Supply-side Policies Topic 4.2.5.2 Students should be able to know: The difference between supply-side policies and supply-side improvements How supply-side policies can help to achieve supply-side improvements How supply-side policies, such as tax changes designed to change personal incentives, may increase the potential output of the economy and improve the underlying trend rate of economic growth How supply-side policies can affect unemployment, the rate of change of prices and UK external performance, as reflected in the balance of payments on current account The role of supply-side policies in reducing the natural rate of unemployment

Supply-side Policies Topic 4.2.5.2 Students should be able to know: Free market supply-side policies include measures such as: tax cuts, privatization, deregulation and some labour market reforms Interventionist supply-side policies include measures such as: government spending on education and training, industrial policy, subsidising spending on research and development Supply-side policies can have microeconomic as well as macroeconomic effects.

What are Supply-side Policies? They are policies that improve the productive potential / capacity of an economy. Illustrated by an outward shift of LRAS (or the PPF) Supply-side policies focus on improving the structural long- term performance/competitiveness of an economy There are different approaches to supply-side policy reforms: Market-led policies – designed to make markets work better and give the private sector more freedom State / government intervention in markets to overcome market failures and address inequality issues Supply-side reforms can affect both short-run and long-run aggregate supply – but the focus is usually on LRAS Time lags involved with supply-side reforms can be long but better to evaluate the effectiveness of policy rather than lags

Examples of Recent UK Supply-Side Policy Ideas Relaxation of the Sunday trading laws – trade union opposition – impact on family life / work-life balance 24 new regional enterprise zones – aiming to take advantage of external economies of scale Completion of Cross Rail - plans for Cross Rail 2 and HS3 (East-West high speed rail in North of England) Tax relief for businesses investing in low carbon technologies – designed to increase I in renewables Increases in the income tax free allowance Main rate of corporation tax (a tax on profits) - currently 20% - to fall to 17% by 2020 UK National Infrastructure Plan – range of projects

Key Aims of Supply-Side Policies Key concepts to focus on when discussing S-SPs are incentives, enterprise, technology, mobility, flexibility and efficiency Improve incentives to look for work and invest in people’s skills Increase labour and capital productivity Improve occupational and geographical mobility of labour to help reduce unemployment Increase investment and research and development spending Promote more competition and stimulate a faster pace of invention and innovation to improve competitiveness Provide a platform for sustained non-inflationary growth Encourage the start-up and expansion of new businesses / enterprises especially those with export potential Improve the trend rate of growth of real GDP to help support improved living standards and regional economic balance Improve a country’s competitiveness and trade performance Meet challenges of climate change / increase resilience to external shocks

Supply-Side Challenges for the UK Economy Persistent Productivity Gap with other nations High rates of long-term youth unemployment Deep and widening regional economic divide in the UK Large trade deficit and declining exports as a share of global GDP Excessive reliance on consumption as a driver of GDP Competitive Threat from Emerging Economies Low capital investment and research & development spending High rates of persistent relative poverty

Competitiveness Issue for UK: The Productivity Gap Labour productivity can be measured by GDP per hour worked and per worker, and growth in GDP per hour worked. This chart shows GDP per worker for G7 countries in 2015

Why does the UK economy lag on productivity? Low rate of new capital investment in the UK Banking crisis affecting lending to businesses Possible slowing rates of process innovation Persistent and deep skills shortages in key industries Relatively low levels of market competition Low aggregate demand & high spare capacity – under-utilizing resources

Countries with Highest R&D Spending (% of GDP) Country (% of GDP) 2005–2012 South Korea 4.0 Israel 3.9 Finland 3.5 Sweden 3.4 Japan Denmark 3.0 Germany 2.9 United States 2.8 Selected other countries Netherlands 2.2 Singapore 2.1 China 2.0 United Kingdom 1.7 Norway Brazil 1.2 Russian Federation 1.1 Source: HDI report 2015, UNDP

If UK Supply-Side Policies are Effective… In general, a stronger supply-side performance allows a government to meet more of the key macro objectives Achieve a sustained improvement in the possible trade-off between inflation and unemployment (see Phillips Curve) Better able to absorb external demand and supply-side shocks such as rising energy prices or a Chinese slowdown Raise living standards through stronger economic growth and spread the benefits of growth more widely / equitably Reduce unemployment by lowering the natural rate of unemployment (less frictional & structural unemployment) Improve UK competitiveness in global markets and achieve a stronger balance of trade in goods and services

Showing Long Run Economic Growth using AD-AS An increase in a country’s productive potential causes an outward shift of LAS. Short run supply increases because of lower unit costs An increase in productive potential allows an economy to operate at a higher level of AD General Price Level LAS1 LAS2 AS2 GPL1 AS1 AD1 AD2 Y1 Yp1 Yp2 Real GDP

Pro-Market (Private Sector) Supply-Side Policies These policies focus on reducing the size of the state and in extending the role of market forces in allocating scarce resources Cutting government spending (including welfare) and borrowing Lower business taxes to stimulate capital investment spending Lower income tax rates to improve work incentives Reducing red-tape to cut the costs of doing business Improving the flexibility of the labour market including reforming employment laws and encouraging more part time work Competition policies i.e. deregulation & tough anti-cartel laws Privatisation of state assets – i.e. transferred to private sector Opening up an economy to increased trade and investment Opening up an economy to inward skilled labour migration

The Rise of Zero Hours Contracts in the UK Economy Total (thousands) % of people in work People on “zero-hours contracts” are more likely to be young, part time, women, or in full-time education when compared with other people in employment. On average, someone on a “zero-hours contract” usually works 26 hours a week

State (Government) Driven Supply-Side Policies Supporters argue that an interventionist state can have a powerful and positive long-term effect on supply-side performance State investment in public services and critical infrastructure A commitment to a minimum wage and/or living wage to improve work incentives & productivity in the labour market Higher taxes on the wealthy to fund public and merit goods An active regional policy to inject extra demand into under- performing areas / regions of persistently high unemployment / low per capita income – e.g. the Northern Powerhouse Project Selective import controls to allow domestic industries to expand Management of the exchange rate to improve competitiveness Nationalisation of and/or tougher regulation of key industries

What is Human Capital? Human capital measures individuals’ skills, knowledge, abilities, social attributes, personalities & health attributes. These factors enable individuals to work & produce something of economic value. Human capital in the UK economy can be improved by: Sustained gains in average educational attainment – in the academic year ending 2015, 53.8% of pupils that left school in England achieved 5 or more GCSE A* to C grades, including Maths and English Expanded access to and quality of in-work training and opportunities for life-long learning Higher real incomes that allow people to consume more knowledge products including online courses Inflow of migrants with above average skills & qualifications

Evaluating the Effectiveness of Supply-Side Policies Supply-side policies can have long time lags but this depends on the type of policy and also the country involved The level and growth of aggregate demand is also important in making business investment and innovation viable – this is a valid Keynesian issue – demand helps to utilise extra supply Some supply-side policies (e.g. cutting higher-rate income taxes) might lead to greater inequalities of income & wealth – again it depends on which taxes are changed and by how much State intervention to “pick winners” in different industries may be ineffective – i.e. are risks of government failure Sustainability issues arise if policies raise a country’s long term growth rate – leading to externalities such as pollution & congestion although some supply policies directly address this! Supply-side policies look to achieve relative improvements e.g. In productivity – but other countries will be making gains too!