2.6 Supply Side Policies

Supply-Side Policies

Definition: Policies aimed at increasing efficiency on the Supply side of the economy so that the there is an increase in the productive potential of the economy. It is shown by an increase in the long run aggregate supply (LRAS shifts to the right).

Traditionally SSPs have been promoted by economists and politicians that believe in a “free market approach”. However there is also a role for government intervention to promote supply-side efficiency. We distinguish (as does the Blink and Dorton textbook) between market based and interventionist SSPs

Free-Market SSPs 

In general the following policies are based on the belief that the market rather than governments bring about increased efficiency. Therefore anything which reduces government “inteference” and promotes competition is good.

Privatisation

The privatisation of various large former state-run industries (telecommunications, electricity, water, steel, gas, rail etc.) is designed to break up the state monopolies to create more competition. 

Many of these privatisations that have occurred throughout Europe simply turned public sector monopolies into private sector monopolies, but there have been efforts to introduce competition into these industries. Note that to truly work privatisation and competition must occur. But some of the privatized industries are natural monopolies, so introducing competition may not be applicable or desirable. How can you introduce a second railtrack? Privatisation may reduce the quality of service as now firms have to cut costs to make profits

The UK government also created utility regulators who have imposed strict price controls on many of these industries and who are now over-seeing the move towards competitive markets in areas such as gas and electricity supply and telecommunications.

Deregulation

De-regulation means the opening up of markets to greater competition, and reduced restrictions and regulations. The aim of this is to increase market supply (driving prices down) and widen the choice available to consumers. The discipline of increased competition should also lead to greater cost efficiency from producers - who are keen to hold onto their existing market share. 

Good examples of deregulation to use include: Urban bus transport, parcel delivery services, mortgage lending, telecommunications, gas and electricity supply. Deregulation of the airline industry has increased competition particularly from low cost airlines and increased output and reduced prices, just as economic theory suggests it should.The only possible problem with deregulation is that fewer regulations may result in new firms coming into the industry and exploiting the fewer regulations to practice unethical behaviour. E.g. In Uk the banking system was deregulated and it was easier for firms to issue loans etc. In a small number of cases this led to unethical behaviour such as issuing loans to people who couldn’t afford to pay back loans and so got into massive debts.

supply-side policies for the labour market

The following policies are all designed to improve the quality and quantity of the supply of labour available to the economy. An expansion in a country’s total labour supply increases the productive potential of an economy. Increased quality will improve the productivity (efficiency) of labour. 

As with the product market policies, successful labour market supply side policies will shift the LRAS curve to the right. The same effect can also be illustrated by an outward shift in an economy's production possibility frontier. 

Trade Union Reforms 

It is argued that just like governments, trade union interference with the market mechanism reduces efficiency in the economy. In the UK trade unions were very strong and many thought they reduced the competitiveness of the UK economy Therefore in the 1980s they were reformed mainly by new laws that reduced their powers. The result has been an increase in the flexibility of the labour market, a decrease in strike action in virtually every industry and (in the long term) a significant improvement in industrial relations. 

Elimination of minimum wage laws. 

This reduces costs to firms and increases their competitivenss relative to other countries. It also creates jobs as now labour is relatively cheaper. But of course this could increase poverty and inequality.

Income Tax and the Incentive to Work 

Income tax is paid directly from earned income. Many economists who support supply-side policies believe that lower rates of tax not only provide a short term boost to demand - but they also improve incentives for people to work longer hours or take a new job - because they get to keep a higher percentage of the money they earn.

Cutting tax rates for lower paid workers may help to reduce the extent of the unemployment trap - where people calculate that they may be no better off from working than if they stay outside the employed labour force. 

Do lower taxes really help to increase the active labour supply in the economy?

It seems obvious that lower taxes should boost the incentive to work because tax cuts increase the reward from a job. But some people may choose to work the same number of hours and simply take a rise in their post-tax income! Millions of other workers have little choice over the hours that they work. 

Also the less progressive taxes are, the greater the inequality

Reform of the Benefits System 

Lower taxes and benefit reforms are seen to go hand in hand in a bid to sharpen the incentives to take paid work. 

Commitment to free trade

Trade creates competition and should be a catalyst for improvements in cost and lower prices for consumers. WTO ASEAN etc are relevant here. But in short terms jobs may be lost due to greater competition from abroad

Interventionist SSPs.

This approach sees a large role for Government in improving the efficiency of the economy.

Measures to encourage small business start-ups

Small businesses are the lifeblood of the economy. They create competition, output and jobs, but may require 

• help initially to get going

• Business start-up grants

• Loan guarantee schemes

• Lower rates of corporation tax for smaller businesses

Investment allowances and regional policy assistance for new business start-ups in some areas

Measures to increase corporate investment spending

Capital investment spending is unusual in that it adds to aggregate demand (C+I+G+(X-M)) but also has an important effect on aggregate supply in the long run.

Increased Spending on Education and Training 

Economists disagree about the scale of the economic and social returns from higher spending on education - but few deny that "investment in education" has the potential to raise the total stock of skills within the work force and improve the employment prospects of thousands of unemployed workers. 

Economies that have invested heavily in education are those that are well set for the future. Most economists agree, with the move away from industries that required manual skills to those that need mental skills, that investment in education, and the retraining of previously manual workers, is absolutely vital. 

It should also be noted that improved training, especially for those who lose their job in an old industry should improve the occupational mobility of workers in the economy. This should help to reduce the problem of structural unemployment. A well-educated workforce acts as a magnet for foreign investment in the economy. 

Evaluation of Supply side policies :

• Often very expensive and there is an opportunity cost to this expenditure. Is it used wisely?

• Can take a long time to work (e.g. education reforms may take 10yrs to really affect quality of workforce)

• SPPS and the distribution of income and wealth-This is a key one! Many exam boards have made it clear that students ought to at least consider the possible effects of different policies on the final distribution of income and wealth. SSPs should not be ignored in this respect. Some policies might risk widening the gap between high and low-income groups - for example those lobbying for lower rates of income tax especially at the top end, or a decision to cut inheritance tax or capital gains tax with a view to encouraging entrepreneurship. Other SSPs such as changes in employment laws, minimum wages, and reforms to welfare benefits also have scope to alter the distribution of disposable income and wealth.

• Some SSP have a narrow impact - for example tax relief for small businesses, targeted subsidies for creative industries, financial incentives for specific industries in specific regions. Other policies have a broader scope or magnitude - changes in direct taxation, changes to welfare entitlement, investment maintained schools and the national health service.

• SSPs in other countries: The global economy changes at an increasingly rapid speed and in nearly every nation there are strategies for reforms and investment that impact on the relative competitiveness of the UK economy. My evaluation point here is that SSPs need to keep pace with what is happening in other parts of the world. eg growth of China has raised the stakes enormously for many countries. They will have to implement SSPs to compete with these countries

• Different approaches to the supply-side. Examiners will reward students who are aware of different approaches to supply-side policy ranging from free-market approaches (cutting the size of government, lower taxes, opening up markets, flat rate taxation) through to those who favour interventionism from the state (active regional policies, a key role for government, progressive taxation, employment protection) and many views in between.

• Remember that SSPs have demand-side effects and Demand policies can have SS impact. Supply and demand are not independent variables - if SSPs work well then there are demand-side spillover effects to consider. Improved innovation creates new demand (from home and overseas markets), infrastructure investment can bring sizeable fiscal multiplier effects, an increase in investment in training and education will increase the demand for people in those sectors, measures to make child-care more affordable or to attract net inward migration of skilled workers will expand the labour supply, lift national income and inject more spending power into the circular flow.

Supply-side policies are important. Ensure that you can bring good AD-AS analysis into your answer and try to make effective use of data contained in the stimulus question. Understand the links between effective supply-side policies and the key macroeconomic objectives of a government. And be prepared to evaluate / discuss some of the limitations of SSPs - some of which are mentioned above.

Student Activities: 

Complete the following "Gap-fill" exercise: