Discussion Paper Series 2004-E-4

Distortions in Factor Markets and Structural Adjustments in the Economy

Masayuki NAKAKUKI, Akira OTANI, Shigenori SHIRATSUKA

In this paper, we carry out qualitative and quantitative analyses of impacts of factor market distortions on Japan's economic stagnation in the 1990s, thereby showing that resolution of structural impediments is essential for sustained economic growth to be restored in the future. Distortions in factor markets lead the economy to exhibit inefficient resource allocations, resulting in an inward shift of the nation's production possibility frontier and decline in its attainable output. Our estimation results reveal that the deterioration of distortions in factor markets is attributable to 0.5% of the decline in real GDP growth (-3.6%) after the bursting of the asset price bubble. This confirms that the exacerbation of structural impediments in factor markets is one of the major causes of the prolonged economic stagnation after the bursting of the asset price bubble. Moreover, given that autonomous resolution of factor market distortions through market mechanism is hardly expected, it is important to take measures to achieve a more efficient allocation of productive resources. Without such measures, monetary and fiscal policies cannot push the economy back to a sustainable growth path.

Keywords: Structural Problems; Heckscher-Ohlin Model; Specific Factor Model; Production Possibility Frontier; and Total Factor Productivity (TFP)

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2004 Bank of Japan All Rights Reserved.

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