The interaction of domestic distortions with development strategies
Balassa, Bela
This paper provides evidence on the unfavorable effects factor market distortions have on the efficiency of resource allocation and on employment in developing countries. It further shows that the policy imposed distortions in product markets tend to aggravate these adverse effects in the countries concerned. Rationing in the product, labor, and capital markets also contributes to inefficiency in resource allocation by generating rent-seeking activities. Such activities misdirect productive energies and tend to lead to excess investments in activities that stand to benefit from rationing. Inefficiencies in resource allocation, in turn, have adverse effects on economic growth. For one thing, less is saved and invested as the distortions lower income levels. For another thing, the efficiency of investments is reduced as capital is directed into industries that do not correspond to the country's comparative advantage.
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