Chapter 40 – supply-side policies
Objectives of the chapter
How
governments
can increase
AS in the
economy.
•
i.
Define: S-side policies, link to PPF
ii.
Draw PPFs showing how various
interventionist and market-based
S-side policies can shift the PPF.
Describe/outline: market-based S-side
and interventionist S-side
iii.
Explain why there is
unemployment even when the
labour market is in equilibrium.
Explain/distinguish/draw: a) lab mkt
policies; b) competition policies; c) tax
policies
iv.
•
Explain… how S-side policies are intended
to be used on the Big 4…e.g. the main
macro goals
Explain how supply-side policies
serve to shift AS and also
v.
•
Explain and give examples of Sside policies for labour markets,
tax policies and competition. Use
examples at all times.
Evaluate/discuss: SR costs of S-side and
LR benefits – another type of trade-off!
Difficulties in implementing S-side – political
and time issues.
•
•
Define supply side policies and
link to the PPF.
•
Explain how S-side policies hope
to address the main macro goals
and increase the LR trend of
potential output in an economy
over time.
•
Evaluate the effects of S-side
policies in the SR and LR. Take
care to address the SR costs
involved.
•
Evaluate possible trade-offs,
limitations and weaknesses of Sside policies.
vi.
•
It is not by accident that S-side policies are right after the chapter on
monetary policy! The grand ol’ father of monetarism was Milton
Friedman and it is from his line of theoretical reasoning that S-side
policies evolved.
Often one hears the term “neo-classical” in line with “monetarist” and
“supply-side” economics. The reason is that they all come from a
common base; markets work and for the optimal possible outcome one
should remove government rules and regulations to the greatest
possible extent and limit government intervention. The market “takes
care of itself” and “supply is its own demand”.
A good deal of supply-side economics took its start in a kind of
counter-reaction to Keynesian D-side economics. D-side (Keynesian)
economics basically states that 1 an active and interventionist
Keynes's main thesis was that laissez-faire
economics was increasingly becoming invalid and that
there was a very strong need for active government
intervention to achieve and maintain full employment.
1
government both can and should use mon/fiscal policy to attain full
employment via D-side policies.
Key terms: S-side, labour market, Reagan and Thatcher, Laffer curve
(NPOS!), Phillips curve (NPOS), money illusion (NPOS), stagflation,
labour mobility (“…between jobs and between regions…”),
privatisation, deregulation, market incentives…
Diagram: The effects of supply-side policy - successful
supply-side policy will shift the AS curve to the right.
Stolen from
http://economicsonline.co.uk/Global_economics/Supplyside_policies.html
Notes on syllabus:
1) Definition of S-side policies; any government policy aimed at
increasing AS
Supply-side economics arose out of the same mould as the
monetarist/neo-classical school during the 1980s and focuses
on policies which enhance the long run output potential in the
economy by way of creating well-functioning factor markets
and incentives for both producers and labourers. Supply-side
policies are in essence microeconomic policies, since the
By lowering interest rates to stimulate investment
and purposely engaging in deficit spending and
redistributing income to stimulate consumption
expenditure, government could be used as an
effective tool to attain full employment and restore an
economy to full strength. This ideology today is
known as "Keynesian" economics. (From
http://www.economictheories.org/2008/07/keynesmacroeconomics-keynesian.html)
policies target specific markets such as the labour or capital
market. Supply-side policies are highly market orientated,
aiming to ‘liberate’ markets which are hindered from clearing
due to various forms of market ‘impurities’ such as labour
legislation and government intervention. I have collected the
various supply-side policies under three main rubrics; labour,
taxes and competition.
1.
Labour: Supply-side economics in labour markets
centre on increasing labour mobility – both in terms of
geography location, industry and ‘time between jobs’ –
by increasing the incentives of firms to hire and
labourers to accept jobs. The basic ideal is to increase
the supply and overall quality of labour while creating
mechanisms for well-functioning labour markets. The
following points are often put forward:






2.
Change labour laws and make it easier for firms to
hire and fire, reducing search costs and risks for
firms while decreasing between-job time for
labourers.
Education and re-training schemes will increase the
quality of labour – e.g. labour capital – and increase
the speed by which redundant labour can be
reallocated. Such schemes can be encouraged by
giving tax breaks to firms which implement them.
Reducing/abolishing regional support schemes in
order to highlight differences in regional
unemployment levels and thus encourage people to
move to new jobs in other regions.
Cutting back on social welfare/unemployment
benefits in order to encourage people to accept jobs
by increasing the opportunity costs of unemployment.
Reducing union power – say, by making sympathy
strikes illegal and making collective bargaining
harder – in order to reduce wage stickiness.
Abolish minimum wages to allow market forces to
set wages.
Taxes: By increasing both the quality and quantity of
labour supply and capital, supply-side economics aims
to increase the long run aggregate supply:



Tax breaks/deductions to firms for (re-) investment
will stimulate investment expenditure.
Decrease marginal tax rates on income as an
incentive for labourers to work more; and decrease
labour taxes in order to decrease labour costs for
firms.
Lower taxes on dividends (a share of company profits
paid to shareholders) can increase investment funding
for firms since more people will be willing to buy
shares.

3.
Lower profit (corporate) taxes encourage further
investment by firms.
Competition: Finally, supply-side economists point to
the importance of competition in an economy as an
overriding element in increasing long run aggregate
supply:




Privatisation of government-run businesses and
deregulation of markets are staple supply-side
measures in increasing competitive forces in an
economy.
Grant subsidies or tax reductions for firms funding
R&D centres.
Encourage entrepreneurship by granting “tax
holidays” and creating beneficial funding schemes for
start-ups, e.g. new firms.
Trade liberalisation – reducing tariffs (= import
tariffs) and other barriers to free trade – and free
capital flows (easier foreign investment) are policies
often put forward by supply-siders.
The main theme in supply-policies is that market forces are
far better at creating output in the long run than government
intervention in the form of demand management. Sustainable
– long run – increases in GDP can only be increased,
according to this neo-classically orientated view, by
increasing long run aggregate supply. Allowing firms to make
a profit under competitive forces and creating conditions for
factor markets to clear will shift the long run aggregate
supply curve and therefore decrease the natural rate of
unemployment.
Evaluation
Benefits of S-side policies
a. Supply-side policies can help reduce inflationary pressure
in the long term because of efficiency and productivity
gains in the product and labour markets.
b. They can also help create real jobs and sustainable growth
through their positive effect on labour productivity and
competitiveness. Increases in competitiveness will also
help improve the balance of payments.
i. If S-side policies ↑productivity and ↓i in the
Homec, then relative to other countries Homec is
more competitive.
ii. That means M↓ and X↑ → improvement in
current account in BoP.
c. Finally, supply-side policy is less likely to create conflicts
between the main objectives of stable prices, sustainable
growth, full employment and a balance of payments.
This partly explains the popularity of supply-side policies
over the last 25 years.
Costs of S-side policies
a. However, supply-side policy can take a long time to work its
way through the economy. For example, improving the quality
of human capital, through education and training, is unlikely to
yield quick results. The benefits of deregulation can only be
seen after new firms have entered the market, and this may also
take a long time.
b. In addition, supply-side policy is very costly to
implement. For example, the provision of education and
training is highly labour intensive and extremely costly,
certainly in comparison with changes in interest rates.
c. Furthermore, some specific types of supply-side policy
may be strongly resisted as they may reduce the power of
various interest groups. For example, in product markets,
profits may suffer as a result of competition policy, and in
labour markets the interests of trade unions may be
threatened by labour market reforms.
d. Finally, there is the issue of equity. Many supply-side
measures have a negative effect on the distribution of
income, at least in the short-term. For example, lower taxes
rates, reduced union power, and privatisation have all
contributed to a widening of the gap between rich and poor.
i. When W↓ in low income areas, the gap
widens between rich and poor
ii. Lower U/soc benefits help widen the gap
too
iii. High social costs of S-side
policies…Hire/fire policies + ↓U benefits
+ privatisation + increased competition +
less union power = higher unemployment
in the SR