Privatization Neutrality Theorem in the Presence of Vertically Related Industries

Abstract

Abstract This paper considers a model wherein public and private firms purchase inputs from a foreign firm to produce a homogenous good and compete in quantity. Using this model, we examine the optimal subsidy for the public and private firms and the optimal degree of privatization. In particular, the privatization neutrality theorem (PNT), which means that the optimal subsidy achieves the first-best allocation and is independent from the degree of privatization, is explored. There are three main results. First, when the foreign firm competitively behaves, the PNT holds. Second, when the foreign firm is a monopolist and applies the uniform pricing, the PNT does not hold and the optimal policy is full nationalization. Finally, when the foreign firm adopts the discriminatory pricing, the PNT does not hold and the optimal policy is partial privatization.