Becker and Posner on the Indiana Toll Road

Richard Posner argues efficiency gains. As you might remember – I have my doubts as to whether this argument was the driving force behind the deal:

The idea of privatizing toll roads is an attractive one from an economic standpoint. Private companies are more efficient than public ones, at least in the limited sense of economizing on costs.

Posner provides a discussion of the complex deal that was a lot clearer than even the Crowe Chizek discussion and he also notes the following:

I call this sense of efficiency “limited” because there are other dimensions of efficiency, for example the allocative; a monopolist might be very effective in limiting his costs, but by charging a monopoly price he would distort the allocation of resources. Some of his customers would be induced by the high price to switch to substitutes that cost more to make than the monopolist’s product but that, being priced at the competitive rather than the monopoly price, seemed cheaper to consumers. (This is the standard economic objection to monopoly.) … There is, however, in the toll-road setting another source of allocative inefficiency, and that is monopoly, which I have mentioned already. Drivers who do not have good alternatives to using the Indiana Toll Road can be made to pay tolls that exceed wear and tear, congestion effects, social costs of pollution, and other costs of the road, engendering inefficient substitutions by drivers unwilling to pay those tolls. To an extent, the toll-road operator may be able to discourage substitution by price discrimination, but this is unlikely to be fully effective and indeed can actually increase the allocative inefficiency of the monopoly. The monopoly issue raises the question: what exactly was Indiana selling when it leased the toll road for $3.8 billion? The higher the tolls and the greater the lessee’s freedom to raise the tolls in the future, the higher the price that the state can command for the lease. If the lease placed no limitations on tolls, the state would be selling an unregulated monopoly. If the lease could constrain the lessee to charge tolls just equal to the cost of operating the toll road (including maintenance, repairs, snow removal, lighting, and the collection of the tolls), the market price of the lease would be significantly lower. To the extent that the state wants to maximize its take from the lease, it will be creating allocative inefficiency by conferring monopoly power on the lessee. It is difficult to determine whether the $3.8 billion price tag for the Indiana Toll Road is closer to the competitive or the monopoly price level.

Gary Becker continues the discussion and on balance is for privatization. While I may be neither as enthusiastic about this deal as Becker and Posner are nor as trusting as the motives of Governor Daniels, I appreciate the fact that both go well beyond the corporate finance aspects of this deal.