Optimal privatization and uniform subsidy policies: A note

• Published date: 01 June 2018
• Author: Ming Hsin Lin,Toshihiro Matsumura
• Date: 01 June 2018
• DOI: http://doi.org/10.1111/jpet.12293

Received: 22 August 2017 Accepted: 20 February2018

DOI: 10.1111/jpet.12293

ARTICLE

Optimal privatization and uniform subsidy policies:

A note

Ming Hsin Lin1ToshihiroMatsumura2

1OsakaUniversity of Economics

2TheUniversity of Tokyo

Fundinginformation

theJapan Society for the Promotion of Sci-

ence(JSPS) KAKENHI, Grant/Award Numbers:

15K03347,16K03681

MingHsin Lin, Faculty of Economics, Osaka

Universityof Economics, 2-2-8, Osumi,

Higashiyodogawa-ku,Osaka 533-8533, Japan

(linmh@osaka-ue.ac.jp).

ToshihiroMatsumura,Institute of Social Sci-

ence,The University of Tokyo,Tokyo, Japan

(matsumur@iss.u-tokyo.ac.jp).

The privatization neutrality theorem states that the share of public

ownership in a firm does not affect welfare under an optimal uniform

tax-subsidy policy. We revisit this neutrality result. First, we inves-

tigate the case in which the private firm is domestic. We show that

this neutrality result does not hold unless public and private firms

have the same cost function. Next, we investigate a case in which

both domestic and foreign investors own the private firm. We show

that the optimal degree of privatization is never zero, and thus, the

neutrality result does not hold, evenwhen there is no cost difference

between public and private firms.

1INTRODUCTION

Studies on mixed oligopolies in which state-owned public firms compete with private firms have become increasingly

popular. Despite a prevalent waveof privatization, many public firms still compete with private firms in a wide range

of industries, including airlines, airports, port management, rail, telecommunications, energy, steel, automobiles, and

overnight delivery,as well as in services such as banking, home loans, insurance, hospitals, healthcare, broadcasting,

and education.

In oligopolies, the firms'market power yields a positive price–cost margin, which is larger when demand elasticity

is smaller.Consequently, production levels are often suboptimal for welfare, especially in the above-mentioned typical

mixed oligopolies with low demand elasticity.Public firms might play an important role in making up for underproduc-

tion by private firms. In the literature on mixed oligopolies, most studies assumed that public firms maximize welfare

(the sum of consumer surplus and firms'profits), whereas private firms maximize their own profits, and assumed that

government cannot nationalize all firms. The most efficient outcome occurs through the nationalization of all firms if

nationalization does not change the firms'costs and public firms maximize welfare. The need for an analysis of mixed

oligopolies lies in the fact that it is impossible or undesirable, for political or economic reasons, to nationalize an entire

sector.For example, without competitors, public firms might lose the incentive to improve their costs, resulting in a loss

of welfare. Thus, the literature neglected the possibility of nationalizing all firms.

Because public firms consider both consumers'benefits and their own profits, public firms produce more than pri-

vate firms do. Although the existence of public enterprises increases total output, it reduces private firms'output,

which might yield another inefficiency in the form of production allocation. The literature on mixedoligopolies showed

that the privatization of public firms can improve welfare (De Fraja& Delbono, 1989; Matsumura & Shimizu, 2010).

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2018 Wiley Periodicals,Inc. wileyonlinelibrary.com/journal/jpet Journal of Public Economic Theory.2018;20:416–423.