Optimal Privatization and Subsidy Policies: A Synthesis of the Privatization Neutrality Theorem

Abstract

The privatization neutrality theorem states that the share of public ownership in an enterprise does not affect welfare (i.e., any degree of privatization is optimal) under optimal tax-subsidy policy. We revisit this neutrality result. First, we investigate the case in which the private enterprise is domestic. We show that this neutrality result holds only when public and private enterprises have the same cost function, and the optimal degree of privatization is zero regardless whether the public or private firm has a cost advantage. Next, we investigate a case in which the private enterprise is owned by both domestic and foreign investors. We show that the optimal degree of privatization is never zero, and thus, the neutrality result does not hold even when there is no cost difference between public and private enterprises.