Supply-Side Economics Objectives of supply-side policies These policies focus on shifting LRAS to the right in order to achieve long-term economic growth There are two major types of supply-side policies that we will discuss today Market-oriented supply-side policies Based on the neo-classical point of view, economists in the early 1980s argued that growth in real GDP depended on the supply-side of the economy as opposed to the demand-side. They argued that increasing potential output should be the focus of economic policy, not the stabilization of the business cycle Any takers? We’re in! The foundation As we know, neoclassical economists argue that in the long-run, macroeconomic equilibrium always occurs at the full employment level of GDP, automatically eliminating inflationary and recessionary gaps. The possibilities Supply-siders argue that an economy pursuing supply- side policies will be able to achieve rapid growth, price stability and full employment all at the same time. The key is to continuously shift SRAS and LRAS to the right and watch increases in AD follow accordingly Stagflation? No problem! Supply-siders argue that if a negative supply shock occurs in the economy, supply-side policies can effectively shift the SRAS curve back to its original position, thus dealing with the dual problems of an increasing price level and falling output……Remember, demand-side policies can only fix one of those problems So how do we put supply-side policies into effect? Market-oriented supply-side policies focus on introducing legislative, regulatory and institutional changes in the economy which are intended to increase efficiency of production, decrease the natural rate of unemployment, and increase the economy’s production possibilities. The gospel according to supply-siders Supply-side policies can be classified under four particular categories. They include: Reducing the size of the government sector Lowering taxes on businesses Making the labour market more competitive Liberalizing international trade and capital flows Smaller government Remember me driving my government car, working 3 hours a day, people asleep at their desks, expensive trips to Puerto Rico? Supply-siders argue that this is common and changes need to be made. Their proposals to reduce the size of the government include….. Privatization Privatization According to supply-siders, by transferring ownership of a firm from the public to the private sector, efficiencies will result due to the more competitive nature of private industry. No more sleeping at your desks! No more 3 hour workdays! Private financing of public sector projects Need a highway or airport built? Supply-siders want private firms to build, finance and operate public services, and then allow the government to buy these services from the private firm. The thinking here is that private firms will be more efficient and the government sector will be reduced Outsourcing Rather than the government employing armies of accountants, information technology workers and other professionals, supply-siders want government to hire private firms to provide these services. Increased efficiencies and competition should result from outsourcing of this work according to supplysiders Deregulation (2 kinds) Economic deregulation involves removing government controls on price and output in industries such as airlines, broadcasting, energy, and financial services. Again the argument is that with less government involvement, more competition and inefficiencies will result. Deregulation (2 kinds) Social deregulation involves removing some of the protections for consumers in areas such as product safety, pollution control and injuries in the workplace. Supply-siders argue that all these protections for consumers are unnecessary, cost businesses too much money to comply with, and result in less output by firms due to the excessive costs Restricting Monopoly Power Supply-siders want to take away monopoly power from firms, by breaking them up and ensuring more competition in the industry. They also try to prevent mergers of companies who could achieve monopoly power if they were permitted to join together. Lowering personal income taxes Supply siders argue that cuts in personal income taxes will have an even greater effect on aggregate supply than on aggregate demand. How does that work you ask? Lowering personal income taxes Supply-siders argue that if the tax rate on individuals is lowered, people will take home more money and then: be motivated to work more hours, motivate unemployed people to go back to work, delay retirement dates. All these can shift LRAS to the right Lowering taxes on interest income Supply-siders argue that if interest income is not taxed, people will save more money, therefore increasing the funds available for businesses to borrow which will lead to greater capital expenditures and more output. The wealthy like this idea Lowering business taxes Supply-siders argue that cuts in business taxes lead to increased spending on capital goods and more money to spend on technology and research and development. This should also lead to increased output Business owners like this idea Increasing labour market flexibility Supply side economists argue that making the labour markets more competitive will lead to increased levels of aggregate supply. They point to several ways this can happen…. No more minimum wage! Supply-siders argue that if minimum wage was eliminated, wage rates would fall to the equilibrium level, companies would hire more workers at the lower rate, company profits would increase, which would then lead to increased investment on capital goods, and long-term economic growth Whaddya think? Down with Unions! Supply-siders argue that unions keep wage rates above the equilibrium rate, having the same detrimental effects on the economy as minimum wage. Less union labour would mean lower wage rates, more workers employed, greater business profits, and long-term economic growth Whaddya think? Reducing unemployment benefits Supply-siders argue that unemployment benefits are too generous and discourage people from looking for work. If we reduce unemployment benefits, lazy people will get motivated to work, find jobs, and increase the level of output in the economy. Whaddya think? Reduce job security Supply-siders argue that job security for workers makes them lazy and unproductive. Put a little fear into a worker and he/she will work harder, it will be easier to fire unproductive workers, and economic output will result Whaddya think? Liberalizing international trade Supply-siders argue that increased global trade and capital flows increase competition and improve allocation of resources. We’ll talk more about this later in the course, but it is a key point of supply-side economic policy Interventionist supply-side policies Market oriented supply-side policies argue that if markets are free, efficiencies will result. Supply-siders also argue for some government intervention to affect the aspects of the economy that the market itself will not act upon. Such as…..? Training and Education Improvements in training and education lead to more productive workers. Improving the quality of our factors of production is one way towards achieving economic growth, right? Hard to argue with that one isn’t it? Improved Health Care Healthier workers are more productive workers and another improvement in our quality of factors of production. Hard to argue with that one isn’t it? Research and Development R & D leads to technological innovation and large potential gains in economic growth. Tax incentives to businesses in this area, as well as patent protection for inventions are all supported by supply-sider economists Hard to argue with that one too isn’t it? Support for infant industries Supply-siders argue for the support of small, growing firms through tax breaks, grants, subsidies and other programs. Small companies can become giants very quickly, right Mr. Google? Infrastructure Investments in infrastructure such as roads, airports and telecommunications can increase efficiencies in production as costs are lowered. Hard to argue with that one isn’t it? Other interventionist policies Provision of job information Support for adolescent industries All of the above interventionist policies are known as industrial policies because they are designed to support the industrial sector of the economy and shift LRAS to the right. These might not be provided by the free market so government must be involved. Criticism of interventionist policies Some argue that any government involvement in the market is likely to do more harm than good. Others argue that using government tax money to support industries could be more wisely used elsewhere, and requires a higher level of taxation that they would like. So what say you, are there any supply-siders in the room? Me neither!