Skip to main content
Log in

Privatization in the presence of foreign competition and strategic policies

  • Published:
Journal of Economics Aims and scope Submit manuscript


Recent evidence shows that developing and transition economies are increasingly privatizing their public firms and also experiencing rapid growth of inward foreign direct investment (FDI). In an international mixed oligopoly with strategic tax/subsidy policies, we analyze the interaction between privatization and FDI. We find that the incentive for FDI increases with privatization. However, the possibility of FDI reduces the degree of privatization. Our paper shows that FDI policies reducing the fixed-cost of undertaking FDI may need to complement the privatization policies to attract FDI and to improve domestic welfare.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Fig. 1
Fig. 2

Similar content being viewed by others


  1. Baer (1994) shows that, as the state ownership in Latin America reduces, the presence of foreign capital increases. Using annual data of eight Asian and nine Latin American and Caribbean countries for 1990–99, Gani (2005) shows that privatization is positively correlated to FDI. Focusing on the Central and Eastern European countries (CEECs), Merlevede and Schoors (2005) have shown that privatization history positively affects FDI.

  2. In a Cournot oligopoly setting, Mukherjee and Suetrong (2009) show that privatization and FDI are mutually reinforcing.

  3. Production tax could be in the form of stumpage or natural resources consumption tax—a tax to help ensure the long run sustainability by making people be more aware of natural resource consumption.

  4. Before 1996, the auction of shares of the Indian public sector enterprises was restricted to dispersed domestic investors only (Kapur and Ramamurti 2002). Countries often restrict foreign individuals and firms from acquiring domestic firms, or apply special restrictions to foreign firms in certain industries, as is the case in Malaysia and the Republic of Korea (UNCTAD 2000). Bortolotti et al. (2002) points out that of the 650 major privatization deals reported in the Privatisation International dataset, only around 150 involved an equity issue on non-domestic markets.

  5. See Vickers and Yarrow (1991), Schmidt and Schnitzer (1997) and Pal and White (1998) for overviews of the privatization literature.

  6. \(F\) captures all the start-up costs of a new plant, including the adjustment cost of learning to operate in a new institutional and financial environment.

  7. Our assumption implies that privatization is more irreversible than FDI, which is more irreversible than tax/subsidy policy and it is more irreversible than output decision.

  8. The domestic country’s product tax rate is indeterminate for \(\alpha =0.\) This is because a fully nationalized firm sees the tax as transferring funds from the firm to the government without affecting welfare, which is what the firm maximizes. From (5) and (6) with \( \alpha =0,\) \(t\) drops out of the firm’s objective function: The tax does not affect the firm’s behavior.

  9. The motive for subsidization to extract rent from the firms in competing countries dates back to seminal work by Brander and Spencer (1985).

  10. See Appendix D for proof.

  11. See Appendices B and C for the proof.

  12. We show in Appendix E that \(\alpha _{R}^{*}<\alpha _{F1}\).

  13. See Kellenberg (2009) for a survey of the literature on environmental regulation and FDI.

  14. For details, see our working paper (Dijkstra et al. 2012).

  15. High cost needed to serve the foreign market may prevent the domestic firm from entering the foreign market. Das et al. (2007) show that there is a significant fixed cost of exporting. Moreover, buyer-seller networks may be important for both international trade and investment (Greaney 2003), and high network costs may prevent the foreign firm in the model from serving the export markets.


  • Anderson SP, de Palma A, Thisse J-F (1997) Privatization and efficiency in a differentiated industry. Eur Econ Rev 41:1635–1654

    Article  Google Scholar 

  • Baer W (1994) Privatization in Latin America. World Econ 17:509–28

    Article  Google Scholar 

  • Bárcena-Ruiz J, Casado-Izaga F (2012) Location of public and private firms under endogenous timing of choices. J Econ 105:129–143

    Article  Google Scholar 

  • Barros F (1995) Incentive schemes as strategic variables: an application to a mixed duopoly. Int J Indus Organ 13:373–86

    Article  Google Scholar 

  • Beato P, Mas-Colell A (1984) The marginal cost pricing rule as a regulation mechanism in mixed markets. In: Marchand M, Pestieau P, Tulkens H (eds) The performance of public enterprises-concepts and measurement. North-Holland, Amsterdam, pp 81–100

    Google Scholar 

  • Bortolotti B, Fantini M, Scarpa C (2002) Why do governments privatize abroad? Int Rev Finance 3:131–63

    Article  Google Scholar 

  • Brander J, Spencer B (1985) Export subsidies and international market share rivalry. J Int Econ 18:83–100

    Article  Google Scholar 

  • Corneo G, Jeanne O (1994) Oligopole mixte dans un marché commun. Annales d’Economie et de Statistique ENSAE 33:73–90

    Google Scholar 

  • Cremer H, Marchand M, Thisse J-F (1989) The public firm as an instrument for regulating an oligopolistic market. Oxford Econ Papers 41:283–301

    Google Scholar 

  • Das S, Roberts MJ, Tybout JR (2007) Market entry costs, producer heterogeneity and export dynamics. Econometrica 75:837–73

    Article  Google Scholar 

  • De Fraja G, Delbono F (1989) Alternative strategies of a public enterprise in oligopoly. Oxford Econ Papers 41:302–11

    Google Scholar 

  • Dijkstra BR, Mathew AJ, Mukherjee A (2012) Privatization in a polluting industry in the presence of foreign competition. Working paper 08/12, Navarra Centre for International Development

  • Fershtman C (1990) The interdependence between ownership status and market structure: the case of privatization. Economica 57:319–28

    Article  Google Scholar 

  • Fjell K, Heywood JS (2002) Public stackelberg leadership in a mixed oligopoly with foreign firms. Aust Econ Papers 41:267–81

    Article  Google Scholar 

  • Gani A (2005) Foreign direct investment and privatization. USPEC Working Paper, No. 2005/6, Department of Economics, University of The South Pacific

  • Greaney TM (2003) Reverse importing and asymmetric trade and FDI: a networks explanation. J Int Econ 61:453–465

    Article  Google Scholar 

  • Harris RG, Wiens EG (1980) Government enterprise: an instrument for the internal regulation of industry. Can J Econ 13:125–32

    Article  Google Scholar 

  • Jain R, Pal R (2012) Mixed duopoly, cross-ownership and partial privatization. J Econ 107:45–70

    Article  Google Scholar 

  • Kapur D, Ramamurti R (2002) Privatization in India: the imperatives and consequences of gradualism. In: Srinivasan TN (ed) India after a decade of economic reforms: retrospect and prospects. Stanford University Press, Stanford

    Google Scholar 

  • Kellenberg DK (2009) An empirical investigation of the pollution haven effect with strategic environment and trade policy. J Int Econ 78:242–255

    Article  Google Scholar 

  • Lin MH, Matsumura T (2012) Presence of foreign investors in privatized firms and privatization policy. J Econ 107:71–80

    Article  Google Scholar 

  • Merlevede B, Schoors K (2005) How to catch foreign fish? FDI and privatization in EU accession countries. Working Paper, No. 785, William Davidson Institute

  • Matsumura T (1998) Partial privatization in mixed duopoly. J Public Econ 70:473–483

    Article  Google Scholar 

  • Matsumura T, Kanda O (2005) Mixed oligopoly at free entry markets. J Econ 84:27–48

    Article  Google Scholar 

  • Matsumura T, Matsushima NN, Ishibashi I (2009) Privatization and entries of foreign enterprises in a differentiated industry. J Econ 98:203–219

    Article  Google Scholar 

  • Mukherjee A, Suetrong K (2009) Privatization, strategic foreign direct investment and host-country welfare. Eur Econ Rev 53:775–785

    Article  Google Scholar 

  • Pal D, White MD (1998) Mixed oligopoly, privatization, and strategic trade policy. South Econ J 65:264–81

    Article  Google Scholar 

  • Rees R (1988) Inefficiency, public enterprise and privatisation. Eur Econ Rev 32:422–431

    Article  Google Scholar 

  • Schmidt KM, Schnitzer M (1997) Methods of privatization: auctions, bargaining and give-aways. CEPR Discussion Paper, No 1541

  • UNCTAD (2000) World Investment Report. United Nations, New York and Geneva

  • UNCTAD (2002) World Investment Report. United Nations, New York and Geneva

  • Vickers J, Yarrow G (1991) Economic perspectives on privatization. J Econ Perspect 5:111–32

    Article  Google Scholar 

Download references


The author would like to acknowledge the support through a Research Project Funding (Ref: ECO2010-18680) from Ministerio de Ciencia E Innovacion, (Ministry of Science & Innovation), Spain. We thank an anonymous referee of this journal for the useful comments and suggestions received. The authors are solely responsible for the views presented here but not their organizations. The usual disclaimer applies.

Author information

Authors and Affiliations


Corresponding author

Correspondence to Anuj Joshua Mathew.



1.1 Appendix A: maximum value of \(c\):

We see from (14) and (24) that \( q_{p}^{x}\) and \(q_{p}^{R}\) are positive respectively for:

$$\begin{aligned} c&< \bar{c}(\alpha ,s)\equiv \frac{1}{2\alpha +4}\left( s+\alpha +s\alpha +3\right) , \end{aligned}$$
$$\begin{aligned} c&< \hat{c}(\alpha )\equiv \frac{3-\alpha }{\alpha +\alpha ^{2}+3}. \end{aligned}$$

We further see that:

$$\begin{aligned} \frac{\partial \bar{c}(\alpha ,s)}{\partial \alpha }<0\quad \text { and }\quad \frac{d \hat{c}(\alpha )}{d\alpha }<0. \end{aligned}$$

Following (41), the least possible values of (39) and (40) are respectively:

$$\begin{aligned} c&< \bar{c}_{\min }\equiv \bar{c}(1,s)=\frac{s+2}{3} \end{aligned}$$
$$\begin{aligned} c&< \hat{c}_{\min }\equiv \hat{c}(1)=\frac{2}{5}. \end{aligned}$$

Comparing (42) and (43), we see that \(\hat{c}(1)<\bar{c} (1,s).\) Hence, the relevant constraint is (3).

1.2 Appendix B: \(W_{h}^{R}\) as a function of \(\alpha \):

Differentiating domestic welfare \(W_{h}^{R}\ \)under FDI in (35) partially with respect to \(\alpha ,\) we see that there are two solutions to \(\partial W_{h}^{R}/\partial \alpha =0,\) which we call \(\underline{\alpha } \) and \(\alpha _{R}^{*}\):

$$\begin{aligned} \underline{\alpha }=c-3,\, \, \, \,\, \, \, \alpha _{R}^{*}=\frac{c}{2-c}. \end{aligned}$$

We see that \(0<\alpha _{R}^{*}<1\) and \(\underline{\alpha }\) is negative.

In order to determine whether these two stationary points are maxima or minima, we differentiate partially with respect to \(\alpha \) again:

$$\begin{aligned} \left. \frac{d^{2}\left( W_{h}^{R}\right) }{d\alpha ^{2}}\right| _{\alpha =\underline{\alpha }}&= \frac{1}{-4c+c^{2}+6}>0, \\ \left. \frac{d^{2}\left( W_{h}^{R}\right) }{d\alpha ^{2}}\right| _{\alpha =\alpha _{R}^{*}}&= -\frac{1}{4}\frac{\left( c-2\right) ^{4}}{ c^{2}-4c+6}<0. \end{aligned}$$

Hence, domestic welfare reaches a global maximum for \(\alpha \in \left[ 0,1 \right] \) at \(\alpha =\alpha _{R}^{*}\) as given by (44) .

1.3 Appendix C: \(W_{h}^{R}\) is not higher than \(W_{h}^{x}\) for \(\alpha =1\):

Setting \(\alpha =1\) in (35) we get the domestic welfare under FDI at \(\alpha =1\) as:

$$\begin{aligned} W_{h\left| \alpha =1\right| }^{R}=\frac{7c^{2}-8c+4}{12}. \end{aligned}$$

Similarly setting \(\alpha =1\) in (33), we get domestic welfare under export at \(\alpha =1\) as:

$$\begin{aligned} W_{h_{|\alpha =1|}}^{x\max }=\frac{\left( 7c^{2}-8c+4\right) -s\left( 3\right) \left( 2c-s\right) }{8}. \end{aligned}$$

From (45) and (46), we see that:

$$\begin{aligned} \frac{d\left( W_{h}^{x}-W_{h}^{R}\right) _{\left| \alpha =1\right| }}{dc}=-\frac{1}{12}\left( 7c+9s-4\right) <0. \end{aligned}$$

The minimum value of \(\left( W_{h}^{x}-W_{h}^{R}\right) _{\left| \alpha =1\right| }\) is at the maximum value that \(c\) can take. From (45), (46) and the maximum value of \(c\) given by (3), we see that:

$$\begin{aligned} \left( W_{h}^{x}-W_{h}^{R}\right) _{\left| \alpha =1\right| _{c_{\max }}}=\frac{1}{200}\left( -60s+75s^{2}+16\right) >0. \end{aligned}$$

Thus, we see that

$$\begin{aligned} W_{h\left| \alpha =1\right| }^{x}>W_{h\left| \alpha =1\right| }^{R} \end{aligned}$$

at \(\alpha =1.\) Also, setting \(\alpha =0,\)in (33) and (35) we see that:

$$\begin{aligned} \left[ W_{h}^{R}-W_{h}^{x}\right] _{\alpha =0}=\frac{1}{6}s\left( 2c-s\right) >0. \end{aligned}$$

1.4 Appendix D: \(\hat{F}\) could be negative at \(\alpha =0\):

Substituting \(\alpha =0\) into (31), we see that \(\hat{F}>0\) at \( \alpha =0\) for:

$$\begin{aligned} c>\check{c}\equiv 2s. \end{aligned}$$

Thus, we see that when \(c<\check{c}\), \(\hat{F}\) is negative at \(\alpha =0\).

1.5 Appendix E: \(\alpha _{R}^{*}<a_{F1}\):

If \(\alpha _{R}^{*}>a_{F1},\) it implies from (29) that \(\hat{F}\) should be positive at \(\alpha =\alpha _{R}^{*}\equiv \frac{c}{2-c}.\)

We see from (29) that \(\hat{F}_{\alpha =\alpha _{R}^{*}}>0\) for:

$$\begin{aligned} c>\mathring{c}\equiv \frac{1}{2}\sqrt{16s+1}-\frac{1}{2}. \end{aligned}$$

However, for this to be consistent with the model setting, \(\mathring{c}\) should be less than \(\hat{c}\) in (3). On comparison from (48) and (3), we see that \(\mathring{c}<\hat{c}\) for \(s<0.14.\) Thus, for cases where \(s<0.14,\) we see that \(\alpha _{R}^{*}>a_{F1}.\)

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Dijkstra, B.R., Mathew, A.J. & Mukherjee, A. Privatization in the presence of foreign competition and strategic policies. J Econ 114, 271–290 (2015).

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI:


JEL Classification