Privatization in Oligopoly: The Impact of the Shadow Cost of Public Funds

The aim of this paper is to investigate the welfare effect of privatization in oligopoly when the government takes into account the distortionary effect of raising funds by taxation (shadow cost of public funds). We analyze the impact of the change in ownership not only on the objective function of the firms, but also on the timing of competition by endogenizing the determination of simultaneous (Nash-Cournot) versus sequential (Stackelberg) games. We show that, absent efficiency gains, privatization never increases welfare. Moreover, even when large efficiency gains are realized, an inefficient public firm may be preferred.