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Economics Department
Supply Side policies - the basics
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Supply side economics came to the fore in the early 1980s, championed by the governments of Reagan in the US and Thatcher in the UK. Traditional Keynesian demand management was perceived to have failed to tackle deep structural problem in developed economies, and as a consequence, markets were less efficient and productivity lower than it might otherwise have been.
Supply side policies aim to improve the efficiency of factor markets, to boost productivity and hence the overall capacity of the economy (shifting long run aggregate supply (LRAS) to the right and pushing out the PPF):
Agg P level AS1 AS2 Consumer goods
P
P
AD
Y1 Y2 Real GDP (Y) Capital goods
Broadly these policies aim to increase:
- The quantity
- The quality
- The efficiency of use
Of the four key factors of production (land, labour, capital and entrepreneurial ability) and thereby foster economic growth.
Broadly policies can be split into three main categories:
- Fiscal supply side policies
- Labour market reforms
- Product market reforms
1) Fiscal supply side policies.
In recent years the government has used fiscal policy to create incentives in both labour and product markets. It has
Introduced individual learning accounts offering big discounts to firms and individuals on training, helping to close the skills/productivity gap with other countries.
Extended the welfare to work program, encouraging/coercing the young unemployed into getting training. Guaranteeing a minimum income of £200 per week for working families with a full time earner and ensuring that no family earning less than £235 a week will pay any income tax overall (therefore helping to tackle the poverty trap). A new 10% bottom tax rate to encourage people to work, increasing the flexibility of the labour market.
Therefore the tax and spending structure has been used not to alter the level of demand overall, but to create incentives and opportunities.
Similarly, in product markets , the government has acted to raise both Capital Investment and R&D spending.:
The introduction of a research and development tax credit which will reduce the real cost of R&D, making it more worthwhile. A 10p corporation tax band for small firms, to encourage their start-up and to give more funds for reinvestment The creation of a new small business service to support growing firms, and 40% capital allowances to encourage investment and growth by small firms.
Each of these polices is attempting to improve the overall use of the key factors of production - boosting the participation rate, increasing investment in both capital goods and R&D, and increasing the skills base of the workforce. These policies should hopefully therefore increase the efficiency of UK firms, therefore boosting productivity, putting downward pressure on prices and increasing international competitiveness.
2) Labour market reforms
These have occurred mainly in terms of labour market legislation. Over the 80s and 90s, legislation passed has weakened the power of Trade Unions and has increased the ability of firms to hire and fire, so that UK labour markets are now considered far more flexible than those on the continent.
Reductions in trade union power have allowed firms to introduce flexible working more easily, so that workers now work more varied hours, and are more multi-skilled, putting an end to demarcation disputes. Changes in employment legislation have meant that firms can take on workers easily and shed them quickly if economic conditions move against them. This means that UK firms can be more sensitive to changing market conditions, hence improving international competitiveness.
Over the last 20 years or so legislation has changed so that:
- Employees can be dismissed without reason within the first year of employment (except for discrimination cases)
- Unions now have to hold secret ballots of members before industrial action can be taken, and they have to give notice to employers well in advance of such action
- Unions are no longer immune to prosecution - if they fail to obey the rules governing strike action, then unions can have their funds frozen, and be subject to substantial fines.
