The effect of allocative inefficiency on CO2 abatement costs for the Korean steel industry: a shadow cost approach

Abstract

ABSTRACTFirms facing a regulatory environment are unlikely to maintain an optimal combination of input rates subject to market prices while bearing the costs incurred by this allocative inefficiency. The distance function approach, widely used in the extant literature, fails to capture the costs of this allocative inefficiency, resulting in the underestimation of CO2 abatement costs. In this study, we test for the allocative efficiency of inputs for the Korean steel industry over 1990–2010 by estimating the shadow cost function as a function of unobservable shadow input prices. The effect of CO2 reduction on allocative inefficiency costs is subsequently analyzed. Empirical results indicate that the hypothesis of allocative efficiency for all inputs is rejected, and a 1% reduction in CO2 emissions would result in a 0.22% increase in allocative inefficiency costs for the median year, 2000.