The history of supply-side policy
From 1945 until the mid 1970s, Keynesian fiscal policy was the major instrument of government economic policy in most countries around the world. It was felt that by influencing AD the economy would remain on target for what the government wanted to achieve. However, in the early 1970s, stagflation arose in many countries, which was the simultaneous increase in both prices and unemployment. Many economists had felt that this was not possible. So, monetary policy began to grow in popularity, especially amongst monetarists. The 'radical right' in America suggested that rather than concentrate on the demand-side of the economy we should turn our attention to the supply-side and so a new school of thought entered the economic arena.
What are supply-side policies supposed to do?
Supply-side policies are designed to make aggregate supply (AS) more responsive to changes in national income. When combined with other macro policies they are supposed to deliver a competitive economy. They are normally focused on:
- Removing market imperfections - barriers to the smooth operation of markets
- Removing restrictive practices - rules that do not allow the free movement of factors within an economy
- Making work more attractive and workers more efficient
Supply-side policies aim to shift the LRAS curve to the right, increasing the level of real output and lowering the price level. This is shown in Figure 1 below.
Supply-side policy examples
Supply-side policies include:
- Incentives to enter work and work harder, such as lower direct taxation, which widens the gap between earnings and social security.
- The reform of the trade union movement and a reduction in their power, so permitting greater wage flexibility (in a downwards direction) and a shift of power towards employers. The focus here is on reducing the power of organised labour.
- Removing the unemployment trap, where some people earn more on benefits than from working and so find it economic sense to stay out of work and draw benefit. The unemployment trap means that the extra income coming from work is insufficient to encourage people to seek a job.
- Paying benefits to those in work, but drawing low wages. The shadow economy of those working unofficially whilst still claiming benefits would be made less easy to be a part of.
- Education and training improvements - we have already seen that the 'quality' of labour as a factor of production is just as important as the 'quantity'. The aim of supply-side education policies is to raise the skill level of the population and therefore make people more productive. This means focusing on both expanding and deepening the skills base of the labour force. Policies could include encouraging more students into tertiary education, broadening access to primary and secondary education, improving teacher/student ratios to improve the quality of education or perhaps providing more teacher training to raise the number of teachers.
- Privatisation - this is the selling of state or publicly owned assets to the private sector. This has happened in many economies in transition between command and market economies (e.g. Eastern European economies like Bulgaria, Romania and Hungary). Many developed countries have also privatised state-owned industries. By doing this it is hoped that firms will become more efficient, competitive and better able to provide a consistent service of high quality. Privatising them in theory would expose them to competition and market forces therefore improving efficiency. Significant privatisation, e.g. of utilities such as gas, water and electricity, has also taken place in the less developed countries, often as part of IMF structural adjustment programmes. Once again these polices, it is hoped, would shift the AS curve to the right.
- Deregulation - these policies concentrate on removing barriers to entry to various markets and forcing participants to be more competitive. The markets then become more contestable and react to changes, especially global changes, more quickly than they had once done. Once again the AS curve is supposed to shift to the right, so expanding the economy by removing bottlenecks and gaps within its capacity to react to changes in national income.
Which of the following would be considered supply-side policies?