Mixed Oligopoly, Privatization, and Strategic Trade Policy

Abstract

This paper investigates the effects of privatization in the presence of strategic trade policies within an international mixed oligopoly serving a single market. If the government uses a domestic production subsidy, then welfare is always increased with privatization, while the optimal subsidy falls. If the government uses an import tariff, privatization increases welfare over much of the parameter space. The optimal tariff, however, may rise or fall. In recent years, many countries around the world are privatizing their state-owned industries. At the same time, many of these countries are also showing remarkable changes in their economic policies toward international trade. On many occasions, tariffs are significantly altered and domestic production subsidies are substantially reduced. For example, Russia has privatized its aircraft industry and doubled its tariff on imported aircraft. Colombia has privatized its stateowned automobile maker Colombia Automotriz and reduced the import tariffs on foreign-made cars. In Argentina, the government is pursuing a policy of selective privatization and subsequent reduction of subsidies. In Western Europe countries such as Germany and Spain have privatized their major airlines (Lufthansa and Iberia, respectively) and significantly reduced subsidies. What is the connection between privatization and strategic trade policies? Does privatization require a welfare-maximizing government to alter trade barriers? The objective of this paper is to answer these questions by investigating the interaction between privatization and strategic trade policies. The effects of privatization are typically analyzed in the context of mixed oligopoly models, where state-owned welfare-maximizing public firms interact with profit-maximizing private firms.1 We investigate the interaction between privatization and strategic trade policies by incorporating strategic trade instruments in an international mixed oligopoly model. Specifically, we consider two strategic trade instruments: an import tariff and a domestic production subsidy. The government chooses the optimal level of tariff or subsidy to maximize domestic welfare. For each trade instrument, we primarily focus on two questions. First, does privatization increase