The Problem of Social Cost in Transportation

The Problem of Social Cost in Transportation


C Angelo Guevara, Massachusetts Institute of Technology, US and Universidad de Los Andes, CL


Economic fundamentals of road pricing are revised. Coase´s arguments against Pigouvian theory are gathered to the transportation field through examples and a review of reported cases in transportation literature where they are implicitly exposed


Optimal allocation of scarce resources is a fundamental problem of society. Theory dictates that, if agents perceive the total social costs of their actions, optimal allocation results from the spontaneous interaction of their individual interests. In 1920 Arthur Pigou in his book ?The Economics of Welfare? proposed what had become a doctrine to treat cases where this does not occur. The method consists in taxing the agent which doesn?t perceive the total social cost of his or her actions, in an amount equivalent to the external cost or externality, that is, the difference between the social cost and the private cost perceived by the agent.

This method, now known as Pigouvian taxation, eventually reached the area transportation economics in the form of ?congestion road pricing?. Since then, it quickly became the public-policy tool most advocated by transportation specialists. However, In 1960, Nobel laureate Ronald Coase virtually destroyed Pigou´s theory in his article ?The Problem of Social Cost?. Nevertheless, his arguments had remained almost unnoticed by transportation specialist. The main purpose of the present article is to gather Coase?s arguments to the transportation field. This is achieved through the revision of some examples applied to this area of knowledge and by means of a review of cases reported in the transportation literature where Coase´s arguments can be implicitly found.

Principally, Coase argues that even in cases, such as transportation, when agents can not be made liable for the externalities and thus, is inevitable to find a difference between private and social cost; imposing a Pigouvian tax will not necessarily drive the system to its optimum. He argues that, concentrating in the correction of divergences between private and social cost diverts the attention from those other effects, related with the corrective measure, which may produce more harm than the original deficiency. The author calls for a change in the approach, ?to examine the effect of a proposed policy change and to attempt to decide, whether the new situation would be, in total, better or worse than the original one?.

Consider for example a transportation system within which is dispatched a critical medicine from a cheap to an expensive market. If a Pigouvian tax is imposed, the congestion will be reduced but, at the same time, the price of the medicine in the importers market will rise and, eventually, somebody will die because of the impossibility to afford such medicine at the new prices. Despite efficiency in the transportation market was improved through the Pigouvian tax, the whole effect in the society is evidently worst. Obviously, if the effect of congestion pricing in the medicines market is accounted for in the analysis of the tolls, they would be really optimally calculated. The problem is that, accounting for all collateral effects, is virtually impossible in practice.

Despite the almost complete absence of Coase´s framework in transportation area, there is indeed some evidence in the transportation literature implicitly supporting his arguments. A remarkable case is Barry and Bento (2001) who show that, if the labor market is taxed and Pigouvian congestion toll revenues are recycled through a lup-sum (as suggested in many textbooks), the social outcome of congestion pricing is actually a significant worseness. Other interesting example is Verhoef and Small (2004) who showed the radical difference attained in distribution and welfare, depending on the type of revenue recycling scheme used, leaving in some cases important parts of the society worse. The authors also showed that practical suboptimal toll plots could heavily reduce the social benefits from congestion pricing.

Other example is Jara-Diaz (2007), who shows that if some substitute modes are not marginally priced, optimal price of other modes will differ from their marginal cost, with the immediate corollary that optimal tolls will actually differ from the Pigouvian tax. Lastly, examples following Coases´s proposition for examining the effect of proposed policies and analyzing the total effect to decide, stands out a set of papers by Mohring (1979), Small (1983) and Guevara (2007) which discuss the potential convenience of reserved bus lanes compared to congestion road pricing.

Other issues analyzed in the article are the theoretical inconsistency of revenue recycling schemes usually considered in transportation literature; an analysis of the political viability of congestion pricing, regarding the fact that all users are worse after road pricing; and a remark on the fact, originally stated by Knight (1924), that welfare economics are ultimately related to aesthetics and morals, a point implicitly reaffirmed, in terms of equity, in Galvez and Jara-Diaz (1995).


Association for European Transport