For decades, there has been a monopoly in telecommunications services controlled by a stable firm, a public enterprise in most of the world. The absence of competition was motivated by the existence of large fixed costs in several parts of the network, whose duplication was neither privately profitable nor socially desirable.
However, the telecommunications industry has been changing rapidly. Due to technological improvement and the political movement toward market liberalization, there is growing interest in substituting competition and privatization for regulation and nationalization in the telecommunications industry. The poor economic and financial performance of many public enterprises and the cases of successful privatization have been used as arguments for privatization and competition. In this worldwide policy-transition situation, policy makers need to know under what conditions privatization of the public enterprise will increase welfare.
In the economic literature there is conventional knowledge on the benefits and costs of privatization. For example, Laffont and Tirole (1993, pp. 637-59) and Viscusi et al. (1995, pp. 453-74) discussed the important regulatory policy issues of public enterprises. Vickers and Yarrow (1988, 1991) and Megginson and Netter (2001) used empirical research to assess the effects of privatization as a public policy. They concluded that enterprises operating under public ownership will be less efficient than their private sector counterparts.
However, standard economic theory is not particularly helpful in understanding the welfare effects of privatization in the telecommunications industry. Little attention has been devoted to incentives in publicly owned firms, even though a "natural monopoly" has been widely used as an argument for regulatory subjects.
In the context of vertical integration, on the other hand, market closure has for a long time been the prime policy concern. For example, Economides (1998), Mandy (2000), Weisman and Kang (2001), and Hackner (2003) have examined several academic debates on market foreclosure and discrimination in the telecommunications industry.
The structure of the telecommunications industry is characterized by an upstream monopolist who supplies an input essential to the competitive downstream firms that are vertically integrated. In other words, the monopolist provides the upstream services and the downstream services as well, and also competes with several firms in the competitive downstream markets. Thus the downstream market structure consists of a mixed market. Because a public enterprise competes with independent, profit-maximizing downstream firms in the telecommunications industry, game-theoretic analysis on privatization policy in vertically mixed market should be examined.
Theoretic research on privatization in a mixed market has been widely studied. De Fraja and Delbono (1989, 1990) showed that welfare might be higher when a public enterprise is a profit-maximizer rather than a welfare-maximizer in an imperfect competition market model. However, they did not consider the privatization effects on improving productivity. Matsumura (1998) and Lee and Hwang (2003) considered the possibility of partial privatization in a Cournot duopoly model and showed that it is optimal for the government to sell some but not all of its shares in public enterprises when there exist production-efficiency effects of partial privatization.
This article considers the telecommunications industry with a vertical market structure to investigate the welfare effects of privatization in a mixed downstream market where public enterprise competes with independent private firms. It is shown that the cost advantage of the independent rivals improves welfare postprivatization. It is also shown that a privatization policy in the telecommunications industry will be well justified if the competition in the downstream market is fierce and the access charge is regulated at certain level. …