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L100 Economics

Published : 20-Sep,2021  |  Views : 10

Question:

Explain how the government can use supply side policies to facilitate economic growth. Use UK examples to support.

Answer: 

Supply side policies attempt to boost economic growth by using the tool of aggregate supply. The policies aim at ensuring an efficient operation of market and industries and hence contribute to bring a faster growth of national output in real terms. Implementation of successful supply side policies leads to an outward shift of long run aggregate supply curve and gives rise to potential output in an economy. Governments in many nations rely on supply side policies as they bring sustainable economic growth without counter result of rising inflation. Application of supply side policies is not limited in not limited to public sector only. Government can implement these policies in private sectors as well.

There are two broad categories of supply side policies- Policies related to supply side in free market and Interventionists policies each having a different set of policy objectives. Policies of free market supply remove barriers of open competitiveness and increases competition. This includes policies of privatization, reducing direct tax rate, deregulation of some protected sectors, reducing power of trade unions and so on. On the other hand interventionist policies encourage government involvement in areas of market failure (Fernández-Villaverde, Guerrón-Quintana and Rubio-Ramírez 2014).

Supply Side policy and economic growth

Government objective in increasing real output by using demand side policies ends with rising inflation rate in the economy. However, implementation of supply side policies along with demand side policies prevents rise in the price level. This is explained in the following diagram

                                           

Figure 1: Effect of rightward shift of long run AS curve

(Source: www.economichelp.org)

Figure 1 shows supply side policies work. In order to increase output (Y), aggregate demand (AD) shifts to the right. If supply curve remains LRAS then shifts in Ad curve increases output from Y1 to Y2 along with a rise in price level. However, when long run AS curve shifts to right as indicated by LRAS 2 then output increases to the same extent without any increase in the price level which is fixed at P1.

Examples of supply side policies

Privatization: Driven by the fact that state owned enterprises very often run with inefficiencies because of lack of competition, government sells its assets in inefficient PSUs to private owners. This is called privatization. It is believed that private run organizations are more efficient because they have profit motives and tend to implement better technology to reduce cost.

Deregulation: Deregulation is done to relax barriers to entry in protected industries and make the industry a competitive one. In the presence of competition resources are allocated efficiently and low price prevail along with a quality product.

Labor market deregulation: Labor market deregulation can be done by following a number of policies (Mankiw 2014). The policies more often used include making the process of hiring and firing of workers easier, enabling zero hour contracts, liberating immigration policies and others.

Lower tariff barriers: reducing tariff rate or elimination of tariff barriers increases prospect of trade in the nation and hence encourage producers to increase production to boost export.

Interventionist policies involve government investment for facilitating education and training program, improvement in transport and other required infrastructure and intervene in areas in which private investors do not participate.

Supply side policies in UK

UK economy has faced several challenges in the supply side. There are persistent gap in productivity, high unemployment rate among youth, low growth rate of GDP, structural deficit in Balance of Payment, low investment in research and  development, problem of rising inequality and relative poverty are some common supply side problems in the economy.

In order to resolve these issues UK government has adapted various supply side policies. The biggest example of privatization in UK is privatization of Royal Mail. Government leaves its entire stake in Royal Mail and ends all involvement of taxpayers in postal firm. With this step government expects to win over major players in the economy such as customers, workforce in Royal Mail and taxpayers (Devereux and Littlefield 2017).

Benefits given to unemployment have increased at a rate slower than that of wage rate in the economy. Objective of this policy is to encourage unemployed to look for a job rather than enjoying unemployment benefit (Argy and Nevile 2016).  Trade unions power to intervene in labor market has reduced. Minimum wage set by trade unions increases unemployment in the economy by pulling wages above the equilibrium wage.

Other market oriented supply side policies of UK government are- cut down spending and borrowing of government, reducing business tax and income tax rate, implementation of anti cartel laws to enhance competition, launching national infrastructure plan and introducing modern apprenticeships.

Supply side policies are quite effective in UK. However, supply side policies alone cannot bring desired results. A combination of aggregate demand and aggregate supply policy is needed for achieving a desired microeconomic environment.

References:

Argy, V.E. and Nevile, J. eds., 2016. Inflation and Unemployment: Theory, Experience and Policy Making. Routledge.

Devereux, M. and Littlefield, D., 2017. A literature review on the privatisation of public space.

Fernández-Villaverde, J., Guerrón-Quintana, P. and Rubio-Ramírez, J.F., 2014. Supply-side policies and the zero lower bound. IMF Economic Review, 62(2), pp.248-260.

Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.

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