Second-best road pricing through highway franchising

This paper considers the welfare impacts of a range of franchising regimes for congestible highways. For a single road in isolation, it is shown that a competitive auction with the level of road use as the decision criterion produces the socially optimal road (in terms of capacity and toll level) as the equilibrium outcome, provided constant returns to scale characterize highway operations. The auction outperforms various alternatives, in which the bidders are asked to minimize the toll level or toll revenues, or to maximize capacity or the bid for the franchise. When second-best network aspects are taken into account, the patronage-maximizing auction is no longer optimal. When unpriced congestion on parallel capacity dominates, the second-best highway would generate losses and the zero-profit condition becomes binding. The auction produces a below-optimal capacity. When unpriced congestion on serial capacity dominates, the auction produces an above-optimal capacity.