Elsevier

Economics Letters

Volume 93, Issue 3, December 2006, Pages 343-347
Economics Letters

Does privatization improve the environment?

https://doi.org/10.1016/j.econlet.2006.06.005Get rights and content

Abstract

Privatization towards profit maximization lowers output and hence encourages a lower tax rate. Because of the reduced tax effect, output is increased when the demand function is highly convex. This gives a paradoxical result that privatization harms the environment.

Introduction

Privatization has been a worldwide phenomenon over the last two decades and its effects on output, efficiency and welfare have been extensively studied in the literature.1 Due to a concern with social welfare, which includes profits and consumer surplus, production of the public-owned firm tends to be inefficient. Therefore, privatization, by shifting the objective facing managers from social welfare to profit maximization, can lead to more efficient production.

However, the impact of privatization on environmental quality has received little attention in the literature. During the production process, by-products such as air and water pollution are generated. Since privatization lowers output and hence pollution emissions, it seems that privatization should improve the environment. This argument is valid only when pollution taxes are absent. In reality, in many countries pollution taxes exist and are levied based on the user-pay principle. To compensate for under-production by privatization, output should be subsidized. This reduces pressure on stringent taxes, thereby raising output and pollution emissions. The purpose of this paper is to use a simple model to identify the conditions under which privatization can in fact worsen the environment.

Section snippets

Analysis

We consider a partially privatized firm that produces good x. During the process of production, however, by-products such as air and water pollution are generated. Letting θ be pollution emissions per unit of output, total damage from production is θx. Because of the pollution damage, a pollution tax is imposed on the producer. The profit function of the firm is:π=[p(x)cτθ]x,where p is the good price, c denotes unit production cost and τ is the pollution tax.2

Conclusions

This paper has shown that privatization can have a negative effect on the environment. The intuition behind this result is straightforward. To reduce emissions, the standard Pigouvian pollution tax is mandated and the tax rate should be set to counteract the marginal damage of pollution. Nevertheless, when the market is not perfectly competitive, to compensate for under-production and to take account of consumer surplus for the partially privatized firm, output should be subsidized. Because of

Acknowledgements

We thank an anonymous referee for useful comments and suggestions. The work described in this paper was supported by a grant from the Research Grants Council of the Hong Kong Special Administrative Region, China (Project No. CUHK4201/02H).

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