Privatization, Strategic Foreign Direct Investment and Welfare under Technology Diffusion

This study examines the interaction between privatization and foreign direct investment (FDI) in a mixed oligopoly characterized by international competition and technology diffusion. We develop a three-stage game-theoretic model where a domestic state-owned enterprise (SOE) competes with multiple technologically advanced foreign firms. The foreign firms enter the domestic market through either FDI or exports, with FDI generating technology spillovers to the domestic SOE. The analysis demonstrates that privatization enhances foreign firms’ incentives to undertake FDI, while partial privatization maximizes domestic welfare under both entry modes. The endogenous location choices of foreign firms impose constraints on the privatization policies. Although FDI generally yields higher welfare than exports, the government may over-privatize to induce FDI or refrain from privatization when the required degree of privatization is excessive. Therefore, the equilibrium privatization policy may deviate from the first-best outcome due to foreign firms’ strategic location choices.