Strategic quality competition, mixed oligopoly and privatization

The argument behind increasing privatization of public firms in developing and transition economies is that profit-driven private enterprises are more efficient than state-owned enterprises. However, when it comes to quality competition where the higher quality is considered as more environmentally friendly, the profit motive may lead to a worse outcome if it fails to incorporate the cost of negative externalities in the form of environmental damages. We demonstrate that neither partial nor full privatization leads to a better outcome in terms of environmental performance and welfare maximization than a state-owned monopoly, which is consistent with recent evidence from China.