Better Lucky Than Rich? Welfare Analysis of Automobile License Allocations in Beijing and Shanghai∗

Economists often favor market-based mechanisms over non-market based mechanisms to allocate scarce public resources on grounds of economic efficiency and revenue generation. When the usage of the resources in question generates type-dependent negative externalities, the welfare comparison can become ambiguous. Both types of allocation mechanisms are being implemented in China’s major cities to distribute limited vehicle licenses as a measure to combat worsening traffic congestion and urban pollution. While Beijing employs non-transferable lotteries, Shanghai uses an auction system. This study empirically quantifies the welfare consequences of the two allocation mechanisms by estimating a random coefficients discrete choice model of vehicle demand to recover consumers’ willingness to pay for a license. Rather than relying on the maintained exogeneity assumption on product attributes in the literature, we employ a novel strategy by taking advantage of a control group as well as information from household surveys to identify structural parameters. Our analysis finds that although Beijing’s lottery system has a large advantage in reducing automobile externalities over auction, the advantage is offset by the significant allocative cost from misallocation. The lottery system foregone nearly 36 billion RMB ($6 billion) in social welfare in 2012 and a uniform price auction would have generated 21 billion RMB to Beijing municipal government, more than covering all the subsidies to the local public transit system.