Congestion Pricing and Network Expansion

Abstract

Over the past decade network industries (such as gas, electricity, and telecommunications) have undergone a dramatic transformation. Competition has been introduced in industries that had long been viewed as textbook examples of natural monopolies. Production and transport have been unbundled to foster the introduction of competition: the capacity provider (the owner of the infrastructure) now often differs from the service provider. Chief among the challenges this raises for economists and policymakers: to design institutions that lead tooptimalnetwork expansion. Different arrangements have been suggested, ranging from indicative planning to decentralization of investment decisions through congestion pricing. Two questions lie at the core of the debate: Is the infrastructure network still a natural monopoly? And what role should congestion pricing play in ensuring optimal network expansion? The author shows that simple economic principles apply to the use of congestion pricing to induce network expansion: a) If network provision is competitive, congestion pricing leads to optimal investment. b) If network provision is monopolistic, congestion pricing leads to underinvestment. He shows the model applying to power networks as well as to the Internet. Policymakers must therefore assess whether network expansion is indeed competitive and design institutions that ease entry, or design an appropriate regulatory framework.