idea: it assumes that everyone inthe country would use the roads to the same extent, and thateveryone in the country would hold an equal number ofshares. The latter condition would _initially_ hold byassumption; but in all likelihood, some people would selltheir shares to others, and the largest shareholders would,as usual, hold the positions of power in the corporation. Similarly, executives would probably receive much of theircompensation in stock benefits. The result would be thatthe people making the pricing and other decisions of thePrivatized Road Corporation would make a great deal moremoney from higher stock earnings than they would lose frompaying high road prices. Indeed, this is the typical corporatesituation in any industry: because an oil executive buys onlya small amount of oil, but receives much of his pay in stockoptions, the fact that he is one of the consumers who willpay high prices is trivial for him. Of course, if the Privatized Road Corporation will be able toearn massive monopoly profits, this will be reflected in thestock price; if everyone in the country starts with a share,the real recipients of the monopoly profits would be all of us. The distributional issue would be irrelevent. But what_would_ matter would be the so-called “deadweight loss ofmonopoly.” If a road firm charges $5000 a year to drive onits roads, but the marginal cost of another driver is only$1000, then consumers who were willing to pay $5000merely _transfer_ some wealth to the road firm; but all of thebenefit of consumers willing to be $4999 to $1000 isneedlessly lost. A system of equal initial distribution ofshares renders the transfer from consumer to road companycompletely neutral; but it does nothing to negate deadweightlosses. Admittedly, some pricing regimes (known as multi-parttariffs) can theoretically eliminate deadweight loss. Onecommon sort of multi-part tariff is to charge a high flat per-person fee and a low per-unit fee. If a convenient multi-parttariff existed, then the simple proposal to distribute sharesand let the Privatized Road Corporation do as it pleaseswould be sound. But normally it is difficult to implement afully efficient multi-part tariff system; in particular, doing somight involve very high transactions costs which wouldthemselves constitute a deadweight loss. Let us then see how this first proposal measures up by thestandards we set at the outset:a. The competitive checks on pricing are extremely weak. While monopoly profits would be shared equally beeveryone, the deadweight losses of monopoly pricing wouldbe captured by no one. There would, at least, be a normalincentive to maintain quality and keep costs down which isnotably absent in state monopolies. b. The incentives for innovation would be distinctivelyimproved. What incentive does a state monopoly have toimprove its product or lower costs? In contrast, a privatemonopoly has every incentive to exploit all possible costsavings and to introduce new and improved products. Itmay charge an arm and a leg for them, but it will certainlywant to introduce them. c. It definitely seems like a private road system could havevery high transactions cost. In a best-case scenario, itwould just charge a (high) flat fee; this would be a definiteimprovement over the current morass of registration fees,gasoline taxes, tire taxes, and tolls used to pay for theexisting highway system. In a second-best scenario, the monopoly privatized firmwould charge per-use fees, but would at least have anincentive to adopt new, cheap technology for collecting itstolls (for example, a device similar to the supermarket pricescanner). Government monopolies can’t directly reap thegains of cheaper toll-collecting technology; in fact, adoptingsuch technology could seriously impede the _political_profits of existing toll collection services, especially thesinecures that toll-collection agencies can bestow onpowerful public-sector unions and their members. In a worst-case scenario, however, the Privatized RoadCorporation would put all of its energies into extractingevery dime of surplus possible. They might spend$1,000,000 on new detection technology in order toincrease profits by $1,000,001. In essence, they wouldfocus their energies on redistributing rather than producingwealth. While this is an extreme picture, would should notdismiss it out of hand. It is a possibility. d. This proposal would indeed end all regulatoryinvolvement. This is its advantage over the more popular”contracting-out” or “contract-bidding” proposal, whichinvolve a host of agency and enforcement problems. e. The simplicity of the proposal is one of its main sellingpoints. Almost anyone could understand the basic idea,although many people might have trouble understanding theconnection between the high value of their share prices andthe high charges for using the roads. 3. My Solution: A Dual-Securities ApproachI have an alternative privatization scheme which I believehas the strengths of the previous proposal without itsweaknesses. Its main drawback it simply that it is quite a bitmore complicated that the previous one. I shall begin byoutlining the basic institutions of the system, and thenexplain how this system would work, and why it would workwell. (Which is not to say that my basic idea could not befurther improved upon — I’m eager to hear suggestions!)To start with, every adult citizen would receive not one, but_two_ securities. The first would be a standard piece ofcommon stock, which would entitle the owner to his or hershare of the Privatized Road Corporation’s profits. Thesecond would entitle the holder to operate _one_ motorvehicle on the highways in exchange for an annual fee. This annual fee should be set around (probably slightlyabove) the per-capita long-run maintainence cost of thehighway system and well below the marginal willingness topay for the right to operate an additional vehicle. Now if you carefully re-read the last paragraph, you willnotice that the system is set up so that _both_ securities willhave a positive price. The share of common stock will havea positive price because the expected value of future profitsis positive. But the second security, which gives the right tooperate a motor vehicle, will _also_ have a positive price,because the annual fee is deliberately set below theconsumer’s surplus of the marginal user.
Now the basic feature of the corporate charter would be thatcorporate officers would be required to hold _equalnumbers_ of both types of securities in their portfolios. Executive stock incentives would be balanced between bothsorts of securities; members of the board of directors wouldbe eligible only if their holdings of both sorts of stock wereroughly equal. Corporate voting rights would be based uponone’s _joint_ holdings of both sorts of stock. In other words,the entire corporate charter would focus upon maximizingthe value of the _sum_ of the two securities. Now why would anyone hold a large number of the secondtype of security? No one can drive a hundred cars, so whyhold a hundred permits to hold cars? The answer is thatlarge holders of the second sort of portfolio would _rent_their use to individual users. One easy method would be ifthe Privatized Road Corporation annually issued oneregistration sticker per type-2 security owned; then theholders of excess stickers could sell their excess annualstickers, while retaining ownership of the security itself. What is so great about this system? The answer is that itgives very strong incentives to adopt policies whichmaximize profits _plus_ consumers’ surplus; it givesincentives to trade off profits and consumers’ surplus tomaximize the size of the total pie. And again, there is noissue of redistribution because by assumption we would allstart off with equal numbers of both securities. Let us consider a simple example. Suppose that the head ofthe corporation is pondering whether to set up a system ofmeters on bridges. In the plan outlined in section two, theCEO just wants to maximize profits; he would implement theplan if the cost of the metering system were less than theextra profits extracted. But in _this_ plan, the CEO has avery different problem. If he sets up the meters, the value ofhis type-1 security goes up due to the greater expectedprofit stream. But the value of type-2 security will _fall_! Before, the marginal motorist was willing to pay $1000 for asticker; but now with the toll the value of the permit is less,so the price will fall. Moreover, if the bridge is uncongested,we would expect the value of type-1 securities to rise by(extra profits from toll – cost of collecting toll), whereas thevalue of type-2 securities will fall by (extra profits from toll -deadweight loss). In short, the sum of the two securities willfall if (costs of collecting toll + deadweight loss) is positive;or in other words, if the proposed change is not Kaldor-Hicks efficient. The only case where the CEO would nowwant to add a toll is if doing so would reduce congestion, cutdown on wear-and-tear, or otherwise improve the quality ofservice or reduce the costs of production by more than thecosts of toll collection. What’s the trick? The trick is essentially that by creating afixed stock of type-2 securities, we create a _perfectlyinelastic_ supply of driving licenses. Since the incidence ofmonopoly power (like the incidence of taxation) will alwaysfall _entirely_ upon the holders of the inelastically-suppliedgood, it becomes possible to make the benefit and theburden of monopoly power fall on exactly the same people. In fact, it isn’t even necessary to set a fixed flat fee for theownership of a type-2 security; since the incidence will beborne entirely by the owners of the security rather thanconsumers, and since we have set up our corporategovernment to evenly balance the interests of both types ofsecurity- holders, we could even let the Privatized RoadCorporation set the annual fee ab libitum without fear. The only important consideration is to make sure that thenon-negativity constraint on the market value of the twosecurities never binds. If it did, then assuming that sharevalues could not fall further, the incentive for inefficienttransfers from consumers to shareholders could re-emerge. The really crucial question is how to set the initial number ofshares. If we set them simply to cover marginal costs, thenwith increasing-returns-to-scale technology it wouldimpossible to cover fixed costs and maintain a positive valuefor type-2 securities. On the other hand, if we set thenumber too low, then a growing population would not enjoythe full potential benefits of the national highway system. To put the first problem in perspective: the current roadsystem _already_ inefficiently excludes many low-valueusers. In most states there is a registration fee, a gasolinetax, a tire tax, and a myriad of other costs which keep low-end drivers off the road. There would be no need for thePrivatized Road System to suffer any greater inefficiency onthis count. In fact, when we consider the fact that the valueof the type-2 securities will discount their expected netearnings into an infinite future, the number of low-end userswho would need to be excluded from the highways in orderto maintain a positive share value could be quite small. The second problem — of the number of type-2 securitiesbecoming progressively less adequate to serve a growingpopulation — could be handled in two ways. First, in thecorporate charter it might be specified that the PrivatizedRoad Corporation is obliged to issue a number of shareseach year equal to e.g. the growth in the population. Butthis would probably not be necessary. The firm wouldalways be free to offer deals to non-security holders. Indoing so, it would exercise some monopoly power, but thismonopoly power would be constrained by the availability ofthe fixed stock of type-2 securities. (Like the existence ofused cars constrains the pricing of new automobiles.)In fact, we could get rid of the non-negativity constraintentirely if we combined the type-1 and type-2 securities sothat they could not be sold separately. Security holderscould “rent” the right to use the roads, and the expected sumof rental values plus the expected sum of profits woulddetermine the value of the combined security. While thiswould be theoretically preferable, I think that the dispersionof renter and shareholder interests created by my dual-security system is desirable on public choice grounds (inparticular, I think it makes abrogation or alteration of thecorporate charter vastly more difficulty), and this gain isworth the slight efficiency created by the non-negativityconstraints. Turning finally to points (a) – (e), we find that:(a) The dual-security system adds powerful incentives forefficient, competitive pricing, while sharing the incentives forquality and cost-control of the first proposal. (b) The incentives for innovation are again quite vigorous. (c) On transactions costs grounds, the dual-security systemis clearly superior to the first proposal. The way that thesecurities are designed ensures that the firm will only incurtransactions costs when the _total surplus_ gain exceedsthe transactions costs; whereas in the first proposal, therewas an incentive to incur any transactions costs which wereless than the extra profits they brought it. (d) As before, there would be no need for continued publicregulation. It would merely be necessary for the corporationto live up to its own corporate charter; and as I noted, thedual-securities approach makes it quite difficult for largeshareholders to alter the charter to their own advantage. (e) Unfortunately, my proposal is quite complicated. Thismakes it difficult to explain it to the general public and winits support. While this is a serious problem, and one thatworries me, the general approach seems promising enoughto make it worth further exploration. In particular, we shouldnote that the principles outlined here could be adapted tothe seemingly intractable problem of how to privatize _any_existing state-owned natural monopoly. 4. ConclusionI haven’t been nearly as rigorous as I would eventually liketo be on this topic. There are several points where Iavoided discussing some of the thornier issues in theoreticalIO. I’m not sure if my proposed system could meet any ofthe strict technical standards for Pareto-optimality. However, I do think that I have proposed a surprisinglyworkable method of privatization for a whole range of statemonopolies which economists usually don’t even considertrying to privatize.