1. OT2010 1 Market Structure and Privatization Policy under International Competition Joint work with Yoshihiro Tomaru

2. OT2010 2 Plan of the Presentation (1) Rough Sketches of the Model and Results (2) Mixed Oligopoly (3) Four Lines of Related Literature on Mixed Oligopoly (4) Model Formulation (5) Results and Implications

3. OT2010 3 Rough sketch of the model (1) The government chooses the level of production subsidy s. (2) One welfare-maximizing state-owned public firm (firm 0) competes against n profit maximizing private firms in Cournot fashion (or Stackelberg). nθ foreign private firms, n(1-θ) domestic private firms (n and θ are exogenous)

4. OT2010 4 Our main concerns (1) Relationship among welfare-improving effect of privatization, n and θ under optimal subsidy policy. (2) What is the desirable role of the public firm, whether public leadership or private leadership yields higher welfare under optimal subsidy policy

5. OT2010 5 Results (1) Privatization more likely improves welfare when n is larger and θ is smaller. →The government should improve the competitiveness of the market before the privatization of the public firms (2) Private leadership is better when θ is small, and public leadership is better when θ is large. →The public firm should take leadership when the foreign penetration in the product market is large.

6. OT2010 6 Mixed Oligopoly, Mixed Market State-owned public firms compete against private firms State-owned public firms compete against private firms Examples in Japan Banking: Postal Bank, DBJ, Iwate Bank Housing Loan: the Public House Loan Corporation Life Insurance: Postal Life Insurance (Kampo) Overnight Delivery: Japan Post Energy: Public Gas Corps (Narashino, Fukui,...) Broadcasting: NHK

7. OT2010 7 Examples of mixed oligopoly in other countries Banking: Postal Banks (New Zealand, U.K., Germany,...) Automobiles: Renault, VW Medicine: Public Institute in Brazil National Defense, Aviation: EADS, Airbus Airline: National airlines (Swiss, Belgian, France, Italy, Indonesia...) Overnight Delivery: USSP Energy: Electricite de France, Gas de France, Macquarie, Broadcasting: BBC

8. OT2010 8 Classical discussions of public firms Why do public firms exist? (1) Natural monopoly (a) Public firm monopoly (b) Regulated private firm monopoly

9. OT2010 9 Natural Monopoly P Ｙ AC D 0

10. OT2010 10 Classical discussions of public firms(2) Why do public firms exist? (2) Unprofitable market (a) Public firm monopoly (b) Private firm monopoly with subsidy (compensation of deficit from public funds)

11. OT2010 11 Non-Profitable Market P Y AC D 0

12. OT2010 12 Classical discussions on state- owned public firms →Public firm is the monopolist In real economies, public firms are not always monopolists. Public firms do not always face significant economy of scale, which guarantees monopoly by the public firm.

13. OT2010 13 Differences between public and private firms (1)Public firms are less efficient than private firms. →Many empirical works do not support this view (and many other papers do support this view). (2) Difference of objective function →Private firms maximize their own profits, whereas public firms might care about social welfare. This paper, as well as many other papers on mixed oligopoly, assume that the public firm’s objective is welfare.

14. OT2010 14 Problem(1) (1) How to provide incentives for welfare maximization? → This is the central issue for the public firm's monopoly If we assume that the public firm is a welfare- maximizer under the monopoly, it is absolutely obvious that the first best is achieved by definition. →No unsolved research problem remains. Thus, researchers never assume that the public firm is a welfare maximizer when they consider monopoly situation.

15. OT2010 15 Problem(2) (2) Is the welfare-maximizing behavior by the public firm efficient? →This problem never appears in the public firm's monopoly. This question makes sense in mixed oligopoly because welfare-maximizing behavior by the public firm might worsen welfare through strategic interaction between public and private firms. →This is the central issue of mixed oligopoly

16. OT2010 16 De Fraja and Delbono(1989) (1) Cournot-type (quantity-setting competition, simultaneous-move, no product differentiation) (2) No cost difference between public and private firms. (3) Linear demand and quadratic cost function. (4) The private firm maximizes its own profits given outputs of other firms. (5) The public firm maximizes social welfare given outputs of other firms. →The public firm chooses its output level so that the price equals to its marginal cost.

17. OT2010 17 Results Compare the pure economy (after the privatization) to the mixed economy (before the privatization) →Privatization of the public firm might improve welfare W P >W M or W P <W M. W P >W M more likely takes place when the number of private firms are large.

18. OT2010 18 Intuition (1) Privatization of the public firm reduces public firm's output q 0 (2) Privatization increases each private firm's output q 1 →production substitution from the public firm to the private firms. (3) Privatization decreases total output q 0 +nq 1 Effects (1) and (3) reduces welfare and effect (2) improves welfare. Effect (2) may be the strongest, leading to an improvement of welfare. (2) is stronger and (3) is weaker when m is larger →Privatization morel likely improves welfare when n is larger.

19. OT2010 19 Production substitution q1q1 reaction curve after privatization reaction curve of the private firm 0 reaction curve before privatization q0q0

20. OT2010 20 More detailed explanation of intuition Privatization of the public firm reduces q 0 and increases q 1 (production substitution). Before Privatization p=c 0 ' >c 1 ' →Public firm's marginal cost is higher than private firm's → Production substitution from public to private economizes production costs →Welfare-improving →Privatization reduces total production level and so consumer surplus → Welfare-reducing It is possible that the former effect dominates the latter effect.

21. OT2010 21 Contribution of De Fraja and Delbono(1989) (1) No cost difference between public and private firms → privatization does not improve production efficiency (2) Public firm's objection: welfare →No agency problem in the public firm (3) No additional policies by regulation, tax, or subsidy after privatization. ⇒ Ideal circumstances for the existence of public firm. Against assumptions for the advocators of privatizations. → Nevertheless, privatization might improve welfare

22. OT2010 22 Assumptions of De Fraja and Delbono(1989) Many researchers in this field believe that the assumptions above are plausible, but many other researchers (as well as I) make these assumptions for strategic purposes. (1) Even without cost differences, privatization improves welfare. →If public firm is less efficient, much more. (2) Even without any agency problem in the public firm, privatization improves welfare. →If public firm has agency problem, much more.

23. OT2010 23 Why quadratic costs ？ Constant marginal cost yields problems If marginal costs are constant and no cost differences exists, the public firm's monopoly yields the first best. → It is nonsense to discuss mixed oligopoly in such a circumstance.

24. OT2010 24 How to avoid this problem? (1) Using constant marginal costs and assuming cost differences between public and private firms. Mujumdar and Pal (1998),Pal (1998),Matsumura (2003a),Matsumura and Ogawa (forthcoming) First best is achieved by the marginal cost pricing of the private firm. The private leadership yields the second best where only private firms produce and the price is equal to the marginal cost of the public firm. It is the equilibrium in the observable delay game.

25. OT2010 25 How to avoid this problem? (2) Using increasing marginal costs. De Fraja and Delbono (1989),Fjell and Pal (1996), White (1996), Matsumura and Kanda (2005), Heywood and Ye (2009a), Wang et al (2009), The paper presented yesterday. If there is no cost difference between public and private firms, at the first best all firms chooses the same output level. It is not always achieved in mixed oligopoly since public and private firms have different objectives.

26. OT2010 26 How to avoid this problem? (3) Dropping the assumption of homogenous goods. Monopolistic competition: Anderson et al. (1997), Matsumura et al (2009) Linear demand (quadratic utility function) with product differentiation: Fujiwara (2007) Mill pricing location model: Cremer et al. (1992), Matsumura and Matsushima (2003,2004), Inoue et al (2008), Delivered pricing location model: Matsushima and Matsumura (2003,2006), Heywood and Ye (2009b)

27. OT2010 27 How to avoid this problem? More general Costs : Matsumura (1998, 2003b), Kiyono and Tomaru (forthcoming) Discuss both (2) and (3): Matsumura and Shimizu Shimizu (forthcoming)

28. OT2010 28 Partial Privatization De Fraja and Delbono: The public sector holds whole shares in the firm (nationalization) or the private sector holds whole shares in the firm (privatization) In the real world, we observe many firms with mixture ownership (partial privatization) NTT, JT, Iwate Bank, Hokuriku Electric Power Company, VW, Renault

29. OT2010 29 Matsumura (1998) (1) Cournot-type (quantity-setting competition, simultaneous-move, no product differentiation) (2) No restrictions on the cost differences between public and private firms. (3) The objective function of the public firm is the weight sum of social welfare and its own profits. （ Partial Privatization) U 0 = (1-α) W+ απ 0 (4) General demand and general costs. The government chooses s and s affects α. After observing α firms compete in the product market.

30. OT2010 30 Results α =0 is optimal only if it yields public monopoly. →If we allow partial privatization, no privatization (full nationalization) never becomes optimal.

31. OT2010 31 Intuition =0. A slight reduction of (1) Suppose that α =0. A slight reduction of α reduces public firm's output q 0. Since p=c 0 ', this effect is negligible (second order) ←envelope theorem (2) Reducing α increases private firm's output q 1 Since p>c 1 ', this effect is nonnegligible (first order) ⇒ (2) dominates (1).

32. OT2010 32 Four Lines of Related Literature on Mixed Oligopoly(1) (1) Relationship between Market Structure and Privatization Policy Privatization more likely improves welfare when the market is more competitive (when the number of private firms is larger). De Fraja and Delbono (1989), Han and Ogawa (2007,2009), Matsumura and Shimizu (forthcoming) All papers ignore the subsidy policy

33. OT2010 33 Related Literature (2) (2) Desirable Role of Public Firm, whether public leadership or private leadership yields higher welfare When private firms are domestic, private leadership yields higher welfare. Pal (1998), Matsumura (2003a) When private firms are foreign, public leadership yields higher welfare. Matsumura (2003b) These outcomes are equilibria in the observable delay game. Pal (1998), Matsumura (2003b), Matsumura and Ogawa (2010) All papers ignore the subsidy policy

34. OT2010 34 Related Literature (3) (3) International competition Public firm maximizes domestic welfare →The public firm's behavior is dependent on whether its rivals are domestic or foreign If the rivals are foreign, the public firm becomes more aggressive. Fjell and Pal (1996)←De Fraja and Delbono (1989) Strategic Trade Policy Pal and White (1998) ← Strategic Trade Policy FDI Mukherjee and Suetrong (2009) ← FDI Chang (2005), Chao and Yu (2006), Fujiwara (2006) ← partial privatization version

35. OT2010 35 Related Literature on Mixed Oligopoly(4) (4) Privatization Neutrality Theorem (PNT) (4-a) Privatization does not affect welfare under simple optimal subsidy policy, unit production subsidy. White (1996), Tomaru (2006), Kato and Tomaru (2007), Hashimzade (2007) (4-b) Public Leadership, private leadership, mixed Cournot, and private oligopoly yield the same welfare under optimal subsidy policy above. Poyago-Theotoky (2001), Tomaru and Saito (2010)

36. OT2010 36 Privatization Neutrality Theorem Privatization Neutrality Theorem: Privatization does not matter under optimal subsidy policy. It implies that if the optimal subsidy policy is adopted, discussing mixed oligopoly or privatization policy does not make sense. Most of the results in mixed oligopoly literature have quite limited implications and importance if this theorem is really robust. Destructive Result, Disaster for researchers in this field.

37. OT2010 37 Intuition behind PNT Suppose that all firms are symmetric. Consider the private oligopoly. The first best is achieved when P=c i ' (price =marginal cost) ~ all firms choose the same output level It is achieved by the production subsidy s*.

38. OT2010 38 Intuition behind PNT Suppose that one firm is nationalized. Suppose that all of remaining firms do not change their outputs. The nationalized firm, which is welfare-maximizer, never changes its output. All remaining private firms obviously have no incentive to change their outputs. →s* yields the first best outcome in the mixed oligopoly.

39. OT2010 39 Condition for PNT When I explain the intuition behind PNT, I do not use any of the conditions (1) profit-maximizing private firms (2) homogeneous product market, (3) single public firm and so on. All we use is the conditions that the first best is achieved at the symmetric equilibrium, that the first best is achieved by controlling outputs only, and that the pubic firm is welfare maximizer.

40. OT2010 40 Robustness of PNT Privatization Neutrality Theorem is far from robust: (1) PNT obviously does not hold when there is cost difference between public and private firms. (2) PNT does not hold unless all firms are domestic.~ This paper (3) PNT does not hold at free entry markets ~Cato and Matsumura (4) If there is an excess burden of taxation, PNT does not hold. ~Matsumura and Tomaru, another paper (5) PNT does not hold if firms control two or more independent variables

41. OT2010 41 Notations m: Number of private firms θ: ration of foreign private firms q i : Firm i's output, Q: Total output C i (q i ) =0.5(qi) 2 : Firm i's production cost P(Q)=a-Q: linear demand function π i : Firm i's profit, W: domestic social surplus, Superscript S: Equilibrium value at the second stage game Superscript M, P, L, F: Equilibrium value in the mixed Cournot oligopoly, private oligopoly, public leadership, private leadership

42. OT2010 42 The Model foreign private firms, domestic private firms, Players: government, firm 0 (public firm), mθ foreign private firms, m(1-θ) domestic private firms, Payoffs: domestic welfare (government 、 firm 0), Its own profits (private firms). (1) Government chooses s (unit production subsidy). and s, firms face Cournot competition (Section 3) or Stackelberg Competition (Section 4). (2) Given m, θ and s, firms face Cournot competition (Section 3) or Stackelberg Competition (Section 4).

43. OT2010 43 Optimal Subsidy Rate Suppose that θ>0. (1) s P and s M can be either positive or negative (2) s P is decreasing in θ, while s M can be either increasing or decreasing in θ. (3) Either s P > s M or s P < s M is possible. (3) implies that privatization neutrality theorem on subsidy rate does not hold.

44. OT2010 44 Resulting Welfare Suppose that θ>0. W P >(<) W M when n is large (small). (a) Privatization neutrality theorem on welfare holds only when θ=0. (b) Privatization more likely improves welfare when the market is more competitive.

45. OT2010 45 Public Leadership, Private Leadership Suppose that θ>0. Public leadership more likely yields larger domestic welfare than the private leadership when n is larger and θ is larger. Privatization neutrality theorem on welfare again holds only when θ=0.

46. OT2010 46 Summary Privatization Neutrality Theorem is quite vulnerable. →We can continue to make intensive researches on mixed oligopoly without bothering PNT. Competition, Privatization, and Trade Policies are very closely related.