Chapter 20 Supply-side policies

The meaning of supply-side policy  Supply-side policies are usually defined as those policies designed to increase the economy’s aggregate supply and hence shift the LRAS to the right  In reality many improvements on the supply side come from the private sector deciding to make improvements such as training and investment  The government needs to promote the ideal conditions in which such improvements can flourish – helping to remove market imperfections and restrictions  Supply side economic policies are mostly microeconomic  These microeconomic policies have a macroeconomic effect – they lead to economic growth without additional inflationary pressure

Supply side policies  Labour market measures  improving education and training  reducing the powers of trade unions  introducing profit related and performance related pay  encouraging more flexible pension arrangements  Tax reforms  Reducing the overall burden of income tax  Replacing direct taxes with indirect taxes

Supply side policies  Reform of the welfare state  Reducing welfare benefits to encourage people to chose low paid unemployment rather than unemployment reducing the unemployment trap  Industrial and competition policy such as privatisation, deregulation and contracting out  Financial and capital market measures  Deregulating financial markets – promotes more competition between banks and building societies  Encourage saving with special tax privileges  Encouraging wider share ownership  Promoting entrepreneurship and an enterprise culture

The labour market and supply- side policies  There are two broad approaches to improving the supply side  Policies focused on the labour market  Policies focused on product markets where goods and services are produced and sold to consumers  Policies aimed at the labour market are designed to improve the quality and quantity of the supply of labour to the economy  They seek to make the labour market more flexible so that it is better able to match labour with employer’s demands in expanding sectors  This reduces structural unemployment  An expansion in the UK’s total labour supply increases the productive potential of an economy

Labour market supply side policies - Income tax reform and improving incentives to work  Key aim to encourage more people to join the labour force leading to an increase in total output  Overly harsh direct taxation and generous social security benefits can act as disincentives to work  It also leads to growth of the hidden economy through evasion of tax  This relationship is hard to prove but economists who support supply-side policies believe that lower rates of income tax 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  Lowering income tax for low income earners does encourage more people to join the labour force  However many people are not paid by the hour so do not get the choice of working more hours

Education and training  Many unemployed people lack the skills required to secure a job  Many 16 year old school leavers and those who have been unemployed for long periods do not have the skills valued by employers  Government provision of training opportunities can help to tackle skill shortages  Most economists agree that the move away from industries requiring manual skills to those needing ‘thinking skills’ means that it is absolutely vital for government to invest in education and the retraining of manual workers  A well educated workforce will attract foreign investment  The Irish government’s supply side reforms has encouraged a huge inflow of inward investment from overseas

Education and training  A number of schemes have been used to boost the UK skills-base  Local skills councils provide vocational training and work placements for teenagers and unemployed adults  Job clubs, Restart schemes, Access courses and personal counselling provide work opportunities for the longer term unemployed  Education reform has been an active area of supply side policy since the 1980’s  The concern of government has been the relatively poor educational attainment of two thirds of the population compared with other developed countries  To boost educational standards the government  Introduced the national curriculum and national frameworks for literacy and maths  Created the school watchdog – Osted  Set targets for achievement in public exams and the publication of school league tables  Read case study P229 and complete activity

Labour force supply-side policies – Trade union forms  A trade union is an organisation of workers set up to negotiate on wages, working hours and working conditions with employers on behalf of its members  Their actions  increase a firm’s costs  Reduce efficiency and  Reduce international competitiveness  The last conservative government significantly reduced the power of trade unions in the labour market

The product market and supply-side policies  Supply-side policies in the product markets are designed to increase competition and efficiency  If productivity improves more will be produced with a given amount of resources shifting the LRAS to the right  Privatisation  The transfer of ownership from state-owned to the private sector  It is argued that the private sector has more of an incentive to be efficient and competitive  Deregulation - the process of removing government controls from markets  helps to remove barriers to entry  Plus contracting-out (public sector activities are contracted out to the private sector)  Replaces public sector monopolies and encourages competition

The product market and supply-side policies  Toughening up of competition policy  Competition forces businesses to become more efficient in the way in which they use scarce resources  This reduces costs which can be passed on to consumers in the form of lower prices  A tougher competition policy includes policies that are designed to curb abuses of a dominant market position (intervention that prevents market failure coming from monopoly power)

The product market and supply-side policies  A commitment to free international trade  Trade between nations creates competition and is the catalyst for improvements in costs and lower prices for consumers  The UK government is committed to an expansion of free trade within the European single market  Plus the liberalisation of trade in the global economy as part of the WTO (World Trade Organisation)

The product market and supply-side policies  Measures to encourage entrepreneurship and capital spending  Small business grow into large businesses  Government wants to increase the rate of new start ups by promoting an entrepreneurial culture  Policies include loan guarantees, regional policy assistance for entrepreneurs in depressed areas and advice for new firms  Capital spending by firms add to AD (Investment) but also has an effect on AS  Supply-side policies would include  Tax relief on R&D  Reductions in the rate of corporation tax  Ireland, again, is a good example of attracting foreign investment by cutting company taxes  Estonia cut its corporation tax to 0% to attract new investment and stimulate growth and employment

Saving, investment and supply- side policies  Consumers have the choice between work and leisure  They also have to choose between consumption and saving  High rates of taxation on income from saving and investment tend to encourage consumption rather than saving leading to a fall in both  Supply side economists argue that tax cuts will encourage consumers to save and businesses to invest so that economic growth can continue without demand-pull inflation.  Read the case study on P231 and complete the activity

Supply-side policies and the AD/AS model  As we know the idea of supply side policies is to shift the AS curve to the right  This helps to increase the underlying trend rate of growth  Most governments accept that sustained growth without inflation will be achieved by using supply side policies  These alone will not be enough  There has to be a high enough level of AD  The diagram shows how an increase in output can only be seen with an increase in demand

Supply-side policies and the governments macroeconomic objectives  When supply side policies are combined with effective policies for AD they will help achieve the 4 main macro objectives  Shifting the LRAS brings growth without inflation  More output brings more employment  Improving efficiency and competitiveness will lead to firms becoming globally competitive increasing exports and improving the balance of payments (although probably not restoring equilibrium or a surplus)  complete activity on P233

Essay Discuss the role of supply side policies in improving rates of economic growth  Start by defining supply side policies and why government would want to do this  Use the diagram to explain what happens to each of the macro objectives when supply side policies are used  Then talk through a few supply side policies and don’t forget to evaluate (explain the difficulties of the policies and if you are not sure what these are then look at the course companion on econandbiz.com)  Lastly talk about the need for demand as well as supply

End of AS!!!! Revision now starts