Privatization, Deregulation and Capital Accumulation Gerhard Glomm Indiana University Department of Economics Bloomington, IN, 47405 [email protected] Fabio Méndez University of Arkansas Department of Economics Fayetteville, AR, 72701 [email protected] October 18, 2004 Abstract In this paper we study how privatization and deregulation of production of intermediate goods influence capital accumulation. Our model is solved under three alternative scenarios: one where the intermediate sector is composed of a public monopoly under government control, one where the intermediate sector is dominated by a private monopoly, and one with a competitive intermediate sector. The comparison of these models suggests that the income benefits of state-to-market transitions are mostly due to increased competition on the deregulated market and that the privatization of state enterprises is not likely to generate significant changes in the economy when the public monopoly is replaced by a private monopoly. In fact, the model predicts that for high enough levels of public investment, a public monopoly would be preferred to a private monopoly in terms of the resulting aggregate income level. We find that elimination of monopoly rights can increase aggregate income by more than 20%. Keywords: Privatization, Deregulation, Public Monopoly, Private Monopoly, Competition, Capital Accumulation JEL Classification: E13, H11, 041, L33 We are grateful to B. Ravikumar for helpful comments.2 Introduction Since the early 1980’s, many countries have privatized and deregulated intermediate goods industries like gas, electricity or telecommunications that had traditionally been run by the government. The European Union, for example, has adopted aggressive policies towards the elimination of all monopolies in the telecommunication market and conducted a general privatization program whose sales receipts amounted to more than 3% of GDP between 1985 and 1995 (Constantinou and Lagoudakis (1996), Parker (1998)). In other regions of the world, countries like Australia, Chile, Brazil, Argentina and the United States have implemented similar policies (Winston (1993), Van der Vlies (1996), Vickers and Yarrow (1991)). To the extent that these intermediate goods are complementary to either physical or human capital, it is expected that any changes in their aggregate level of output or in their productive efficiency would also have an impact on the rate of growth of the economy. Stern (1993), for example, shows that energy use and quality can be a limiting factor for economic growth, and that any factors that cut energy use would also reduce aggregate income levels. So far, the available empirical studies have not provided definite conclusions on whether privatization (alone or combined with free market entry) has a positive impact on productivity and hence on aggregate income (see for example Kay and Thompson (1986), Cook and Kirkpatrick (1988), Wallsten (1999), and Domberger and Pigott (1994)). Furthermore, as pointed out by Kay and Thompson (1986), it is difficult to distinguish empirically whether any changes in productive efficiency or output are caused by privatization or by increased competition. Part of the difficulty, at least, arises because3both privatization and market liberalization usually occur together within a short time period. The literature on the macroeconomic effects of privatization is relatively sparse [see the survey by Sheshinsky and Lopez-Calva (2003)]. There is a small related literature initiated by Parente and Prescott (1999, 2000) that studies whether and to what extent differences in monopoly rights can explain differences in average income across countries. Herrendorf and Teixeira (2003), for example, find that monopoly rights can reduce aggregate income by a factor of over 7 which is almost three times as large as the effect found by Parente and Prescott (1999). Herrendorf and Teixeira (2003) infer the extent of monopoly rights from differentials in the relative price of non-tradables. Instead of inferring the extent of monopoly power from such relative prices, here we take the stand that monopoly power is likely to exist in the public production of intermediate goods like public utilities or telecommunications and that the size of these sectors can be directly estimated (see World Development Report (1997)). Schmitz (2001) uses a two sector growth model to calculate the impact of government production of investment goods on aggregate labor productivity to be about 30%. In these calculations Schmitz (2001) completely abstracts from the issue of monopoly rights. Here we find that for a reasonable benchmark case elimination of monopoly rights (public or private) can increase aggregate income (in the steady state) by more than 20%. There is also a literature on privatization in the context of the post-Soviet reforms in Eastern Europe, which includes for example Aghion and Blanchard (1994), Alexeev and Kaganovich (2001), Blanchard (1997), Castanheira and Roland (2000) and Roland4(2000). Our paper is distinct from the post-Soviet privatization literature since we do not study whole-scale privatization of (almost) all productive activity, but rather only privatization of one relatively small, albeit important sector of the economy. In this paper, we analyze some of the general equilibrium implications of state-to-market transitions. We examine separately the consequences of both privatization of public enterprises and deregulation of intermediate markets. By privatization we mean simply a transfer from public to private allocation decisions. By deregulation we mean changing the industrial organization from monopoly to competition. We present a model of capital accumulation under three alternative scenarios: one where the intermediate sector is composed of a public monopoly with investment decisions constrained by government control, one where the intermediate sector is dominated by a private monopoly, and one with a competitive intermediate sector. In doing this, we abstract completely from any changes due to productivity differences between public and private firms and concentrate on the effects on capital accumulation. That is, we assume that all firms have access to the same production technology. Unlike the literature mentioned above on privatization in the post-Soviet context our paper focuses on privatization of one sector in a market economy. We