Imported inputs and privatization in downstream mixed oligopoly with foreign ownership

This paper examines welfare implications of privatization in a mixed oligopoly with vertically related markets, where an upstream foreign monopolist sells an essential input to public and private firms located downstream in the domestic country. The impact on domestic welfare of privatizing the downstream public firm is shown to contain three effects. The first is an output distortion effect, which negatively affects welfare since privatization decreases the production of final good for consumption. The second is an input price lowering effect resulting from a decrease in derived demand for the input. When the level of privatization increases, a decrease in final good production lowers input demand, causing input price to decline and domestic welfare to increase. The third is a rent-leaking effect associated with foreign ownership in the downstream private firm. The rival domestic firm strategically increases its final good production, causing profits accrued to foreign investors to increase and domestic welfare to decline. Without foreign ownership in the downstream private firm, the optimal policy toward the public firm is complete privatization as the output distortion effect is dominated by the input price lowering effect. With foreign ownership, however, complete privatization can never be socially optimal due to the additional negative impact on domestic welfare of the rent-leaking effect. We further discuss implications for domestic welfare under different privatization schemes (e.g., selling the privatization shares to the upstream foreign monopolist or to the rival domestic firm).