3.7: Supply-Side Policies

Supply side policies focus on the

supply and production side of the economy.

Supply side policies aim to

Shift supply curves right, increase potential output, and achieve long-term growth.

Supply side policies are achieved through

Increasing quality and quantity of factors of production and through institutional changes.

Goals of supply side policies

- Promote long-term growth by increasing the productive capacity of the economy;

- Improve competition and efficiency;

- Reduce costs of labour and reduce unemployment through greater labour market flexibility;

- Increase incentives of firms to invest in innovation by lowering costs of production;

-Reduce inflation to improve international competitiveness;

Market-based supply-side policies

Reducing government intervention to allow competitive markets to efficiently function, achieving economic growth, price stability and full unemployment.

Market-based policies include

- Encouraging competition.

- Labour market reforms.

- Incentive-related policies.

Policies that encourage competition include

- Privatisation.

- Deregulation.

- Contracting out to the private sector.

- Anti-monopoly regulation.

- Trade liberalisation.

Greater competition forces firms to

- Reduce costs.

- Increase efficiency.

- Improve resource allocation.

- Improve quality of products.

Privitisation

Transfer of ownership of a firm from the public to the private sector.

Benefits of privatisation

Increase efficiency and improved management/operation.

Deregulation

Elimination/reduction of government regulation of private sector activities.

Benefits of deregulation

New private firms can enter industry; leads to competition.

- Increased efficiency and quality.

- Reduced price.

What is economic regulation, and how does deregulation change it?

Regulation of price, output, protection; decreased.

What is social regulation, and how does deregulation change it?

Protection of consumers against negative externalities; increased.

Contracting out to the private sector.

Where the government creates a contract with private firms to produce goods and services for them.

Benefits of contracting out to the private sector.

Increased competition between private firms for contracts.

Anti-monopoly regulation.

Restricting market power of firms by:

- Breaking up large monopolistic firms into small units.

- Prevent merging between firms.

Benefits of anti-monopoly regulation.

More competition.

Trade liberalisation,

More free trade; reducing trade barriers.

Benefits of trade liberalisation.

- Increases competition.

- Improved allocation of resources.

Benefits of competition.

- Increase in quality.

- Increase in efficiency.

- Lower prices.

Labour market reforms.

Increasing labour market flexibility and reducing labour market rigidities.

Governments remove labour market rigidities by:

- Abolishing minimum wage.

- Weakening power of labour/trade unions.

- Reducing unemployment benefits.

- Reducing job security.

Benefits of abolishing minimum wage.

- Equilibrium wage can fall.

- Less unemployment.

- Less costs, more profit.

- Lower prices.

- More investment spending.

- Economic growth,

What are labour/trade unions?

Association of workers who negotiate with employers to improve working conditions and defend rights of workers.

Benefits of weakening power of trade/labour unions.

- Wages can respond to supply and demand.

Benefits of reducing unemployment benefits.

- Reduce incentives for the unemployed to stay unemployed.

- Encourages them to look for work.

- Reduces unemployment.

- Reduces natural rate of unemployment.

Benefits of reducing job security.

- Removes laws protecting workers from being fired.

- Less costlier for firms to lay off workers.

- Firms more likely to hire workers.

- Decreases unemployment.

- Decrease costs, reduces prices.

- Increased investment spending; economic growth.

Incentive-related policies

Changing incentives of tax payers by cutting taxes.

Benefits of lower income taxes.

- People more willing to work; higher after-tax incomes.

- Increases incentive to work.

- Reduced unemployment.

- Increases AD.

- Decreases natural rate of unemployment.

- Increases potential output.

What are taxes on capital gains and interest incomes?

Taxes on profits from financial investments i.e. stocks, real estates, bonds.

Benefits of reducing taxes on capital gains and interest incomes.

- People more motivated to save; more investments.

- Increased production of capital goods.

- Increased potential output.

Benefits of lowering business taxes.

- More profit, more investment.

- Increased AD.

- Incentive to invest in R&D.

- Increased potential output.

Interventionist Supply Side Policies

Policies that increase potential output through government intervention.

Examples of Interventionist Supply Side Policies

- Investment in human capital

- Investment in new technology.

- Investment in infrastructure.

- Industrial policies.

Forms of investment in human capital

- Training and education.

- Improved health care services and access.

Effects of investment in human capital

- Increases AD (short run).

- Increases potential output (long run).

Benefits of training and education

- Increased quality of labour.

- Increases productivity.

- Economic growth.

- Positive externalities.

- Workers more employable.

- Reduces natural rate.

Examples of measures of training and education

- Retraining programs.

- Financial assistance.

- Government hiring.

- Grants and subsidies to forms that hire structurally unemployed.

- Help workers relocate.

- Provide information.

- Government projects.

Forms of investment in new technology.

- Research and development.

Benefits of research and development.

- New technologies developed.

- New/improved capital goods.

- Increases potential output.

- Economic growth.

- Positive production externalities.

How do governments encourage research and development?

- Patents and tax cuts to incentive private sectors.

- Government spending to support R&D.

What is infrastructure?

- Physical capital.

- Essential for the economy.

Examples of infrastructure

- Power.

- Telecommunications.

- Sewerage.

- Roads.

- Dams.

- Transport.

- Ports.

- Airports.

Benefits of investing in infrastructure.

- Count as merit goods/public goods.

- Lowers costs.

- Increased efficiency.

- Increased productivity.

- Increase AD (short term).

- Increase potential output (long term).

Industrial policies

Government policies that support the growth of the industrial sector of an economy.

Examples of industrial policies.

- Support for small and medium-sized enterprises/firms.

- Support for infant industries.

Support for small and medium-sized enterprises/firms includes

- Tax exemptions.

- Grants.

- Low-interest loans.

- Business guidance.

Benefits of supporting small and medium-sized enterprises/firms..

- Supports private sector.

- Promotes efficiency.

- More capital formation.

- More employment possibilities.

- Increase in AD (short term).

- Increase in potential output (long term).

Infant industries

Newly emerging industries.

Infant industries are supported through:

- Grants.

- Subsidies.

- Tax exemptions.

- Tariffs.

- Trade protection against imports.

Benefits of supporting infant industries.

- Supports growth of private sector.

- Increase in AD (short term).

- Increase in potential output (long term).

Demand-side effects of interventionist supply side policies.

Increased government spending increases AD.

Demand-side effects of market-based supply side policies.

Reduced taxes; more disposable income; more investment spending; increases AD.

Supply-side effects of monetary policy.

Low interest rates encourages investment; more capital goods produced; increases potential output.

Supply-side effects of fiscal policy.

Government spending increases capital goods.

- Infrastructure, R&D.

- Increases productivity of labour.

- Increases potential output.

Government spending develops human capital.

- Training, education, healthcare.

- Increases quality and quantity of labour.

- Increases potential output.

Constraints of market-based supply side policies.

- Time lags.

- Increase unemployment (short term).

- Possible negative effects on equity.

- Negative impacts on government budget.

- Possible interference of vested interests.

- Possible negative effects on environment.

Constraints of interventionist supply side policies.

- Time lags.

- Negative impact on government budget.

Strengths of market-based supply side policies.

- Improved resource allocation.

- May not burden government budget.

- May create employment.

- May reduce inflationary unemployment.

Strengths of interventionist supply side policies.

- Direct support of sectors important for growth.

- Ability to create employment.

- Potential ability to reduce inflationary pressure.

- Possible positive effects on equity.