Privatization and policy competition for FDI

In this paper, we provide an explanation of why privatization may attract foreign investorsinterested in entering a regional market. Privatization turns the formerly-public firm into a lessaggressive competitor since profit- maximizing output is lower than the welfare-maximizingone. The drawback is that social welfare generally decreases. We also investigate tax/subsidycompetition for FDI before and after privatization. We show that policy competition isirrelevant in the presence of a public firm serving just its domestic market. By contrast,following privatization, it endows the big country with an instrument which can be used eitherto reduce the negative impact on welfare of an FDI-attracting privatization or to protect thedomestic industry from foreign competitors....