Factor price distortions, resource allocation, and growth: A computable general equilibrium analysis

The present paper estimates the welfare cost of both labor and capital market distortions in South Korea using a computable general equilibrium model and expands on earlier studies by distinguishing autonomous differentials from distortions in accounting for differences in sectoral wages and returns to capital. The results of this paper cast doubt on the generality of the proposition on the sensitivity of economic efficiency to market distortions. Our results show that removing labor market distortions would increase output by less than 1% of the base year GDP. Even when capital market distortions are also removed, the GDP increases only by 3.2%, and welfare by 5.6%. The study also examines a consequence of capital market distortions which suggests that distortions may lead to more rapid capital formation and higher concentration of capital stock. Given the industrial policy configuration in Korea, we find that financial incentives had more distorting effects than fiscal incentives.