Unit 2 Macro: Evaluation on Supply-Side Policies

Lots of students will be revising the economics of supply-side policies this week with their AS macro paper coming into view. There are different interpretations of what constitutes a supply-side policy measure. I like to label SSP (supply-side policy) to any policy or group of measures where emphasis is given to improving the working of markets, raising factor efficiency, improving the quantity and quality of labour and in lifting the capacity and competitiveness of an economy in a constantly-changing international environment.

Many supply side policies focus on improving incentives and outcomes in the labour market, others are geared towards bettering the performance of markets for goods and services, All of them centre on helping to sustain non-inflationary growth, improve trade performance, lift living standards and create new and fulfilling jobs opportunities.

This revision blog looks in particular at some evaluation points on supply-side approaches:

1/ Be Specific!

When writing about SSPs, it is always better to be specific rather than talk in generalised terms. So for example, you might be discussing measures to improve occupational mobility and employability for the long-term unemployed. In my experience, few students venture far beyond mentioning New Deal (..... old deal ...... New Deal no longer exists in its original format) and perhaps flirt with mentioning government subsidies. Far better to be clear on specific measures such as the new Youth Contract, educational maintenance allowances (now being phased out by Gove), Modern Apprenticeships and a raft of other labour market interventions focusing on a key objective of creating a more educated workforce that is the most flexible in Europe (see this document from HM Treasury, March 2012)

Some specifics from the March 2012 Growth Review:

* reducing the main rate of corporation tax by a further one per cent. From April this year, the rate will be reduced to 26 per cent and by 2014 it will reach 23 per cent
* increasing the SME rate of R&D tax credit
* opening up more land for development, while retaining existing controls on greenbelt land
* etting up 21 new Enterprise Zones with superfast broadband, lower taxes and low levels of regulation and planning controls
* increasing green investment through support for the carbon price and a Green Investment Bank
* establishment of a High Value Manufacturing Technology and Innovation Centre
* development of a new degree-equivalent Higher Level Apprenticeship
* nine new university based centres for innovative manufacturing
* funding for up to 100,000 additional work experience placements for young people and 50,000 additional apprenticeship places over the next four years
* University Technical Colleges programme - establish at least 24 new colleges by 2014

There are many commentators of course who argue that these measures are half hearted and do not go far enough

2/ Long time lags

Supply-side policies tend by their nature to have longer time lags between a policy being applied and the effects becoming visible and durable. This is an important evaluation point. Many of the structural weaknesses and problems in Britain have been around for a long time and seem to have become embedded - for example the deep problem of functional illiteracy among millions of adults or the long-standing productivity gap between the UK and a number of advanced high-income nations.

3/ Policy combinations

SSPs on their own may be necessary but insufficient to make significant progress in achieving macroeconomic goals. Students are encouraged to think about combinations of policies that might work well together - policies that might have a mutually reinforcing effect. A good example to discuss here would be a set of policies designed to promote innovation, change consumption and make noticeable progress in cutting carbon emissions per unit of output

Fiscal and monetary policy

Changes in fiscal and / or monetary policy can have supply-side consequences too! Well targeted government spending on infrastructure or changes in direct and indirect taxation can have an effect on a number of supply-side variables. Likewise monetary policy decisions that affect the cost of borrowing or the value of the exchange rate clearly have aggregate demand effects but also second round implications for investment, research, productivity and jobs.

4/ 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.

5/ 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. Where does the UK stand in terms of educational achievement, health outcomes, research and development spending, progress towards low and zero carbon technologies? Are we getting value for money from supply-side investments? What can we learn from the experience of other countries?

6/ 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.

7. SSPs have demand-side effects

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.