Privatization under Political Ties

Abstract

I study a product differentiation model with endogenous entry where a politically connected public firm competes with a private one. Consumers are heterogenous in their willingness to pay. First, I argue that because of political ties, the public firm may mimic the preferences of the consumer with the median type. Then, I show that as privatization increases, the market outcome shifts from an inefficient public monopoly to a duopoly, where the public firm can even be more profitable than the private one, and welfare is higher. However, full privatization is not socially optimal as it implies excessive product differentiation.

Keywords: Mixed Markets, Privatization, Product Differentiation. JEL Classification L33