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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 supplyside 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 supplyside 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!!!!
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