Unit 2 Macro: Revision Notes on Supply-side Policies

Supply-side policies are mainly (but not exclusively) micro-economic policies designed to improve the supply-side potential of an economy, to make markets and industries operate more efficiently and contribute to a faster underlying-rate of growth of real national output.

Most governments believe that improved supply-side performance is the key to achieving sustained growth without causing a rise in inflation. Supply-side reform on its own is not enough to achieve this growth. There must also be a high enough level of AD so that the productive capacity of an economy is actually brought into play.

Different approaches to the supply side

Free-market Approach

(1) Cut overall levels of government spending and taxes to reduce burdens on the private sector and improve work incentives
(2) Laws to limit trade union powers and improve the flexibility of the labour market e.g. flexible hiring and firing by changing employment laws
(3) Keep government intervention to a minimum to avoid government failure -
(4) Tough competition policies to keep monopoly power in check and laws to protect intellectual property to boost research and innovation

Interventionist Approach

(1) State has key role in investing in public services and building critical infrastructure for long run economic benefits
(2) Targeted tax incentives and welfare reforms to make work pay can encourage more people into actively looking for and taking paid work
(3) Activist regional policy to boost under-performing areas / areas of high unemployment - higher incomes and employment can create a strong regional multiplier effect
(4) Some case for intervening in trade and currency markets to promote growth and development of key industries

Supply-side objectives

The key supply-side concepts to focus on are incentives, enterprise, technology, mobility, flexibility and efficiency.

1. Improve work incentives and invest in people’s skills for people to find work to raise employment and cut unemployment - human capital investment

2. Increase labour and capital productivity

3. Increase the occupational and geographical mobility of labour - skills shortages are a supply-side weakness in the UK and hamper attempts to get more people into jobs.

4. Increase capital investment and research and development spending by firms - traditionally spending in research and development in the UK has been a low percentage of our annual GDP

5. Promoting more competition and stimulate a faster pace of invention and innovation

6. Provide a platform for sustained non-inflationary growth by expanding the country’s productive capacity

7. Encourage the start-up and expansion of new businesses / enterprises

Data from Timetric.

To view this graph, please install Adobe Flash Player.

OECD Economic Outlook Database (version 88) from Timetric

There are two broad approaches to the supply-side.

Firstly policies focused on product markets where goods and services are produced and sold to consumers

Secondly policies directed at the labour market – a factor market where labour is bought and sold

Product markets refer to markets in which all kinds of goods and services are made and traded, for example the market for airline travel; smart-phones, new cars; pharmaceutical products and the markets for financial services such as banking, mortgages and pensions.

Supply-side policies in product markets are designed to increase competition and efficiency. If productivity improves, more can be supplied with given amount of resources and at lower costs and prices.

* These policies are designed to improve the quality and quantity of the supply of labour available to the economy.

* They seek to make the British labour market more flexible so that it is better able to match the labour force to the demands placed upon it by employers in expanding sectors thereby reducing the risk of structural unemployment.

* An expansion in the labour supply increases the productive potential of a country.

* That expansion in the supply of people willing and able to work can come from several sources for example: encouraging older people to stay in the workforce; a relaxed approach to labour migration and measures to get non-working parents to actively look for work

Data from Timetric.

To view this graph, please install Adobe Flash Player.

OECD Economic Outlook Database (version 88) from Timetric

How can supply-side policies help lift a country out of recession?

Recessions are often the result of negative demand-side shocks that hit real incomes of consumers and demand and profits for businesses. The consequences show through in higher unemployment, a fall in capital investment and an increasing rate of business failures. Most macroeconomic policies in a recession centre on boosting demand and confidence in a bid to generate a rebound in output, jobs and incomes within the circular flow. What role can supply-side policies play during an economic downturn?

The key to answering this is to understand the range of policies that have a supply-side dimension or have supply-side effects!

1. Extra capital spending on an economy’s critical infrastructure - much of this might be funded by the government for example bringing forward some investment spending on hospital re-building, transport projects and environmental schemes. Other big capital spending projects might be partly financed by the private sector perhaps as part of a public-private partnership. These projects are often labour-intensive and can create a sizeable multiplier effect on demand. BBC - What would a growth agenda look like?

2. Reductions in business taxation - for example lowering the standard rate of corporation tax (to stimulate investment) or reducing employers’ national insurance contributions (to boost the demand for labour). The UK Government is reducing the main rate of corporation tax. From April 2011, the rate will be reduced from 28 per cent to 26 per cent and, by 2014, it will reach 23 per cent Lower taxes for business research and development spending or tax relief for inward investment projects also have a supply-side aspect to them - Osborne cuts corporation tax

3. Policies designed at improving the quality of and access to education and training for all. This is particularly relevant when coming out of a recession because many of the new jobs in an economy as recovery gathers momentum are not in the same industries as before a downturn. It is hugely important to prevent cyclical unemployment from turning into structural unemployment

4. Measures to stimulate business start-ups – seed-corn finance and other help for new enterprises can provide a flow of new jobs as an economy picks up

5. Policies to maintain the openness to trade and investment from overseas - instead of choosing protectionist policies, politicians should understand the importance of trade and competition as a means of generating new demand and creating extra jobs.