From the Grabbing Hand to the Helping Hand

Abstract:     
I present a study of ownership of firms under government rent seeking. Using its control of regulated inputs, a government agency extracts rents from a manager who undertakes an investment. Such a government rent seeking activity leads to a typical hold-up problem. Government ownership is shown to serve as a second best commitment mechanism through which the government agency will restrain itself from the rent seeking activity and even offer the manager support and favor such as tax breaks and subsidies. This mechanism works at a cost because government ownership creates distortion in resource allocation. In contrast to the property rights literature, the analysis shows that government ownership may Pareto dominate private ownership even when the government agency has only unproductive roles in the investment. The analysis corresponds to a host of stylized empirical observations concerning local government-owned firms during China's transition to a market economy. Based on this analysis, I suggest that local government owned firms may be transformed to private ownership as China's input markets become more liberalized.

Number of Pages in PDF File: 34

JEL Classification: G34, L33

working papers series