Supply Side Policies

1. Supply-Side Policies
EdExcel AS Economics 2.6.2

2. Supply-Side Economic Policies
They are 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

3. Key Supply-Side Challenges for 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

4. Main Objectives of Supply-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

5. 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

6. Evidence for the UK 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

7. Why does the UK 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

8. Economic Advantages of Higher 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

9. If Supply Side Policies 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

10. Showing Long Run Economic 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

11. 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

12. Recent UK Government Supply-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

13. 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

14. 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

15. 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

16. What is Innovation?
Innovation is 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.

17. International (External) Competitiveness
External competitiveness 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

18. Policies to Improve International 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

19. Evaluating the Impact of 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

20. Supply-Side Policies
EdExcel AS Economics 2.6.2