Supply side policies

Supply side policies

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  Supply-Side Policies EdExcel ASEconomics 2.6.2
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  Supply-Side Economic Policies Theyare policies that improve productive potential / capacity of an economy. Illustrated by an outward shift of LRAS (or of the PPF) • Supply-side policies focus on improving the structural long- term performance of an economy • There are different approaches to supply-side reforms • Market-led policies – designed to make markets work better and give the private sector more freedom • State / government intervention in markets to overcome different types of market failure • Supply-side reforms can affect both short-run and long-run aggregate supply – but the focus is usually on LRAS • Time lags involved with supply-side reforms can be long
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  Key Supply-Side Challengesfor the UK Economy Persistent Productivity Gap High rates of youth unemployment Deep and widening regional economic divide Structural trade deficit (current account of BoP) Low trend growth rate of real GDP Rise of Emerging Nations Low capital investment & research Rising inequality / relative poverty
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  Main Objectives ofSupply-Side Policies 1. Improve incentives to look for work and invest in people’s skills 2. Increase labour and capital productivity 3. Increase occupational and geographical mobility of labour to help reduce the rate of unemployment 4. Increase investment and research and development spending 5. Promoting more competition and stimulate a faster pace of invention and innovation to improve competitiveness 6. Provide a strong platform for sustained non-inflationary growth 7. Encourage the start-up and expansion of new businesses / enterprises especially those with export potential 8. Improve the trend rate of growth of real GDP Key concepts to focus on when discussing S-SPs are incentives, enterprise, technology, mobility, flexibility and efficiency
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  Difference between Production& Productivity There is a clear distinction between production and productivity • Production • Value of output of goods and services e.g. measured by GDP or an index of production in specific industry • Productivity • A measure of the efficiency of factors of production • Measured by output per person employed • Or output per person hour • An increase in production DOES NOT automatically mean an increase in productivity - it depends on how many factors of production have been utilised to supply the extra output
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  Evidence for theUK Productivity Gap The table below measures an index of constant price GDP per hour worked for a range of countries – evidence of the productivity gap France Germany Italy Japan UK USA 2007 100.0 100.0 100.0 100.0 100.0 100.0 2008 99.3 99.6 98.9 100.0 99.5 100.5 2009 98.7 96.9 96.7 99.1 97.8 102.9 2010 100.2 98.5 99.0 102.8 99.3 105.5 2011 101.4 99.5 99.1 102.8 101.7 106.0 2012 102.1 99.9 98.3 103.9 99.7 106.3 2013 102.4 99.4 98.5 105.5 99.4 107.6 Source: ONS, Feb 2015
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  Why does theUK economy lag on productivity? Low rate of new capital investment in the UK Banking crisis affecting lending to businesses Possible slowing rates of innovation Persistent skills shortages in key industries Relatively low levels of market competition Low aggregate demand & high spare capacity
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  Economic Advantages ofHigher Productivity 1. Lower unit costs: Cost savings for businesses can bring lower prices, encouraging higher demand, more output and an increase in employment 2. Improved competitiveness and trade performance (BoP) 3. Higher profits: Efficiency gains are a source of larger profits for companies which might be re-invested 4. Higher wages: Businesses can afford higher wages when their workers are more efficient 5. Economic growth: If an economy can raise productivity then the trend growth of national output can pick up 6. Productivity improvements mean that labour can be released from one industry and be made available for another
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  If Supply SidePolicies Work 1. Achieve a sustained improvement in the possible trade-off between inflation and unemployment (see Phillips Curve) 2. Be more flexible in response to external demand and supply-side shocks such as rising energy prices 3. Raise living standards through stronger long term economic growth / an increase in underlying trend rate of growth 4. Reduce unemployment by lowering the natural rate of unemployment (less frictional & structural unemployment) 5. Improve competitiveness in global markets and achieve a stronger balance of trade in goods and services In general, a stronger supply-side performance allows a government to meet more of the key macro objectives
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  Showing Long RunEconomic Growth using AD-AS General Price Level Real GDP GPL1 AS1 Y1 AD1 Yp1 LAS1 An increase in a country’s productive potential causes an outward shift of LAS. Short run supply increases because of lower unit costs An increase in productive potential allows an economy to operate at a higher level of AD LAS2 AS2 AD2 Yp2Y2
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  Pro-Market (Private Sector)Supply-Side Policies These policies focus on reducing the size of the state and in boosting the role of market forces in allocating scarce resources • Cutting government spending (including welfare) and borrowing • Lower business taxes to stimulate capital investment • Lower income taxes to improve work incentives • Reducing red-tape to cut the costs of doing business • Improving the flexibility of the labour market including reforming employment laws and encouraging more part time work • Competition policies such as deregulation & anti-cartel laws • Privatisation of state assets – transferred to the private sector • Opening up an economy to overseas trade and investment • Opening up an economy to inward skilled labour migration
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  Recent UK GovernmentSupply-Side Policies Privatisation of Royal Mail Patent Box Incentive Modern Apprenticeships – e.g. the Youth Contract Welfare Caps / and other Welfare Benefit Reforms Shale Gas Tax Cut Incentives Large Fall in Corporation Tax UK National Infrastructure Plan including HS2 Launch of a Green Investment Bank
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  Government Intervention -Supply-Side Policies Supporters argue that an interventionist state can have a powerful positive long-term effect on supply-side performance • State investment in public services and critical infrastructure • A commitment to a minimum wage and/or living wage to improve work incentives & productivity in the labour market • Higher taxes on the wealthy to fund public and merit goods • An active regional policy to inject extra demand into under-performing areas / regions of persistently high unemployment / low per capita income – e.g. the Government’s Northern Powerhouse Project • Selective import controls to allow domestic industries to expand • Management of the exchange rate to improve competitiveness • Nationalisation of and/or stronger regulation of key industries
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  Regional Policy –The Northern Powerhouse Project The UK government wants to achieve a greater degree of regional balance in the economy to help supply-side potential growth • Goal of Northern Powerhouse idea is to have a balanced regional recovery • North has a relatively higher concentration of public sector and manufacturing jobs and has grown less quickly since the end of the last recession • Aim is to increase long-term growth in the major cities of the North including Liverpool, Manchester, Leeds and Hull • Policy options include: • Investment to improve transport connections • Supporting science and innovation including the universities • Backing specialist clusters of businesses including high tech sectors such as life sciences and marine engineering
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  Research and Development(R&D) R&D is focussed on the creation and improvement of products and processes, based on scientific research – applied to market needs • Spending on R&D in the UK has been <2% of GDP for many years • The biggest barriers to innovation are • Risk aversion – research is expensive, rewards are uncertain • Uncertainty about ability to exploit research and make a profit • A lack of high-skilled workers • Top EU companies: Nokia, Volkswagen, Bosch and Siemens • The top UK firms are GlaxoSmithKline and AstraZeneca • The level of research spending is not necessarily a guide to the pace and success of innovation. Many businesses do not patent all their most innovative ideas but keep them as trade secrets
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  What is Innovation? Innovationis putting a new idea or approach into action. Innovation is 'the commercially successful exploitation of ideas' • Product innovation • Small-scale, frequent subtle changes to the characteristics and performance of a good or a service • Process innovation • Changes to the way in which production takes place or is organised • Innovation has demand and supply-side effects in markets and the economy as a whole Austrian economist Joseph Schumpeter coined the term creative destruction. This is a term that refers to the complete upheaval of the established order in the pursuit of innovation.
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  International (External) Competitiveness Externalcompetitiveness is the ability to sell goods and services at competitive prices in a foreign country • Cost competitiveness – differences in unit costs between producers – reflected in prices • Non-price competitiveness – product quality, design, reliability and performance, choice, after-sales services, marketing, branding and the availability and cost of replacement parts • Non-wage costs: • Costs of meeting environmental / health regulations • Environmental taxes e.g. carbon taxes and waste taxes • Employment protection laws and health and safety laws • Requirements to provide pensions for employees
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  Policies to ImproveInternational Competitiveness Improving functioning of Labour Markets • Investment in all levels of education and training • Encouraging inward migration of skilled workers • Improvements in management quality Infrastructure Investment • Better motorways, ports, hi-speed rail • Northern Powerhouse project • Communications e.g. super-fast broadband, 4G networks Supporting Enterprise / Entrepreneurship • Improved access to business finance e.g. for start-ups • Incentives for business innovation and invention • Reductions in business red tape Macroeconomic Stability • Maintaining low inflation / price stability • A sustainable and more competitive banking system • A competitive exchange rate v major trading partners
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  Evaluating the Impactof Supply-Side Policies Supply-side policies can have a powerful effect on economic performance – but be aware of limitations and disadvantages 1. Supply-side policies have long time lags – especially when they are trying to achieve structural changes 2. The level of aggregate demand is also important in making business investment and innovation viable 3. Some supply-side policies (e.g. cutting higher-rate income taxes) might lead to greater inequalities of income & wealth 4. State intervention to “pick winners” in different industries may be ineffective – there are risks of government failure 5. Sustainability issues if policies aim to raise a country’s long term growth rate – leading to increased externalities such as pollution 6. Supply-side policies look to achieve relative improvements e.g. In productivity – but other countries will be making gains too
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  Supply-Side Policies EdExcel ASEconomics 2.6.2