Privatization, Public Deficit Finance, and Investment in Infrastructure

The paper presents a theoretical analysis of the relationship between privatization and public deficit finance. We examine the optimal magnitude of public asset sales and the extent to which privatization can be used to reduce taxes, or, to retire public debt, for two cases. In the first, standard case, privatization proceeds are used directly to finance the public deficit, while in the second they are used in cost-reducing public investment in infrastructure. In the latter case the government gains through smaller deficits of remaining public firms, higher proceeds from profit taxation and a smaller net employment loss. We find that the second case will often be associated with lower taxes for any given number of privatizations and a greater optimal number of privatizations than the first.