Abstract
AbstractWe analyze privatization in a differentiated oligopoly setting with a domestic public firm and foreign profit‐maximizing firms. In particular, we examine pricing below marginal cost by the public firm, the optimal degree of privatization, and the relationship between privatization and foreign ownership restrictions. When market structure is exogenous, partial privatization of the public firm improves welfare by reducing public sector losses. Surprisingly, even at the optimal level of privatization, the public firm's price lies strictly below marginal cost, resulting in losses. Our analysis also reveals a potential conflict between privatization and investment liberalization (i.e., relaxing restrictions on foreign ownership) in the short run. With endogenous market structure (i.e., free entry of foreign firms), partial privatization improves welfare through an additional channel: more foreign varieties. Furthermore, at the optimal level of privatization, the public firm's price lies strictly above marginal cost and earns positive profits.
Highlights
In several industries such as energy, steel, airlines, and banking, public or state-owned firms co-exist and often compete with private firms (Matsumura and Matsushima 2004)
Does privatization necessarily improve welfare in an open economy setting? Second, what are the effects of privatization on the financial health of public firms? We address these questions in a differentiated mixed oligopoly where a welfare-maximizing public firm competes with profit-maximizing foreign firms
If the utility function is quadratic and privatization is optimally set, unlike Anderson et al (1997), privatization can improve welfare. We extend this line of enquiry to open economy settings and show that such welfare improvements occur in the short run, and in the long run
Summary
In several industries such as energy, steel, airlines, and banking, public or state-owned firms co-exist and often compete with private firms (Matsumura and Matsushima 2004). In a closed economy with homogenous goods, privatization improves welfare in the short run, if the marginal cost of production is increasing (Matsumura 1998), but not in the long run (Matsumura and Kanda 2005) In such settings, the fully public firm produces more and sets price equal to its own marginal cost. The government privatizes up to a level at which the public firm earns strictly positive profit, and social welfare is maximized Authors such as Anderson et al (1997) and Matsumura et al (2009) did not obtain the underpricing result; nor did they find an unconditional welfare improvement, possibly because they did not examine optimal privatization as we have done. Privatization needs to be complemented with both trade and entry reforms
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
