Privatization, deregulation, and capital accumulation.

• Author: Glomm, Gerhard

1. Introduction

   Since the early 1980s, many countries have privatized and deregulated intermediate goods industries, such as gas, electricity, or telecommunications, that had traditionally been run by public monopolies. The European Union (EU), for example, has adopted aggressive policies toward the elimination of monopolies in the telecommunication market and conducted a general privatization program whose sales receipts amounted to more than 3% of GDP between 1985 and 1995 (Constantinou and Lagoudakis 1996, Parker 1998). In other regions of the world, countries like Australia, Chile, Brazil, Argentina, and the United States have implemented similar policies (Vickers and Yarrow 1991; Winston 1993; Van der Vlies 1996).

   While there is a large literature studying the microeconomic effects of privatization and deregulation, the long-run macroeconomic effects of such types of reforms have been subject to relatively less scrutiny. In this paper we use a model of capital accumulation in order to investigate the long-run effects of privatization and deregulation. This paper complements a small literature that includes Parente and Prescott (1999, 2000), Schmitz (2001), and Herrendorf and Teixeira (2004).

   Parente and Prescott (1999, 2000) and Herrendorf and Teixeira (2004) study the impact of monopoly rights on long-run levels of income and find that the effect is large. The latter authors find, for example, that monopoly rights can reduce aggregate income in the long run by a factor of seven. Schmitz (2001) uses a two-sector model to calculate the impact of government production of investment goods on long-run levels of labor productivity. He finds that government production can lower labor productivity levels in the long run by about 30%.

   Our approach differs from Herrendorf and Teixeira (2004), who infer the extent of monopoly power from differentials in the relative prices of nontradeables. Instead we take the approach that monopoly power is likely to arise and exist in the public production of intermediate goods, such as public utilities or telecommunication, and that the size of these sectors relative to the rest of the economy can be directly estimated (see World Bank 1995). Our approach also differs from Schmitz (2001) in a fundamental way because he abstracts completely from the issue of monopoly rights. In his model, the only difference between the public and private production is that the government is endowed with a less productive technology than the private sector.

   The long-run income gains from privatization and deregulation in our paper are similar in magnitude to those found in Schmitz (2001). In our base-case calculation, the long-run income gain of changing from a public sector monopoly to a competitive market with private firms is 18%. These welfare gains can be larger when there has been relatively low governmental investment in the public sector capital and when the elasticity of substitution between the intermediate input and physical capital is small. Like Schmitz (2001), we view our results as less pertinent for rich economies like the United States, where public sector involvement in intermediate good production is relatively small; rather, we view the results of our model as being applicable mostly to least developed countries (LDCs), such as Egypt, where governments typically play a large role in intermediate goods production.

   For our model, which is described in section 2, we use a version of the Cass-Koopmans economy as a basic building block and augment this economy in some fundamental ways. In our model, both final and intermediate goods are produced. The final good is produced by a competitive industry that employs three inputs: capital, labor, and an intermediate good. In turn, with respect to the production of the intermediate good, we contemplate three alternative scenarios. In a first scenario, the intermediate good is produced by a public monopoly. In a second scenario, it is produced by a private monopoly, and finally, in a third scenario, it is produced by a competitive market.

   When the intermediate good is produced in a competitive market, each producer hires capital and labor at the given prices and sells its output to the final good's firms at the competitive price. When the intermediate good is produced by a private monopolist, the monopolist sets the price of the intermediate good but acts as a price taker in both the capital and labor markets. Correspondingly, when the intermediate good is produced by a public sector firm, we assume that the government allocates the stock of capital to the public sector enterprise, so that the public sector enterprise only has to decide how much labor to hire. We assume that the government is a price taker in the labor market but has monopoly power in the intermediate good's market.

   The amount of intermediate good produced differs across the three scenarios (as the result of the alternative market structures assumed). The central focus of this paper is to investigate the implications that such a difference in the amount of intermediate good produced can have on the aggregate income level. To the extent that intermediate goods are complementary to either physical or human capital, it is expected that any changes in their level of output or in their productive efficiency would also have an impact on the rate of growth of the economy. Stern (1993), for example, shows that energy use and quality can be a limiting factor for economic growth, and that any factors that cut energy use would also reduce aggregate income levels.

   Throughout the paper, we refer to privatization as the transition experienced in an economy when the intermediate good's production decisions cease to be taken by a public monopoly and start to be taken by a private monopoly. Similarly, we refer to deregulation as the transition experienced in an economy when the intermediate good's production decisions cease to be taken by a public monopoly and start to be taken in a competitive industry.

   In section 3, we solve the models associated with each alternative scenario and compare the steady-state output levels that result. We find that privatizing intermediate goods production alone is likely to generate only relatively small increases (if any) in steady-state income. We also find that deregulating intermediate goods production can increase steady-state income significantly. Furthermore, in this section we allow the final good's production technology to be of the constant elasticity of substitution (CES) variety and study how the assumed value for the elasticity of substitution between final and intermediate goods affects our results in the steady state. We find that the gains in steady-state income that follow a change in market structure depend crucially on the elasticity of substitution between intermediate goods and capital, with greater income gains being associated with lower elasticities.

   In section 4, we simulate the transition paths that take place in the economy after the privatization and deregulation of the intermediate sector. We restrict the analysis to the special case where the production function is Cobb-Douglas. We find that transitions to the new steady state are monotonic on each of the experiments we perform; thus, there are no conflicts between the short-run and the long-run outcomes. Finally, in section 5 we summarize our conclusions and directions for future research.

2. The Model

   The economy is populated by a large number of individuals, which we set equal to one. Each individual lives forever, is endowed with [k.sub.0] units of capital at time zero and with one unit of labor in each period, and supplies labor and capital inelastically in exchange for the before-tax wage rate, [w.sub.t], and the before-tax rental price of capital, [q.sub.t].

   The individual's utility function takes the form

   [[infinity].summation over (t=0)][[beta].sup.t]([c.sup.1-[sigma].sub.t]/1-[sigma]);

   where [beta] is the discount factor, [c.sub.t] represents consumption of final goods at time t, and 1/[sigma] is the elasticity of intertemporal substitution. Every period the individual divides his total income between consumption at period t ([c.sub.t]) and investment at period t ([i.sub.t]). In addition, capital depreciates at the rate [delta], regardless of the specific use to which they are put.

   Two goods are produced in this economy: a final good, [Y.sub.t], which is used for consumption, and an intermediate good, [E.sub.t], which is used completely in the production of final goods. In this sense, the role of [E.sub.t] is similar to the role of many intermediate goods, such as electricity, gas, coal, or general energy, that are used in almost all production processes. For simplicity, we assume that this intermediate good is not consumed directly by the individuals.

   The final good is produced competitively by a large number of firms that use the same constant returns to scale technology, which is given by

   [MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]. (1)

   Here [K.sub.F,t] and [N.sub.F,t] represent the amount of capital and labor used in the production of final goods at time t, respectively, A is total factor productivity, and [rho] and [alpha] are constants that measure the degree of substitutability and the marginal products of the factors in the production function, respectively. Because the technology exhibits constant returns to scale, we can assume that there is one firm and that [Y.sub.t] is aggregate output.

   The intermediate good E is produced using the constant returns to scale technology

   [E.sub.t] = [K.sup.[gamma].sub.I,t][N.sup.1-[gamma].sub.I,t], (2)

   where [K.sub.I,t] and [N.sub.I,t] represent capital and labor used in the production of intermediate goods at time t, respectively, and [gamma] is a positive constant. Notice that since the production function in Equation 2 exhibits constant returns to scale we abstract from any natural monopoly issues...