The Importance of Supply Side Policies

Supply side policies are government policies which seek to increase the productivity and efficiency of the economy. They can involve interventionist supply side policies (e.g. government spending on education) or free market supply side policies (e.g. reduce government legislation)

The main macro economic objectives of the government include:

  1. Higher economic growth
  2. Low inflation
  3. Low Unemployment
  4. Equilibrium on the balance of payments

Quite often these objectives conflict with each other. For example, expansionary fiscal policy may contribute to higher economic growth and lower unemployment; however, it will be at the cost of inflation and a deterioration on the current account.

To achieve all objectives simultaneously it is essential to improve the supply side of the economy. If the government can increase productivity and shift AS to the right, it can enable low inflationary growth.

supply side policies

Supply side policies are of great importance in reducing the natural rate of unemployment. The natural rate of unemployment includes supply side unemployment such as structural and frictional unemployment. For example, economists suggest the EU could reduce its unemployment levels through certain supply side policies. One policy could involve making labour markets more flexible. e.g the government could make it easier to hire and fire workers; this will encourage firms to invest and employ workers. Another supply side policy could involve better education and training for young unemployed people. Therefore, these supply side policies can help reduce unemployment levels.

However, policies such as investing in education and training will take a long time to have an effect. Also there is no guarantee that government supply side policies can actually reduce unemployment. For example, people may be unwilling to go on training schemes. If it is easier to hire and fire workers there may be more temporary unemployment. Arguably the biggest reason for lower unemployment in the UK (between 1994-2007 (is 15 years of consecutive economic growth. Therefore, unemployment has been falling due to demand side policies.

However, even after many years of economic growth, we still get some residual unemployment. This kind of unemployment can not be solved by demand side policies, but supply side policies.

To attain low inflation, supply side policies can help reduce costs and increase productivity. For example, privatisation and deregulation can help reduce costs. However, in the control of inflation, the most significant factor is the use of monetary policy and controlling AD through interest rates. Supply side policies will take a long time to have any effect on reducing inflationary pressures.

Increased productivity can also help the balance of payments. If firms become more competitive, then UK goods will be in greater demand, increasing exports and improving the current account deficit

Supply side policies can be very beneficial. However, in practise it is not always so easy to increase productivity. Also, there is a limit to how much benefit they can give, it is often more appropriate to use demand side policies.

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