Interpretation and measurement of capacity utilization: the case of Korean manufacturing

This paper focuses attention on the conceptual difference between optimal (ex ante) and actual (ex post) capacity untilization (CU). The dynamic version of the efficient output approach to capacity untilization which this paper presents is theoretically superior to other alternative approaches. Our concept of optimal CU has been applied to estimate CU measures for Korean manufacturing. We fing that our measure of CU explains the trends and cycles in Korean economy rather convincingly, and that Korean manufacturing has adjusted much more flexibly to market-demand shocks than it has to exogenous changes in factor prices. From the examination of the determinants of CU we find that, while wages and material prices have positive effects on CU, energy prices and capital stock have nagative effects. The study also implies that overambitious government incentive policies to stimulate investment may have an adverse effect on capacity utilization.