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The case for electronic road pricing

I just finished reading an HBS business case on road pricing in Hong Kong for a class I’m taking as part of my MBA. Since it’s a topic that’s integral to cities, I thought I would post my case prep here. Below are the questions I was asked to my prepare, with my answers below.

The case is essentially about traffic congestion in Hong Kong and a decision to either build more road (a bypass route running adjacent to the harbour: The Central-Wan Chai Bypass) or implement an Electronic Road Pricing (ERP) system, similar to what was implemented in Singapore in the 70s and in London in 2003.

If you’re a reader of this blog, you can probably guess which side I’m going to lean towards. I believe fundamentally that the only way to construct a large well functioning urban region is on the shoulders of mass transit. 

Q: For a typical commuter, what are the costs and benefits involved in using a car over using public transportation? Why would a commuter choose to drive? Who are the most likely to drive?

A: In my view it’s a trade off between cost, time and, to some extent convenience, although convenience and time are somewhat linked.

From a cost standpoint, your typical driver has the fixed cost of owning a car (payments, insurance, maintenance, etc.) and the variable costs of driving (gas, parking, applicable road prices, etc.). For those who have already committed to purchasing a car, probably as a result of where they’ve decided to live, it then becomes largely a question of variable costs. In most cases, these costs are higher for driving than they are for public transportation.

But then comes the question of time and convenience. Residents of global cities, such as Hong Kong, are becoming increasingly cash rich and time poor. There’s a real value to time. And driving often offers speed, as well as the convenience of a personalized and “comfortable” ride (personally, I find gridlock highly uncomfortable). So if the value of the time you’re going to save by driving exceeds the variable cost of driving, you’re likely going to drive. In other words, higher income individuals should choose to drive.

Q: What are the costs of traffic and congestion for society?

A: The costs of traffic and congestion to society are huge. You have the lost productivity as a result of people and goods sitting idle. You have the strain on family life caused by working parents struggling to find enough time outside of work. And you have the environmental impact of idling cars.

Here’s a few stats from Natural Resources Canada:

“In fact, if Canadian motorists avoided idling for just three minutes every day of the year, CO2 emissions could be reduced by 1.4 million tonnes annually. This would be equal to saving 630 million litres of fuel and equivalent to taking 320,000 cars off of the road for the entire year. Eliminating unnecessary idling is one easy action that Canadians can take to reduce their GHG emissions that are contributing to climate change.”

Q: Discuss the effect of electronic road pricing (ERP) on: (a) urban re-development and town planning, as well as residential property prices; (b) fare faced by public transport.

A:

(a) Based on London’s experience, their property market “recorded no impact, positive or negative, in or around the charging zone.” (Case) However, intuitively, I would expect development pressures and pricing to increase within the boundary of any charging zone and for prices to fall outside, along the periphery. The reason for this is that urban real estate models, such as the Monocentric City Model, argue that as you move out from the center of a city, land prices fall, but transportation costs increase. It ties into the whole “drive to affordability” notion. In the case of ERP, transportation costs have now increased for the periphery, so it could drive down land/property prices. 

(b) Relatively speaking, an ERP system should make pubic transportation fares appear cheaper since the marginal cost of driving has now increased. Therefore, in the longer term, it may create an opportunity to raise fares.

Q: Why is the use of road usually free of charge?

A: Roads are thought of as a public good. And so they’ve been typically priced as such. However, roads, and in particular highways, are also thought of as an economic development engine. They’re a heavily subsidized form of infrastructure that have been used as a tool to spur suburban and exurban growth. By driving down the cost of transportation (without factoring in the environmental costs, of course), extensive highway networks have been used to unlock the value of previously under utilized outlying land. However, I disagree with the notion that all roads should be “free.”

Q: Why roads are often provided and managed by the government and not by profit- maximizing firms?

A: Because typically profit-maximizing firms require paying customers. Also, since they’re viewed as a public good, governments typically want to control them.

Q: What are the differences between ERP and a classic toll?

A: A classic toll is typically based on a fixed price that is paid regardless of the time of day. ERP is variable. Pricing fluctuates based on the time of day and/or the traffic and congestion levels. It’s the idea that as demand for the public good in question rises, so does the price of using it.

Q: What are the advantages of implementing ERP?

A: There are number of advantages. The first is that you get an immediate drop in traffic/congestion. This has been clearly shown through previous case studies in Singapore, London and Scandinavia. As a result of this, the city is then able to offer an improved user experience for those who are willing to pay the increased transportation costs. At the same time, the city now has a new revenue source that it can dedicate towards other infrastructure improvements, such as public transportation. Indirectly, the city will also benefit from increased productivity levels and a smaller environmental footprint.

Q: Why are there such few cities that have successfully adopted ERP despite the fact that the idea is praised by many economists? Singapore is one of the few successful examples, why?

A: It’s politically unfavourable. Nobody likes any sort of new “tax”. When Livingston first proposed a congestion charge in London residents called it “Carmageddon.” Few leaders have the guts to push something like this through.

Singapore, on the other hand, had no choice. Geographically they couldn’t afford not to discourage car use and so the political will was there. I think that Hong Kong is in a similar boat.

Q: Imagine that you were the government official responsible for the introduction of ERP. What would be your strategy to persuade the public to support your implementation?

A: I would focus on two main ideas: (1) the value proposition being offered and (2) the future use of the funds being collected through ERP. 

The main value proposition is reduced congestion for a segment of the population that I suspect would be willing to pay for the convenience. Again, I return to the idea of being cash rich and time poor. 

For those with absolutely no willingness to pay for this convenience, the value proposition becomes increased investment in public transportation (as a result of the ERP funds). This is how I believe the funds should be allocated.

I also think it’s critical to be open and transparent to the public about how exactly the funds will be used. You don’t want the public to think of ERP as a tax. You want them to think about it as investment in infrastructure in the region.

However, it’ll take a change in mindset. People are accustomed to roads being “free.” But to paraphrase Harvard economist Edward Glaeser, from his recent book the Triumph of the City, if you offer a hugely valuable good—such as a road or highway—and make it free, you’ll never be able to keep up with demand. It’s for this reason that building new and more roads is rarely the answer. Traffic patterns simply adjust to take advantage of the increased supply.

If you want to control usage, you need to slap a price tag on it.

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