3.3 Supply side policy

• Supply-side policies:

  Attempts to increase productivity and efficiency in the economy. They aim to improve the quantity and/or the quality of the factors of production.
• Productive capacity:

  The supply capacity/productive potential of an economy. The maximum output that an economy can produce without big increases in inflation.
• Market-based policies:

  Policies that allow markets to operate more freely and provide incentives for enterprise and initiative.
• Interventionist policies:

  Policies by which the government intervenes to stimulate aggregate supply
• Examples of supply-side policies:

  1. Education and training

  2. Reforms in the tax and benefit system

  3. Improved labour market flexibility

  4. Investment in infrastructure

  5. Research and development

  6. Privatisation

  7. Deregulation

  8. Subsidies

  9. Competition policy

  10. Immigration control
• Education and training:

  Government investment into this should raise the skills base of the labour force and improve occupational mobility
• Reforms in the tax system:

  For example, lower direct taxes on incomes can increase LRAS by increasing the incentive to work, so reducing the number of people who are economically inactive and increase the quantity of labour available to firms.
• Reforms in the benefit system:

  For example, the recent introduction of Universal Credit in the UK means there is less support for those who are economically inactive and greater reward for those entering the labour market.
• Improved labour market flexibility:

  For example, a reduction in labour market regulations, such as limiting the power of trade unions, an employer's ability to adjust the demand for labour and the opportunity employees have to request more flexible working hours.
• Investment in infrastructure:

  Government expenditure on transport links, communication networks and facilities can aid greater geographical mobility of labour and reduce supply-side bottlenecks.
• Research and development:

  Investment into R&D and innovation increases technological advancement and boosts the dynamic efficiencies enjoyed by firms.
• Privatisation:

  Transfer of an industry from public to private ownership and control. Many economists believe that this lead to production becoming more economically efficient because of the profit motive.
• Deregulation:

  Removal of regulations to open up the industry to competition, thus leading to the advantages of competition.
• Subsidies:

  A sum of money granted by the government or a public body to assist an industry or business so that the price of a commodity or service may remain low or competitive. It reduces the cost of production, promoting greater production in certain industries e.g. merit goods.
• Competition policy:

  The CMA works to promote competition for the benefit of all consumers in the UK through greater choice and lower prices
• Immigration control:

  Migrant workers may have different skills from native workers and so can plug a skills gap or increase productivity rates
• Advantages of supply-side policies include:

  1. Greater productive potential

  2. There is no trade-off between economic growth and inflation

  3. An increase in international competitiveness

  4. It can lead to a new comparative advantage

  5. A developing country with a new comparative advantage can help to avoid the development trap

  6. Improvements in geographical mobility of labour

  7. It may encourage savings, creating loanable funds for investment
• Disadvantages of supply-side policies may include:

  1. There is little point to them if there is not sufficient aggregate demand.

  2. Good governance is required in order to identify the most appropriate policies

  3. Economic growth effects may be limited by shortages of skilled labour

  4. Government investment into supply-side may be constrained by political cycles

  5. Policies may be constrained if there is not access to global markets.

  6. Time lags

  7. Budget constraints

  8. Crowding-out considerations
• Define supply-side policies

  Government policies aimed at increasing the productive potential of the economy and shifting LRAS to the right.