Externalities in Urban Planning: A Case Study on Congestion Pricing in New York City
In most places, roads are considered public goods that can be used by anyone without payment. However, roads are not pure public goods in that they are not nonrivalrous in consumption - enough people using a road can reduce its ability for use by others. This rivalry in consumption occurs when there is traffic congestion, and is common in dense urban areas like New York City or the downtown areas of many other large cities. Therefore, the use of roads is not truly unlimited.
Negative Externalities and the Need for Regulation
With roads and traffic come various problems that affect people other than the drivers themselves. In economics, problems that affect third parties who are not part of the economic transaction (i.e., producer/seller or consumer/buyer) are called social costs, which are created by negative externalities. When problems only affect the two parties to the transaction, they are private costs and are assumed to be self-regulated by free market economic concepts like explicit costs (financial costs), implicit costs (opportunity costs), and utility (satisfaction). In theory, problems that affect only the producer and consumer will be limited by economic self-interest.
When problems affect third parties, however, economic self-interest does limit the harm - neither producer nor consumer benefits from limiting their own [harm-causing] actions. Policymakers must create a system to limit these harmful actions, either through taxation to reduce output, numerical limits on output, government actions to mitigate the harms of output, or subsidies to incentivize more efficient or less harmful output. The coase theorem is often used to determine when government regulation is unnecessary or, by contrast, necessary to limit harms caused by economic production.
Social Costs of Traffic Congestion
Private costs of driving a personal automobile include the explicit costs of vehicle operation and the implicit costs of additional time required to drive one’s own car versus carpooling or using public transportation. When traffic congestion becomes significant, social costs arise. These include explicit costs of additional road maintenance to taxpayers, pollution abatement costs to taxpayers, and insurance costs of increased vehicle-related damages to all insurance customers. Implicit costs are also elevated, with traffic congestion causing additional wait times for non-drivers and increased risk of harm for anyone near the congested roadway.
If the traffic congestion is not addressed, it could lead to significant social harms through loss of productivity due to pollution, stress, infrastructure erosion, and decreased on-task time as workers both arrive late and leave early due to longer commute times. These costs affect society at large, and thus should be dealt with by society at large through policymaking. In 2024, it is estimated that traffic congestion in New York City cost drivers more than $1,800 each, with a total productivity loss for the city’s economy of about $9.5 billion.
Options to Reduce Negative Externality of Traffic Congestion
The problem of traffic congestion is too many cars on limited roadways at one time. Some cities have tried to reduce congestion by increasing the number of available roadways. This is expensive and time-consuming, and usually requires an abundance of available open land. In areas where open land is not available, the government may have to use the power of eminent domain to force landowners to sell their property to the government for development. This power is highly controversial and may impose additional social costs on society due to increased distrust of government. Additional roadways may also incentivize additional driving, leading to increased air pollution in the long run.
Limiting the number of drivers or cars in a city, such as by restricting permits, is another option. Some cities, such as Singapore and Shanghai, established Vehicle Quota Systems (VQS) in the 1990s. Limited number of permits to purchase or import new vehicles into the city were established, reducing the increase of cars on the road. VQS systems have been considered successful in reducing the number of cars on the road, but can require lots of government labor and oversight to implement through additional bureaucracy related to permitting, needs-testing, overseeing auctions for transferring permits and licenses, and overseeing vehicle inspections for roadworthiness.
Some cities restricted driving instead of vehicle ownership by allowing only certain drivers to drive on certain days, such as Mexico City’s No Driving Day Program. The effectiveness of these restrictions has been debated, with some researchers finding high levels of noncompliance. As these day-related restrictions were based on drivers’ license plates, many simply made or purchased false license plates that they affixed to their vehicles on different days of the week, allowing unrestricted driving. Some drivers, however, were incentivized to purchase vehicles that were exempt from the restrictions, such as electric vehicles (EVs) that did not add to the cities’ high levels of pollution.
A less restrictive option for reducing traffic congestion is a congestion tax, also known as congestion pricing, placed on drivers who access certain roads during peak hours. Cities like London and Stockholm, Sweden have implemented these systems to reduce traffic in downtown areas. Proponents argue that congestion pricing has been highly successful by revealing that it is easier than critics claim to adjust one’s schedule or driving route. To avoid paying higher tolls or parking fees, drivers adapted or innovated. Quickly, public criticism of congestion pricing in London and Stockholm dissipated, especially as people could see noticeably less traffic in the downtown areas.
Economic Success of Taxation Versus Rationing
When building new roads is not an option to reduce traffic congestion, limits on traffic must be imposed. This can be done through government rationing or through the free market using the rationing function of prices. Government rationing, such as the restriction of driving permits, vehicle-ownership permits, or times or locations one can legally drive, is often criticized as cumbersome and abusive. It requires additional costs to implement and may be regressive in that it affects those with less wealth or income more than is fair.
Government rationing may lead to additional social costs as consumers attempt to avoid rationing, either through simple noncompliance or by engaging in unsanctioned and unmonitored black markets. In terms of traffic congestion, noncompliance with government rationing could lead to additional law enforcement and court costs as errant motorists need to be pursued and adjudicated. Use of black markets could result in unsafe vehicles as people attempt to camouflage or mis-equip their vehicle to appear to be in compliance, such as re-badging a higher polluting vehicle to look like one that is exempt from restrictions.
Congestion pricing uses the rationing function of prices to efficiently allow those who have sufficient utility or productivity reasons to go into the crowded areas to do so. Downtown workers may make high enough wages to easily pay the increased tolls and parking fees, and occasional visitors may find the special occasion to visit a downtown restaurant or museum so satisfying that it justifies the higher tolls and fees. Nobody is banned from the crowded area, but is incentivized to think rationally about whether their visit is worth the increased cost.
For motorists who regularly visit downtown without sufficient utility or productivity attached, congestion pricing will incentivize them to adapt, such as using public transportation or finding venues outside the crowded area to frequent instead. This is similar to raising interest rates to restrict borrowing as part of monetary policy: no borrower is banned from the market, but must be more honest about whether the loan’s return on investment (ROI) is sufficient to warrant the higher interest payments. Investments with less guaranteed ROI will likely be foregone when interest rates are high, but investments with high likelihood of future profit will still be made.
