Government auctions - good or bad?

I have been having a debate with Paul Lockett on Tim Worstall's site, which I have found very interesting and illuminating. The topic was the TPA's green-tax-calculator, and what it said about costs of carbon in this country. I claimed that one thing it showed was that road-use is overcharged and domestic heating is undercharged. Paul gave some very interesting reasons, which I hadn't considered before, why road-use is not as overcharged as I (and I suspect many others) tend to think.

He has certainly persuaded me of his basic point, which (if I have understood it correctly) is that the crude comparison that many of us make between costs of construction and maintenance of roads on the one hand, and revenue from vehicle excise and fuel duty on the other, cannot be taken as a rough indicator of the extent of overcharging (whether for "green-ness" or any other attribution), because there is an element of charging for the use of a scarce resource (road-space) within that balance. As you can see from the exchanges on Tim's site, I still think that there are reasons to believe that the government is charging us more than a market price for use of the roads, but I guess we won't know unless we actually move to full road-use pricing. In my opinion (and this is something I didn't put into the debate, because I am happy to accept the concept, if not the reality of road-use charging), the transaction costs and civil-liberties implications of road-use charging exceed the economic benefits of more accurately tailoring charges to supply and demand, so in a sense, I hope we never find out whether we are being over- or under-charged. But it is an interesting thought experiment.

Anyway, I expanded the debate into a question of the merits (or otherwise) of government auctions, on the basis that the question of whether there was a high initial capital value in a road-use charging system would depend on whether the market created by the government was truly competitive or embedded monopoly privileges. I (unwisely) cited the 3G auction as an example of a bad government auction of monopoly rights. Paul observed:

-"I find this comment extremely odd. What else would you propose to do to allocate the use of spectrum, which is a scarce resource? The government hasn’t created a system where competition is limited in the case of spectrum, it is inherently limited."-

To which I replied:

-"I agree with your distinction between natural scarcity and artificially-enhanced scarcity. This wasn’t the best example for me to pick. I should have used the example of the Non-Fossil Fuel Obligation, which was the first case where I became aware of this problem, but it’s rather obscure. In the case of NFFO, government created artificial scarcities of unknown quanta for a dutch auction. Their monopoly position was so effective that they drove prices down strongly. The problem was that it was so effective and people were thus so desperate to win one of the unknown number of contracts that would be let for their technology, that the optimists bid down the price below where most projects were viable and many realists were shut out. NFFO ended up being a tremendously successful way of driving the price down to a level at which it prevented development of the thing it was supposed to encourage.-

-The 3G auction nearly had the same effect, delaying roll-out, and nearly bankrupting some of the winning optimists and shutting out some of the realists. But in this case, the water is muddied because the scarcity, as you say, is genuine. Someone would have taken the profits from the excess of demand over supply, and who better than the government on our behalf? All the same, I would have structured it in a different way, separating the natural-monopoly infrastructure-provision part from the service-provision part more clearly (analagous to the structure of the electricity industry in that brief halcyon period after supply and distribution had been split but before Sir Callamity McCarthy* allowed the competitive market to be undone by vertical-integration), and creating a more flexible market for accessing the infrastructure. This would have maintained the competitive threat from new entrants and removed the need for regulation of this part of the business, with tighter but limited regulation (of compliance with the rules, not of prices) over the natural-monopoly part. Having the revenue from sale of bandwidth-rights come in to the infrastructure-provider rather than the government in the first place would make the provision of that infrastructure well-funded and relatively low-risk, which would have helped to get the systems built, rather than being delayed by cash being sucked out of the system by the government maximising its revenue at auction. The risk and benefits could be further shared with society, by government-underwriting of minimum returns for the infrastructure-provider (highly unlikely ever to be needed), and provision for a proportion of profits above the minimum returns to go to the Treasury. This would have kept the cost of money as low as possible, getting the systems built, maintained and expanded as quickly and cheaply as possible.-

-You may say that if idiots want to overbid (or under-bid in a dutch auction), that is their lookout, it is the market working as intended, and not a sign of a bad mechanism. But we see it time and time again where government is letting contracts for monopoly positions. We have seen it in many public-sector construction projects, where standard practice is to bid a non-viable price in order to win the contract, and then hope to claw it back by renegotiation once the project is under way and the government is frightened to let it fail or be further delayed. That is the real reason why so many of these projects go over-budget and over-time - they were never going to come in on-budget and on-time. The amazing thing is that some occasionally do, not that so many don’t.-

-The incentives in government-auctioning are to drive honest men out of the market and encourage the crooks. It also tends to inflate ultimate costs, because it is more expensive to put right something done badly than to get it right in the first place. The government is in a unique position, and should try as hard as possible to design mechanisms that ameliorate this impact, even at the expense of reducing the amount of revenue raised. But of course, the public-choice incentives for the government strongly encourage the opposite behaviour."-

I have created this post, partly because it is a topic on which I have strong negative experiences (in NFFO) that I wanted to highlight, partly because I don't feel that I have properly explored the alternatives and whether they are any better, and partly so that, if the debate on this subject were to continue, it wouldn't have to divert the debate on road-use charging on Tim's site.

• I was going to explain in a note who Sir Callum McCarthy is, but the incompetent, lackadaisical, credulous fool deserves a post all of his own.