Supply side policies can be defined as government initiated plans whose aim is to boost productiveness and skillfulness in the economy. In doing this, the government may be seeking to achieve the following macroeconomics objectives;
An increase in the national economic growth
Lowering the level of inflation
Reducing the level of unemployment
Maintaining the equilibrium on the balance of payments
The above objectives involve a trade off in some cases in that, for example, increasing government expenditures may contribute to an increase in economic growth and lower unemployment, but it will mean a rise in inflation.
In order to realize success in all these objectives, there is need to initiate changes in the supply side of the economy. The state can achieve low inflation and improve the overall competitiveness of the economy if it is able to increase productivity and shift the aggregate supply to the right. (Linbeck, 2013, p. 67)
To understand better how the supply side policies could stimulate economic growth, we need to analyze its impact on each of the above government’s macroeconomic objectives.
The supply side policies would increase the long run aggregate supply. It would also lead to a rise in overall demand from AD1 to AD2. This would in turn increase the economic growth from Y1 to Y2.
Supply side policies will boost the rate of economic growth by improving the long-run aggregate supply. This leads to an increase in the rate of growth in the economy without causing inflation.
It is impossible to increase the long-run rate of economic growth using demand side policies. This calls for effective supply side policies from the side of the government if it needs sustainable growth rate. (Cook., 2014, p. 158)
An example is where effective training schemes are established, which gives workers extra skills and thus leading to productivity. The state should make efforts in encouraging businesses to invest in more research plus development by giving them subsidies. If it is achieved, these policies would enable the country to increase its growth rate.
Practically, the government has minimum control on as far as its supply side policies are concerned, in improving the long run flow of economic growth, as this counts largely on technological advancements. These advancements are independent of government policies. (Fernandez-Villaverde, 2014, p. 172)
In its attempt to lower the level of unemployment, the government can employ interventionist’s supply side policies, for example, by offering better education and training. This would provide the necessary skills which would help those unemployed to train and thus enable them get jobs in the ever changing job market. The government should be ready and able to provide skills that employers need, or else there would be no assurance that the state expenditure on education will be able to equip learners with the necessary skills required in the job market. (Oulton, 2015, p. 187)
The training and education should also focus on better job information to reduce frictional unemployment. The government could also try free-market policies such as increased labor market flexibility. This involves, for example, making it possible to recruit and retrench workers, thus enabling the firms to be in control of the hiring process theoretically in the first place. The UK has registered a reduction in unemployment levels since 2010; partly due to more flexible labor markets and a growth zero-hour contracts. (Cook., 2014, p. 203)
The demerit of increased labor market flexibility is that it may instill fear of losing jobs in workers and also a lower wage growth.
Supply side policies are very important in dealing with and reducing persistent rates of unemployment, which includes structural and frictional unemployment.
Supply side policies however, have been unable to deal with unemployment that comes as a result of low economic growth. This is evident during recession as most firms lay off workers to cut cost. Another way through which the free market supply side policies could solve unemployment is the reduction in unemployment benefits. This would increase the incentive to acquire a job. It is believed widely that huge unemployment benefits give rise to unemployment trap where people are unwilling to take up tasks and work. This is because those in unemployment benefits would only get a minimum increase in after tax income if they get employed. (Zagler, 2014, p. 123)
The government could also provide employment subsidies. The state could provide firms with subsidies if they agree to take up or absorb the long-term unemployed. This, however, has a disadvantage in that the firms could render the current workers redundant in order to cash in on the benefits that are being provided by the government. (Roldos, 2013, p. 178)
Low levels of unemployment again come with high inflation rates as depicted from Philip’s curve. It involves a tradeoff between low unemployment rates and some inflation.
To achieve low levels of inflation, involvement of supply side policies may help reduce costs and improve productivity greatly. An example is where the government uses privatization and deregulation to help reduce costs. Policies should be put in place to reduce the powers of trade unions in order to reduce inflation that arises due to high wages being pushed by trade unions, and hence reducing inflation. (Oulton, 2015, p. 122)
Shifting the aggregate supply to the right will lead to a reduction in price levels. This will make the economy more, efficient thus reducing the inflation that comes as a result of high costs of productions. (Linbeck, 2013, p. 198).
The UK has always had the problem of current account deficits since 1980s.
Increased productivity may be very important in establishing or achieving a better balance of payments.by making firms more productive and competitive, the UK products will be in higher demand, thereby increasing their exports and improving the current account deficits. (Zagler, 2014, p. 169)
The supply side policies that would be helpful here is the quality of transport sector. The government should invest in improving the transport sector i.e., the rail and the road networks. The cost of doing business would reduce if the congestion and supply bottlenecks are reduced.
The government should pursue a policy of privatization and deregulation. This is because privatized entities are usually more efficient. This efficiency would cut the costs of production and raise exports. (Boix, 2016, p. 179). The following is a breakdown on how these policies could work;
Free-market oriented
Privatization –this is where the state owned businesses are sold off to the private sector. By doing this, their efficiency is improved as these privately owned entities are free from political interferences. They are also able to perform better since they have profit motives.
Deregulation- this is whereby barriers to entry into the business lines are reduced or done away with so as to allow more firms to enter the market and make it more competitive. Many businesses would provide employment and also increase the national income. (Oulton, 2015, p. 165).For example, in the year 2015, the government of the UK came up with what was referred to as ‘1 in 2 out’ system, whereby, no new regulation would be introduced without being offset by a deregulation of two times the equivalent value (Linbeck, 2013, p. 174). UK’s red tape challenge has identified over 3000 regulations to be done away with and improved, and this would bring over £1000 annual savings to firms and businesses.
Reduction in income tax rates-lowering income tax rates increases incentives for people to work, resulting to more labor supply and more output.
At the same time, a reduction in the firms’ corporation tax leaves them with more retained profits that they can use for investment in the economy hence leading to economic growth.
A closer look at the income substitution effect reveals that lowering taxes do not always make individuals ready to work. Our argument here won’t be true if the income effect is greater than substitution effect. (Lucas, 2014, p. 190)
For instance, the government of UK in decided to cut corporation tax from 27% in the year 2010 down to 23% in order to support businesses in their investment and growth. In the year 2013 the government further declared that the rate would be reduced to 20% by the year 2014. This was affected and it gave the UK the lowest rate as compared to all the G20 states (Le Grand & Bartlett, 2015, p. 153).
Increase free trade-the government should reduce tariff barriers in order to increase trade activities and provide and make export firms are willing to invest. Most important are non-tariff barriers (Fernandez-Villaverde, 2014, p. 154). For example, the UK government should harmonize the regulations, so as to enable more frictionless trade.
Non-restriction of immigration-free movement of labor would increase the labor supply and deal with the problem of labor shortages, whether skilled or non-skilled. The immigration policies should be made liberal in order to make labor markets more flexible and consequently help the firms keep up with the increasing demand for labor during the boom periods (Cook., 2014).
Immigrants have made a positive fiscal contribution even at a time when the United Kingdom was running current account deficits. The university college of London reported that immigrants most of the times are more highly skilled than the locals. For example, in 2011 75% of grandaunts were immigrants as compared to only 21% who were British adult population. Interventionist’s supply side policies.
Investment in human capital-the government should make efforts to improve the education sector by bettering the level of schools or even providing free education. Training of manpower should be done extensively. Such a policy would increase the aggregate demand in the short run, but above all, lead to a positive shift in long run aggregate supply. This is because as people’s skills improve, their productivity increases too (Linbeck, 2013, p. 132).
For example, the government of the UK has in the past continued to roll out academies and is providing for close to 190 new free schools, 22 new studio schools and 20 university technical colleges each year. There are currently over 3000 new academies and free schools. More are due to open. Reforms in the curriculum and qualifications are aimed at making education and training more relevant in the job market (Boix, 2016, p. 169).
Improvement or advancement in the level of technology-the government should put its resources in doing extensive research and also coming up with new technologies. By doing so, demand would be boosted in the short run period while long-run aggregate supply would increase. This is because advancement in technology increases output and growth. An example is the 3D printers which have really made modelling more efficient together with production of various related products (Cook., 2014, p. 146).
Going by figures and facts, the government of UK has increased its capital expenditure on science and technology by £1.4 billion in excess of the amount that had been previously budgeted for in 2010. This has greatly improved investment in projects and research initiatives.
Investment in infrastructure-this majorly includes roads and railways (Kene, 2016, p. 132). Logistics is very important in doing business activities. The government therefore needs to invest hugely in infrastructure. By doing so, the transfer cost and duration would reduce and thus increasing productivity which in turn would shift the long-run aggregate supply to the right (Fernandez-Villaverde, 2014, p. 176).
For instance, the government of the UK has committed a total of 100 billion shillings that is being geared towards infrastructural development. The plan was broken down as follows;
£15bn investment in the transport sector
£5.9bn was ploughed into scientific improvements up to and until 2021
£2.3bn was ploughed into flood defense schemes.
The government also published an infrastructure pipeline which was approximately £40 billion.
Increasing exports and supporting inward investment-the UK government, through the United Kingdom export finance, is providing insurance to the country’s exporters and a guarantee to financial institutions to share the risks of giving out export finance (Strbac, 2016, p. 80).
Since the year 2011, the United Kingdom export finance has provided over £13.9bn of support for exports to close to 90 countries. Through the United Kingdom trade and investment, the government has provided expert international trade advice and support to local industries who are interested in bettering their firms abroad (Le Grand & Bartlett, 2015, p. 245).
The United Kingdom trade and investment received more resources in countries like India and China to assist in funding the first time exporters. The body has doubled the number of industries that it aids to close to 49000. This has helped generate £49.1 billion more sales. The number is projected to grow in the coming years (Lundvall , Dosi , & Freeman, 2014, p. 167).
Annual investment allowances have also been increased from the previous £25000 to £500000 and this has encouraged small and medium sized businesses to invest in plant and machinery.
Summary of the total impact of supply side policies on the stimulation of economic growth
Supply side policies can be very important with very little demerits. However, practically it is most of the times difficult to increase productivity. Also, there are limited advantages that could be accrued from this. In a recession is often advisable to use demand side policies rather than the supply side policies (Cook., 2014, p. 145).
At (Y1) which is a recession, we need demand-side policies to improve aggregate demand. Shifting long run aggregate demand to the right will only have little effects in dealing with macro-economic issues.
References
Boix, C. (2016). political parties and the supply side economies. American journal of political science, 814-855.
Cook., M. (2014). Supply side policies. Heinneman.
Fernandez-Villaverde, J. (2014). Supply side policies and zero lower bound. IMF economic review, 62(2), 250-280.
Kene, M. S. (2016). The demand for international regimes. International organization, 23(3), 132-187.
Le Grand , J., & Bartlett, W. (2015). Quasi-markets and social policy: the way forward? Quasi-markets and social policy: the way forward?., 12(3), 276-290.
Linbeck, A. (2013). The Scandinavian Journal of Economics, 8(2), 280-308.
Lucas. (2014). Oxford economic papers, 2(42), 290-310.
Lundvall , B. A., Dosi , G., & Freeman, C. (2014). Innovation as an interactive process. from user-producer interaction to the national system of innovation, 15(3), 154-198.
Olson, M. (2014). Distinguished lecture on economics in government: big bills left on the sidewalk: why some nations are rich, and others poor. Journal of economic perspectives, 6, 231-256.
Oulton, N. (2015). supply side reform and UK economic growth. National institute economic review, 154(1), 50-90.
Roldos, J. E. (2013). IMF staff papers, 42(1), 159-190.
Strbac, G. (2016). Demand side management: Benefits and challenges. Energy policy, 4, 77-90.
Zagler, M. (2014). Fiscal policy and economic growth. Journal of economic surveys, 3(17), 390-420.
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