Download Supply Side Policies

Supply side policy
issues
Learning Outcome: To understand
the issues of using supply side policy
Supply side policies
 Supply side policies are government
policies designed to increase the
productive potential of the economy
and push the long run aggregate
supply curve to the right
 They affect the economy in 4 main
ways
 May increase the supply both of the
quantity and quality of labour
 May raise the amount of capital
employed or to the introduction of
more technologically advanced capital
 May lead to further exploitation of
natural resources such as oil deposits
or agricultural land
 May increase the efficiency with which
the factors of production are combined
Labour productivity and
unit labour costs
 Supply side policies may
affect both labour productivity
and unit labour costs
 A firm introducing new
technology may need less
labour and output per worker
will increase
 If the average wage rates do
not change the cost of labour
per unit will fall
 The firm would now be more
competitive
 If all firms use the same
technology relative
competitiveness will remain
the same
Labour productivity and unit
labour costs
 As an economy grows productivity will
rise
 More and more capital will be used by
labour to produce goods and services
 Workers will become better trained
and have more skills
 Unit labour costs for the whole
economy may stay the same because
increases in productivity will be
matched by increases in wages
 Karl Marx (19th C) predicted that all
the benefit of the increase in labour
productivity would go to the owners of
capital
 History shows this not to have been
the case
Labour productivity and
unit labour costs
 Unit labour costs in individual
industries and occupations may
change over time
 If a good or service is not traded
internationally and there is a lack
of domestic competition labour
costs may rise
 Labour costs in the NHS and
schools have risen substantially
over time
 When there is a lot of competition
unit labour costs tend not to rise
as fast
 If they get too high the industries
become less competitive and
production may cease
 Falling unit labour costs in the
third world led to a decline in the
UK textile industry in the second
half of the 20th Century
Labour productivity and unit labour costs
 There are a variety of supply side policies which
can be used to increase labour productivity
 Policies that lead to better education and
training of workers
 Either they become more productive at the
same job or are able to do more complex
jobs that create higher value products
 Policies could include reforming the
vocational education system
 Tax incentives to firms for spending on
training young people
 Giving workers training vouchers to
spend on training courses
 Policies which lead to higher levels of physical
investment that will increase the amount of
capital per worker
 E.g. government grants to firms for
investment
 Tax incentives to invest
 Government loads at below the commercial
rate of interest for investment
Flexible Labour Markets
 If labour markets are highly flexible
there will be rapid changes in
demand and supply
 As a result the natural rate of
unemployment will be very low
 If labour markets are highly inflexible
external shocks will lead to long term
disequilibrium
 The natural rate of unemployment
will be high
 There are many ways to classify
types of labour market flexibility
 One way is to classify according to
the strategies that companies use to
manage their workforces
 External numerical flexibility
 Internal numerical flexibility
 Functional flexibility
Labour market
flexibility – the
degree to which
demand and
supply in a labour
market respond to
external changes
such as changes in
demand for a
product or
population
changes to return
the market to
equilibrium
Flexible Labour Markets
 External numerical flexibility
 In a completely flexible labour
market firms can hire and fire
workers at any time
 They can adjust the numbers on a
day to day basis
 Modern labour markets prevent this
 Law gives employment rights
 Trade unions threaten industrial action
 Some countries make it very difficult to
sack permanent workers
 This raises the cost of permanent hire
and tends to increase numbers of
temporary workers
 When there is less flexibility less
workers will be employed
 This may lead to an increase in
capital intensity of production
Flexible Labour Markets
 Internal numerical flexibility
 In a completely flexible labour market
firms can adjust the number of working
hours their staff work to suit their needs
 It can change shifts from day to night if
necessary
 It can cancel holiday leave
 In practice firms are restricted in their
internal flexibility by both employment
law and by workers and their trade
unions
 Custom and practice means that
employees tend to work relatively fixed
hours
 Firms use a wide variety of schemes to
give greater flexibility e.g. overtime
Flexible Labour Markets
 Functional flexibility
 This occurs when a firm can redeploy a
worker from one job to another
 The workers have to be multi skilled
 Traditionally trade unions have resisted
functional flexibility because they argue it
rates unemployment
 Countries where functional flexibility is
common are likely to be more competitive
 Wage flexibility
 Firms that can adjust wages up and down
will be more competitive
 In practice most workers are on fixed wage
contracts
 Wage flexibility can be achieved by using
bonuses or individual pay bargaining
 It is more flexible now in the UK than 30
years ago because there is less union
power
Flexible Labour Markets
 There are many other types of labour
market flexibility
 Geographical flexibility – willingness of
workers to move areas to get jobs
 The UK has a relatively high level of
mobility compared to the rest of EU
 Industrial flexibility – willingness of workers
to move from industry to industry
 Some argue that flexible labour markets
are one of the key reasons why the US and
UK economies performed well in the
decade prior to the recession compared
with some EU countries that have much
less flexibility
 These countries have more labour laws and
union power
 Less flexible labour markets do tend to
have higher levels of unemployment
Incentives at the margin
 Tax at the margin is tax paid on every extra £
earned
 Neoclassical economists argue that
incentives at the margin can significantly
change behaviour
 Cutting marginal rates on income tax leads to
a significant rise in the number of hours
worked
 It gives an incentive for those not working to
get a job
 Giving income tax rebates to those who save
for a pension encourages people to pay into a
pension plan
 Cutting unemployment benefits will
encourage the unemployed to get a job
 The more progressive the tax and benefit
system the less incentive individuals have to
work
 There is a strong economic case to make the
tax and benefit system more regressive
Progressive tax - A tax
system in which those
who earn higher incomes
pay a higher percentage
of their income than
those with lower incomes
Marginal Income
tax rate earned
20%
0-37k
40%
37k to
150k
150k
plus
50%
Regressive tax - A tax
system in which those
who earn lower incomes
pay a higher percentage
of their income
Incentives at the margin
 Marginal tax rates are not the only
influence on employment
 Many who currently do not have a job
face major obstacles to gaining a job
 Single people with young children
may have difficulties getting good
child care
 People that are physically or mentally
disabled may find it difficult to find a
job which is manageable for their type
of disability
 The Netherlands and Sweden have
better systems to deal with these
issues but they are expensive to run
Migration
 In recent years there has been significant net
migration into the UK of people of working
age
 This increases the potential size of the labour
force
 When there is an increase in the supply of
labour wage rates may fall
 If the economy is at full employment this
helps inflationary pressures
 The exact impact on wages in individual
occupations and on economic growth as a
whole is more difficult to determine
 If all the migrants were plumbers there would
be downward pressure on the earnings of
plumbers but little impact elsewhere in the
economy
 Some have said that the UK could benefit
from net immigration by targeting particular
types of immigrants (highly skilled and highly
qualified)
Taxation and Investment
 The level of taxes on businesses
(corporation tax) has an impact on
investment and therefore long run
AS
 An increase reduces firm
profitability
 Fewer investment projects will be
undertaken
 Affects both domestic and foreign
investment (FDI)
 A country can raise inward levels of
FDI by lowering taxes
 Many argue that the high economic
growth in Ireland in the 1980s was
due to low business tax
Taxation and Investment
 Governments place high taxes on business
for 3 possible reason
 Government spending as a proportion
of GDP may be high – the tax finances
the spending
 If there is higher tax on business the tax
on individuals can be lower
 In the short term government may be
forced to raise tax when in financial
difficulty
 Free market economists tend to argue that
business taxes should be low
 It encourages investment and leads to high
economic growth
 It will encourage FDI
 Some argue that tax is only a small part of
investment decisions and that levels of
business tax are a relatively unimportant in
the supply policy mix
The contribution of demand side
policies
 Good economic management of the
economy by government which minimises
fluctuations in AD has significant supply
side benefits for two main reasons
 Macro economic stability helps economic
agents to make decisions; if the economy is
stable there are high levels of investment,
more labour mobility and higher consumer
spending
 When there is low demand in recession it can
lead to both physical and human capital being
destroyed; equipment is not needed and
people become long term unemployed
Watch holden
video
http://www.yout
ube.com/watch
?v=v9HEm8w5
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Essay Practice
 Compare the Effectiveness of Supply side
and Fiscal Policies to Correct deficits on a
country’s current account of the Balance of
Payments (25)
 Plan your essay (20 mins)
 Think about what the question is asking –
which is best supply side or fiscal?
 Be prepared to share your plan (or part of
your plan) with the rest of the class
 Don’t forget to include evaluation points in
your plan (don’t wait until the conclusion to
evaluate)
Essay Practice
• Define Current account deficit - means the country imports a greater
value of goods and services than it exports.
• To reduce a current account deficit we need to either increase
exports and or reduce imports.
• Supply side policies aim to increase the productivity of the economy.
• If the manufacturing sector becomes more productive, the relative
cost of British goods will fall and therefore they will become more
competitive.
• This will help increase exports and reduce the current account
deficit.
• Always give a couple of examples….
• government could increase spending on education and training.
– Vocational training schemes may help increase labour productivity
because workers will have more skills.
– A more productive workforce can improve the competitiveness of UK
Exports.
• Alternatively, the Government could introduce a free market supply
side policy such as reducing the power of trades unions.
– If unions are powerful, productivity may be lower due to frequent strikes
and disruptive working practises such as working to rule.
– If union power is reduced it helps reduce time lost to strikes, increases
labour market flexibility and therefore should help increase UK exports.
Essay Practice
• Evaluation
• The problem of supply side policies is that they will take
time to have effect.
• Again give an example
• spending on education and training may take several
years before the effects are noticed.
• Also, there is no guarantee that education spending may
actually increase labour productivity
• The money may be misspent or the workers may not
want to learn.
• Show UK knowledge
• In the UK, trades unions are no longer very powerful, so
this policy would only have limited impact.
• Also, some argue trades unions can actually help
introduce new working practises and thereby increase
productivity.
Essay Practice
• Now look at fiscal
• Current account deficits often occur during times of
economic growth and therefore
• high consumer spending on imports.
• Fiscal policy can be used to reduce consumer spending
and therefore reduce demand for imports.
• For example
• Higher income tax would reduce consumer’s disposable
income and therefore reduce imports.
• UK knowledge
• In the UK, consumers have a high marginal propensity to
import (people spend a high % of extra income on
imports), therefore, a reduction in disposable income
would have a big impact in reducing import spending.
• Deflationary fiscal policy would also reduce inflation and
help to make UK goods more competitive.
Essay Practice
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Evaluation
However, the problem with using fiscal policy is that
it will conflict with other macroeconomic objectives
Higher taxes will reduce growth and could cause
unemployment (explain)
Furthermore, unemployment and growth are considered
more important than the current account deficit.
Also fiscal policy doesn’t address the fundamental
underlying problem, which is a lack of competitiveness.
This needs to be addressed through supply side policies.
Now directly answer the question
Deflationary Fiscal policy may be good in a boom when
the economy is expanding too fast. However, in the long
term supply side policies are best solution to addressing
poor competitiveness.