Privatization, underpricing and welfare in the presence of foreign competition

Ghosh, A.; Mitra, M.; Saha, B.

Abstract

We 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 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 it earns positive profits.

Citation

Ghosh, A., Mitra, M., & Saha, B. (2015). Privatization, underpricing and welfare in the presence of foreign competition. Journal of Public Economic Theory, 17(3), 433-460. https://doi.org/10.1111/jpet.12095

• Journal Article Type: Article
• Acceptance Date: Mar 12, 2013
• Online Publication Date: May 4, 2015
• Publication Date: Jun 1, 2015
• Deposit Date: Aug 7, 2014
• Publicly Available Date: Jun 17, 2016
• Journal: Journal of Public Economic Theory
• Print ISSN: 1097-3923
• Electronic ISSN: 1467-9779
• Publisher: Wiley
• Peer Reviewed: Peer Reviewed
• Volume: 17
• Issue: 3
• Pages: 433-460
• DOI: https://doi.org/10.1111/jpet.12095
• Public URL: https://durham-repository.worktribe.com/output/1425275