Measurement of factor price distortion: A new production function method with time-varying elasticity

Factor price distortions affect factor allocation efficiency, which in turn affects the total factor productivity. This paper proposes a new method, the time-varying elasticity production function model, to measure the price distortions of capital and labor factors. The actual price of factors is measured by the factor share method according to national accounting. The empirical research in China from 1978 to 2017 finds: First, from 1978 to 1991, the degree of capital price distortion was greater than 1, and after 1992, it was less than 1, showing a positive distortion. With the reform of the marketization of factors, the distortion of capital prices has been alleviated, and it has generally shown a downward trend. Second, the degree of labor price distortion from 1978 to 2003 was less than 1, and it was greater than 1 since 2004. As the quality of labor improves, the degree of labor price distortion is generally on the rise. Third, the time-varying elasticity production function model can truly describe the actual changes in the income shares of capital and labor in different periods. Based on the time-varying elasticity production function, the Cobb-Douglas production function underestimates the 5.9% of the average capital factor price distortion measure, translog production function underestimates 1.5%. As for labor price distortion, the Cobb-Douglas production function overestimates 5.5%, and translog production function underestimates 5.4%. This study provides a new production function for correctly measuring factor price distortions and helps understand China's factor market reforms and structural changes.