Essay: Evaluate Policies that the government can use to increase the rate of economic growth. (15)
The rate of economic growth measures the annual % increase in Real GDP.
To increase economic growth, the government can increase either AD or AS.
If the economy is below full employment and there is spare capacity within the economy, the govt can use demand side policies to increase the rate of economic growth.
For example, the govt could use fiscal policy to increase the rate of AD. This could involve cutting taxes and increasing the level of govt spending. AD = C+I+G+X-M. Therefore, higher G will increase AD and lower taxes will increase disposable income, thereby increasing C and AD.
Also, the MPC could cut interest rates. This reduces the cost of borrowing and reduces monthly mortgage payments. Therefore, there will be an increase in the level of borrowing, consumption and investment.
However, demand side policies do have some problems; firstly there will be time lags between changing taxes or interest rates and having an effect on AD. Also, if consumer confidence is low, a cut in interest rates may not have much effect on increasing consumption. Also, increasing AD can conflict with the govt objective of low inflation. If the economy is close to full capacity higher AD will cause inflation.
Also Classical economists argue that higher AD will always cause inflation, because the LRAS is inelastic. Therefore, in the long run there will not be any increase in economic growth unless both AD and AS increase.
Diagram Long Term Economic Growth
To increase economic growth in the long run it is necessary to increase productivity and shift the LRAS to the right; this can be done through supply side policies. For example, the govt can increase the incentive to work by cutting taxes and reducing benefits. However, there is no guarantee that lower taxes do increase work incentives. Also inequality may increase.
The govt can overcome market failure by increasing spending on education and training, this will increase labour productivity and therefore increase efficiency in the economy. However, this policy will take time to have effect. Also, govt intervention may not be very successful because of poor information leading to subsidising of the wrong types of training.
A third type of supply side policy could be to follow a programme of privatisation and deregulation. Privatisation involves selling govt owned industries to the private sector. The advantage of this is that the private sector has a profit incentive to increase efficiency. However, there are dangers that a private monopoly may exploit consumers. The example of rail privatisation also showed that privatisation may not be successful; private firms under invested in the network because they took the short term view.
Supply side policies may help improve productivity in the long term. However, there is a limit to how much the govt can increase productivity; for example, it is difficult for the govt to improve technology and working ethics. Also, the rate of economic growth is likely to be effected by global events over which the UK govt has no control.
Commentary on Essay
- It is important to consider both the demand and supply side causes of economic growth.
- To evaluate the policies it is important to give their limitations and disadvantages, alternatively you could say how important the policy was.
- AD/AS diagrams are very helpful to explain points
- To get a high marks it is important consider points critically.