3.2 Privatization and an Open-door Policy
3.2.3 Effects of an Open-door Policy
Allowing foreign firms enter domestic market and the effects of adding a new foreign firm in the market are,
0
Under an open-door policy, public firm’s profit increases if and only if {(2 3 ) 6 /(4 3 )}
m< − α n− α − α , that is, if and only if the number of foreign private firms is small relative to the number of domestic private firms. The reason is that an additional foreign firm literally shifts the reaction function of all private firms outward, but it also shifts public firm’s reaction function outward due to the public firm producing more if the output comes from a foreign firm. However, if the reaction function of all private shifts outward more than the public firm’s, the public firm’s output decreases with the entrance of foreign
firms. Hence, the result obtained in Fjell and Pal (1996): the public firm’s output always increase with an additional foreign private firm even if foreign firms reinvest in the home country; is not robust.
Moreover, social welfare increases if and only if m>{(2 3 )− α n−6 /(4 3 )}α − α , that is, if and only if the number of foreign private firms is large relative to the number of domestic private firms.12 Entry of an additional foreign private firm reduces price, public firm’s profit, and all private firms’ profit respectively. Although there is social welfare loss because the loss in domestic profits is transferred by the additional foreign firm, yet the domestic equity control on foreign firms may improve social welfare even though more foreign firms enter the market.13 We have the following proposition.14
Proposition 3.4: Under an open-door policy, public firm’s profit increases if and only if the number of foreign private firms is small relative to the number of domestic private firms;
social welfare increases if and only if the number of foreign private firms is large relative to the number of domestic private firms.
3.3 Concluding Remarks
We considered in an international oligopoly market with a homogeneous good, one partially privatized domestic public firm competes with n domestic private firms and m foreign private firms. To protect domestic firms in this single market, the government determines the proportion of domestic equity on foreign competitors. We have shown that
12 Note that if the public firm competes only with foreign private firms (n=0), then entry by a new foreign firm always increases welfare, namely,
2
without partial privatization still has the same result as a partial privatization case. See appendix (C.4)
13 The case of a public firm without partial privatization still has the same result as the partial privatization case.
See appendix (C.3)
14 Proposition 2 of Fjell and Pal (1996) does not always hold.
stringent control of domestic equity on foreign firms increases private firms’ outputs, profits, market price and social welfare, but decreases the public firm’s output. Furthermore, along with the stringent control on the domestic equity of foreign firms, the government should increase the degree of privatization. In an opening market, intensive competition from private firms in general will enhance the degree of privatization.
Comparing our results with the result in Fjell and Pal (1996), we found that the effect of the number of foreign firms on the public firm’s profit is ambiguous. The public firm’s profit increases if and only if the number of foreign private firms is small relative to the number of domestic private firms; social welfare increases if and only if the number of foreign private firms is large relative to the number of domestic private firms.
CHAPTER FOUR： PARTIAL PRIVATIZATION, FOREIGN COMPETITORS, AND INCENTIVES FOR MERGER
This chapter considers a single international differentiated mixed oligopoly market where there exists one domestic public firm with partial privatization, one domestic private firm and several private foreign firms competing in a domestic country. Firms produce horizontal differentiated commodity. To be more efficient, the public firm is allowing for partial privatization. Public firm will proceed partial privatizing through a program with two distinct measures: (i) privatizing directly, and (ii) deciding to merge with domestic private firm. However, there exist some incentives for domestic firm to choose to merge.
The chapter is organized as follow. Section 4.1 presents the models. Section 4.2 analyses the partial privatization and the merging incentives derived from the privatization of the mixed firm. Section 4.3 summarizes our main conclusions.
4.1 Basic Model
Consider a single international mixed oligopoly market in which there exist one domestic public firm (firm a) with partial privatization, one domestic private firm (firm b) and several private foreign firms (firm j , j=1,...,m) without considering transport cost and paying the tariff in the presence of trade liberalization, and all firms compete in a domestic country. Under the Cournot-Nash assumption, the private firm aims at maximizing the firm’s profit, and the public firm maximizes social welfare when the domestic government owns it.
Due to firms produce horizontal differentiated commodities, the utility function of the representative consumer in the domestic country is following Häckner (2000) in generalizing the utility function to allow for two domestic firms and m foreign firms producing
differentiated goods15, if ( 1,0)γ∈ − products are complementary. The inverse demand function is given by
1 ( )
Therefore, consumer surplus is given by
1 1
All firms share identical cost function with increasing marginal cost represented by the following quadratic function.
1 2
Domestic social welfare is measured as the summation of the consumer surplus and the
15 Häckner assumed the utility function is quadratic in the consumption of q-goods and for simplicity let
1 2 1
domestic firm’s profit,
a b
W =CS+π + , π (4.6)
where πa represents the profits of public firm and πb the profits of domestic private firm.
To be more efficient, the public firm allows for partial privatization. In the following, public firm will proceed partial privatizing through a program with two distinct measures: (i) privatizing directly, and (ii) deciding to merge with domestic private firm.
If public firm allow for partial privatizing directly, i.e. case (i), we follow the assumption in Matsumura (1998), which the government owns a share of (1− ∈δ) [0,1] and the manager of this firm will maximize the weighted average of social welfare and the profit. Then, we define the objective function of firmaas
(1 δ)W δπa
Ω = − + ；δ∈[0,1]. (4.7.1)
Note that the manager of fully privatized firm (δ =1) seeks the firm’s profit, while the manager of a fully nationalized firm (δ =0) maximizes social welfare.
If there exists enough incentives for both public firm and domestic private firm to make them choose to merge with each other, i.e. case (ii), we follow the assumption in Mé ndez-Naya (2008), which is assumed that, the merging firm is partially owned by private and public owners. The private owner owns a percentage of the shares of the merging firm which depends on the degree of privatization of the merged firm. Therefore, assuming that the domestic firms merge, the objective function of the merged firm is given by,
(1 δ)W δ π( a πb)
Ω = − + + ；δ∈[0,1]. (4.7.2)
Identically, the merged firm would be a public firm if δ=0, and as δ increases, the degree of privatization of the mixed firm increases, becoming a private one if δ=1.
In order to develop the analysis, we set up two stage game. Government decides the degree of partial privatization for public firm or merged firm at the first stage. All firms simultaneously choose their output at the second stage. The game is solved by backwards induction.