Supply-side Policy

Key Terms
Supply-side Policy: Policies that aim to increase the productive capacity of the economy.
Theory

Types of Supply-side Policy


  • Free market supply-side policy
  • Labour market supply-side policy
  • Supply-side policies for industry
  • Financial market supply-side policy


    • Supply-side policies for the free market

    Supply side policies in product markets are designed to increase competition and efficiency.

    1) Privatisation

    Privatisation is designed to break up state monopolies and create more competition. Examples of privatisation include British Gas, British Telecom, British Airways and British Aerospace.


    2) Deregulation of markets

    De-regulation or liberalisation means opening up of markets to greater competition. Recent e.g. parcel delivery service. The aim is to increase market supply thus driving down prices and widening the range of choice for consumers. This should also lead to greater cost efficiency from existing producers who want to keep market share.


    3) Measures to encourage entrepreneurship

    The expansion of new businesses means greater output, increased employment and innovative behaviours that can have positive spill over effects.

    Government can encourage entrepreneurship by introducing:

  • Loan guarantees for new businesses
  • Advice for new firms
  • Start-up funding


    • Supply-side policies for labour markets

    These policies are designed to improve the quality and quantity of the supply of labour. They also seek to make the labour market more flexible so labour can be better matched to the demands of employers thus reducing the risk of structural unemployment.


    1) Spending on Education and Training

    Investment in education has the potential to raise the skills within the workforce and improve employment prospects. Improved training, especially for those who lose their job in an old industry should improve the occupational mobility of workers.

    A well-educated workforce also acts as a magnet for foreign investment in the economy.


    2) Income Tax Reforms and the Incentive to Work

    Lower rate of income tax provides a short-term boost in aggregate demand. This provides an incentives for people to work longer hours or take a new job. Cutting taxes also reduces the extent of the ‘unemployment trap’.

    However some people may choose to work the same number of hours and simply take a rise in post-tax income. Millions of other workers have little choice over the hours they work.



    Supply-side policies for industry

    1) Reduced Corporation Tax

    Reduced corporation tax will reduce costs of production for firms giving firms more retained profits. Firms may invest profits in capital equipment, this increase the quantity and quality of capital, which increases the productive potential of the economy.


    2) Subsidies for Research & Development

    Subsidies provide an incentive for firms to innovate more advanced methods of production. Successful research and innovation will result in an increase in the quantity and / or quality of capital, thus increasing the productive potential of the economy.


    Supply-side policies for financial markets

    Supply-side policies in this area make finances more readily available E.g. the creation of the Alternative Investment Market (AIM) allows firms not yet ready to be listed on the Stock Exchange to raise share capital.
    Advantages of Supply-side Policies
    1) Time Lag

    Supply-side policies take time to work their way through the economy E.g. With deregulation it may take time for firms to enter the market. In addition to this, supply-side fiscal measures can only be changed when the budget is announced.

    2) Cost

    Change in infrastructure or provision of education comes at a significant cost. Political short-sightedness make supply-side policies unlikely as Political parties cannot derive benefits in the run up to election. If the government don’t have the money they will be forced to borrow which could be dangerous territory.
    Disdvantages of Supply-side Policies
    1) Time Lag

    Supply-side policies take time to work their way through the economy E.g. With deregulation it may take time for firms to enter the market. In addition to this, supply-side fiscal measures can only be changed when the budget is announced.


    2) Cost

    Change in infrastructure or provision of education comes at a significant cost. Political short-sightedness make supply-side policies unlikely as Political parties cannot derive benefits in the run up to election. If the government don’t have the money they will be forced to borrow which could be dangerous territory.


    3) Interest groups

    Supply-side policies may compromise the interests of certain groups E.g. Trade Unions may be threatened by labour market reforms. They may retaliate with protests which could come at the cost of a loss of productivity.


    4) Will be ineffective if there is a large amount of spare capacity

    When there is a large amount of spare capacity in the economy, an increase in aggregate demand is needed. If supply-side policies are introduce in an economy where there is large spare capacity then there will be no improvement in actual growth.


    5) Short-term equity issues

    In the short-term, supply-side policies may negatively effect the distribution of income E.g Cutting benefits – It may take some time for the incentive to earn more through working to be realised. Therefore in the short-term, those relying on benefits (most likely lowest earning households) become worse off.









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