Supply side policies are government attempts to increase productivity and shift aggregate supply (AS) to the right.
- Free market supply side policies involve policies to increase competitiveness and competition. For example, privatisation, deregulation, lower income tax rates, and reduced power of trade unions.
- Interventionist supply side policies involve government intervention to overcome market failure. For example, higher government spending on transport and communication.
Benefits of Supply Side Policies
1. Lower Inflation
Shifting AS to the right will cause a lower price level. By making the economy more efficient, supply side policies will help reduce cost push inflation.
2. Lower Unemployment
Supply side policies can contribute to reducing structural, frictional and real wage unemployment and therefore help reduce the natural rate of unemployment. See: Supply side policies for reducing unemployment
3. Improved economic growth
Supply side policies will increase the sustainable rate of economic growth by increasing LRAS; this enables a higher rate of economic growth without causing inflation.
4. Improved trade and Balance of Payments.
By making firms more productive and competitive, they will be able to export more. This is important in light of the increased competition from an increasingly globalised market place. See also: Economic Importance of Supply Side Policies
Diagram showing effect of supply side policies
Classical view of LRAS shifting to the right.
Keynesian view of LRAS shifting to the right.
Examples of supply side policies
Most supply side policies aim to enable the free market to work more efficiently by reducing government interference.
This involves selling state owned assets to the private sector. It is argued that the private sector is more efficient in running businesses because they have a profit motive to reduce costs and develop better services. See more on Privatisation.
This involves reducing barriers to entry in order to make the market more competitive. For example, BT used to be a monopoly but now telecommunications is quite competitive. Competition tends to lead to lower prices and better quality of goods/service.
3. Reducing income tax rates
It is argued that lower taxes (income and corporation) increase the incentives for people to work harder, leading to more output. However this is not necessarily true, lower taxes do not always increase work incentives (e.g. if income effect outweighs substitution effect)
5. Deregulate Labour Markets
Labour markets can be deregulated through policies such as
- Easier to hire and fire workers
- Reduce maximum working weeks and minimum holiday pay
- Enable zero hour contracts
- More liberal immigration policy to attract migrants for jobs difficult to fill.
If it is cheaper to hire and fire workers, it encourages firms to take on workers, creating more employment opportunities.
However, more flexible labour markets can cause increased uncertainty and lower productivity. See also: Flexible labour markets
5. Reducing the power of trades unions
Legislation which reduces the ability of trade unions to go on strike. This should:
- Increase efficiency of firms e.g. less time lost to strikes
- Reduce real wage unemployment (if labour markets are competitive)
6. Reducing unemployment benefits. Lower benefits may encourage the unemployed to take jobs. Lower means tested benefits for those in work, may increase the incentive to work longer hours
7. Deregulate financial markets. For example, building societies were allowed to become for profit banks. Deregulation should allow more competition and lower borrowing costs for consumers and firms.
7. Lower tariff barriers this will increase trade and provide an incentive for export firms to invest.
9. Removing unnecessary red tape and bureaucracy which add to a firm’s costs
Interventionist supply side policies
1. Increased education and training
Better education can improve labour productivity and increase AS. Often there is underprovision of education in a free market, leading to market failure. Therefore the government may need to subsidise suitable education and training schemes.
- However govt intervention will cost money, requiring higher taxes, It will take time to have effect and government may subsidise the wrong types of training
2. Improving transport and infrastructure
Due to market failure this is likely to need govt intervention to improve transport and reduce congestion. This will help reduce firms costs.
3. Build more affordable homes
Building affordable homes in expensive areas can make it easier for workers to move and find jobs in expensive areas, reducing geographical immobility.