Microeconomic distortions : static losses and their effect on the efficiency of investment

In the past decade the developing countries have tried much harder to achieve macroeconomic stability than they have to eliminate inefficiencies from microeconomic distortions. The author has pursued a relatively new line of inquiry in examining measurement of the social income losses induced by the reduction of the investment efficiency caused by trade distortions. Empirical findings of the study suggest a strong negative effect of trade distortions on the social efficiency of investment. The social income losses caused by the reduced investment efficiency are considerable. Countries that have a moderate investment ratio (about 20 percent of GDP) can experience social income losses in excess of 18 percent in 30 years, if tariffs are about 50 percent. This study confirms earlier findings about the relatively modest efficiency losses caused by the independent effects of specific distortions. The author alsofound a significant synergistic effect when trade and wage distortions coexist and lead to larger efficiency losses. The key issue is the combination of price distortions favoring capital-intensive activity with wage distortions that cause unemployment and underemployment. This pattern is pervasive in developing countries.