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Auction and Lottery: Which Is a Better Method of Allocating Scarce Licenses?

China traffic
China traffic
www.autoevolution.com

In China, some major cities are restricting new car purchases so that they can cut down on traffic and pollution. According to reports, only a certain number of licenses to purchase cars will be granted. The cities have been experiment with various models for granting these licenses that feature either an auction of lottery method. These methods each have their strong points, but there are also many critics of both systems. As the world watches China to see if this new license program will work to cut down on the nation's traffic and pollution problems, it will also be able to witness the success of either type of allocation process.

The Auction Process

The auction process allows interested parties to bid on the licenses that are up for grabs, so to speak. In essence, interested bidders could run the cost of each license quite high. For a poor person who really needs a license in order to get to work or for traveling to visit family frequently, the cost at auction could be prohibitive. Critics say that only the wealthy will be able to obtain licenses at auction. On the other hand, people who really want a license and are willing to pay whatever it takes to obtain one will have the opportunity to do so.

The Lottery Process

The lottery process is far less lucrative for the city but also more democratic for the people. Anyone interested in obtaining a license can sign up for the lottery. Licenses are then granted by pulling names out of a hat, so to speak. While this system regards the rich and poor alike, it also allows anyone who is remotely interested in a license to throw their hat into the ring right along with parties that are more in desperate need of a license.

Which Allocation System Is Best?

What has been emerging from China's large cities is that the auction system is increasingly favored. For one, lottery rules prevent winners from trading their licenses. So, if someone threw their name into the lottery and won, but they didn't want the license as much as a relative, they couldn't transfer the win. Moreover, the lottery seems to fuel more black market activity regarding the sale of licenses. As reports suggest, "the lottery does not satisfy all gainful trades is made painfully obvious by black markets for licenses." (1)

Moving the process to an auction-based system removes the necessity of a black market process substantially and allows the city to reap the monetary benefits. In fact, cities that are making money on licenses can then turn around and spend that money on their public transportation systems.

Can't Cities Adopt Both Models?

The simple answer to whether cities can adopt both the lottery and auction model is yes. Some are suggesting that it's a great idea to split the licenses between the two systems. Allow some to be granted by the lottery and allow the rest to go to auction. It's important to remember that the auction process assure "buyers of normal, traditional closings, without unnecessary confusion." (2) While the auction system seems to be increasingly popular in China, it is also a popular allocation method worldwide.

Sources:

1. CKGSB Knowledge, "Restrictions on New Car Purchases," http://knowledge.ckgsb.edu.cn/2014/07/09/policy-and-law/restrictions-on-new-car-purchases-an-economists-road-trip/

2. Heritage Global Partners, "Auctions," http://www.hgpauction.com/our-auctions/