Privatization, Underpricing and Welfare in the Presence of Foreign Competition
UNSW Australia Business School, School of Economics
Indian Statistical Institute, Kolkata
University of East Anglia (UEA) - School of Economic and Social Studies
February 22, 2013
UNSW Australian School of Business Research Paper No. 2013ECON03
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.
Number of Pages in PDF File: 26
Keywords: privatization, welfare, underpricing, foreign firms, free entry
JEL Classification: L33, F12, D43
Date posted: April 3, 2013
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