Supply Side Policies
AS Discuss the importance of supply side policies in improving the performance of the UK economy?
Supply side policies are govt measures to increase productivity in the economy and therefore shift LRAS to the right. Supply side policies usually involve reducing blockages to the free market or overcoming market failure. The key macro economic objectives of the govt include low inflation, low unemployment, increasing the sustainable rate of economic growth and minimising the balance of payments disequilibrium.
Privatisation and deregulation were an important supply side policy of the 1980s they involved selling state owned assets to the private sector and increasing competition within markets. Private companies have a profit incentive to cut costs and be more efficient. Greater competition also causes lower prices and more efficient methods of production, as firms compete for customers. This has enabled lower prices and greater productivity in some industries. However this policy has been relatively unsuccessful in industries such as Rail and water because they are a natural monopoly and it is difficult to introduce competition into these industries
Another example of supply side policies is education and training, if these policies are adopted then it enables higher labour productivity and improved economic performance. However this policy may be subject to govt failure, for example the govt may have poor information and set up inappropriate schemes which do not benefit workers
Effect of Supply side policies in a Classical Model
Diagram AS shifting to the right
Supply side policies can also be used to reduce unemployment. For example it is argued some unemployment is caused by wages being above the equilibrium due to trades unions and min wages. Therefore if the govt reduces min wages then there should be a fall in classical unemployment. However this policy may not be very effective if the demand for labour is inelastic or firms have monopsony power.
Lower benefits and taxes may also increase the incentive for people to take a job rather than remain unemployed, however the extent of voluntary unemployment is debatable as benefits are already very low compared to wages.
However if unemployment is caused by demand deficiency and a fall in AD then supply side policies may not be effective. When the economy is an a recession the economy needs higher levels of AD supply side policies would not be able to solve the immediate problem
The above diagram shows an increase in LRAS does not solve the recession however increased AD would help significantly.
Supply side policies can also help other macroeconomic problems. If supply side policies such as education and training are successful in increasing the UKs competitiveness we could see an increase in exports and this would help the balance of payments current account. However they would take time to have effect and would not stop a rapid increase in imports which has been a feature of the UK economy.
If supply side policies increase productivity and competitiveness it can help reduce the rate of inflation. For example in the 1970s the UK experienced high inflation, partly caused by powerful trades unions reducing the power of trades unions helps keep wage inflation low. However supply side policies may be insufficient for keeping demand pull inflation low, this will require effective Monetary and fiscal policy.
Commentary:
· It is not necessary to make a list of 10 supply side policies.
· What is important is to explain a few policies and critically examine their effectiveness in improving the main macro economic objectives
· To give benefits of supply side policies is fairly straightforward it is more challenging to give limitations and problems of supply side policies
Copyright Richard Pettinger 1/05/05
