an-introduction-to-supply-side-policies

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Introduction to Supply-side Policy

Supply-side policies aim to shift the long-run aggregate supply (LRAS) outwards, increasing the productive potential of the economy
“There are two categories of supply-side policies
- Interventionist policies
- Free market policies
Market based supply side policies can create conditions in which firms thrive and are incentivised to generate supply-side improvements

The Distinction Between Supply-side Policy and Supply-side Improvements

	Supply-side Policy	Supply- side Improvements
Definition	Government policies aimed at increasing the production capacity of the economy Achieved by by focusing on factors that affect the supply side, such as labor, capital, technology, and entrepreneurship	Specific actions made by firms within the supply side of the economy to enhance its performance and efficiency
Objective	Influence the macroeconomic environment and structural conditions of the economy to promote long-term growth and competitiveness	Enhance efficiency, quality, and competitiveness within individual firms or sectors
Examples	Tax cuts, deregulation, investment in education and training, subsidies for research and development, and infrastructure development	Firms adopt new production techniques, invest in advanced machinery, implement quality control measures, streamline supply chains, enhance worker skills through training programs etc.
Scope	Broad range of government interventions aimed at shaping the overall economic environment	Actions taken by firms, industries, or markets to boost efficiency and productivity
Agency	Typically involves government intervention and policymaking.	Can be driven by various agents, including businesses, workers, consumers, and technological advancements

Supply-side policies can be extremely useful in generating long term trend growth, lowering average price levels, and creating new jobs in an economy

When successful, supply-side policies have the following effects on the government’s macroeconomic objectives:

Supply-side Policies and the Macroeconomic Objectives

Impact of Supply-Side Policies	Explanation
Economic growth	The potential national output increases, leading to higher real gross domestic product (rGDP)
Unemployment	Supply-side policies reduce labour costs and create labour market flexibility through: Decreasing trade union power so wages can be decreased Decreasing or abolishing minimum wages to lower costs of production Restructuring the unemployment benefits system to incentivise the unemployed to seek work
Inflation	Supply-side policies reduce average price levels By deregulating the market and reducing taxes, it reduces businesses’ costs of production there will be less cost-push inflation Demand-pull inflation could also be reduced as potential capacity of economy increases (PPC curve shifts outwards)
Balance of payments	Supply side policies such as Increased spending on innovation and direct support to firms (subsidies) promotes international competitiveness This can increase the value of net exports An increase in export demand from abroad causes the balance of payments on the current account to improve

Supply-side policies play a crucial role in reducing the natural rate of unemployment by addressing structural issues within the labour market
The natural rate of unemployment (NRU) refers to the level of unemployment that exists in an economy when it is operating at full potential or potential output
- It includes frictional and structural unemployment but excludes cyclical unemployment, which fluctuates with the business cycle

Here’s how Supply-side Policies Reduce the NRU

Why it reduces the NRU	Explanation
Enhances labour market flexibility	Labour market deregulation, flexible work arrangements, and reducing barriers to entry into professions increase the flexibility of the labour market This flexibility allows workers to more easily transition between jobs, and reduces frictional unemployment
Investment in human capital reduces structural unemployment	Education and training systems enhance the skills of the workforce A more skilled workforce is better equipped to meet the demands of a changing economy, which reduces structural unemployment
Encouraging entrepreneurship and innovation creates new jobs	Policies such as tax incentives for research and development (R&D), subsidies for small business create new job opportunities, thereby reducing unemployment.
Lowering barriers to employment reduces frictional unemployment	Cutting red tape for businesses, lowering taxes on labour, and implementing targeted employment subsidies, encourage hiring and labour force participation More people enter the labour market, reducing the natural rate of unemployment.
Promoting investment and economic growth can reduce structural and frictional unemployment	Tax cuts for businesses, deregulation, infrastructure investment, and trade liberalisation, stimulate investment and economic growth A growing economy generates more job opportunities and reduces unemployment over the long term