Strategic Privatization in Developing Countries

Privatization of state-owned enterprises may have important welfare implications, in particular in less developed economies where markets are small and domestic firms are typically relatively weak, both technologically and financially. In these environments, a high-tech foreign investor acquiring the state-owned assets may end up dominating the local market, thereby harming local consumer and producer interests. A foreign investor, however, is likely to be both willing and able to offer a higher bid for the assets than local investors. This paper addresses the trade-off for local governments between privatization revenues and foreign market power. The authors find that there may be an incentive to privatize "strategically" by selling the state-owned firm to a local (less advanced) investor at a lower price in order to achieve a more competitive post-privatization market structure.