The most important economic motive for privatization and liberalization is to reduce costs, which are believed to be higher in a public monopoly for several reasons, including internal rent capture. We assume that there is wage-bargaining both before and after privatization and liberalization. Wages are then in most cases reduced by liberalization but not by privatization as such. Social welfare may increase after liberalization with decentralized wage-bargaining if many firms enter, if the employees' bargaining strength is high and if there is no need of vertical separation. However, the social costs of privatization and liberalization are more likely to dominate despite free entry if sunk costs are high, and will always dominate under central wage-bargaining or vertical separation. *

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Competition in an industry with an upstream natural monopoly infrastructure requires vertical separation. However, this cannot increase welfare unless marginal costs are reduced, given the advantages of vertical integration. It turns out that entry increases marginal costs and has ambiguous welfare effects if there is a downstream agency problem, and reduces marginal costs and increases welfare if it occurs upstream. While vertical separation and competition are outperformed even by a profit-maximising monopoly, a welfare-maximising vertically integrated monopoly yields, in both cases, superior cost efficiency and welfare.

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