Supply-Side Economics

Objectives of supply-side policies

These policies focus on shifting LRAS to the right in order to achieve long-term

economic growth There are two major types of supply-side policies that we will discuss today

Market-oriented supply-side policies

Based on the neo-classical point of view, economists in the early 1980s argued that

growth in real GDP depended on the supply-side of the economy as opposed to the

demand-side. They argued that increasing potential output

should be the focus of economic policy, not the stabilization of the business cycle

Any takers? We’re in!

The foundation

As we know, neoclassical economists argue that in the long-run,

macroeconomic equilibrium always occurs at the full employment level of

GDP, automatically eliminating inflationary and recessionary gaps.

The possibilities

Supply-siders argue that an economy pursuing supply-side policies will be able to achieve rapid growth, price stability and full employment all at

the same time.

The key is to continuously shift SRAS and LRAS to the right and watch increases in AD follow

accordingly

Stagflation? No problem!

Supply-siders argue that if a negative supply shock occurs in the economy, supply-side

policies can effectively shift the SRAS curve back to its original position, thus dealing with the dual problems of an increasing price level

and falling output……Remember, demand-side policies can only fix one of those

problems

So how do we put supply-side policies into effect?

Market-oriented supply-side policies focus on introducing legislative, regulatory and

institutional changes in the economy which are intended to increase efficiency of

production, decrease the natural rate of unemployment, and increase the economy’s

production possibilities.

The gospel according to supply-siders

Supply-side policies can be classified under four particular categories. They include:

Reducing the size of the government sector Lowering taxes on businesses Making the labour market more competitive Liberalizing international trade and capital flows

Smaller government

Remember me driving my government car, working 3 hours a day, people asleep at their

desks, expensive trips to Puerto Rico? Supply-siders argue that this is common and changes need to be made. Their proposals to reduce

the size of the government include…..

Privatization

Privatization

According to supply-siders, by transferring ownership of a firm from the public to the

private sector, efficiencies will result due to the more competitive nature of private

industry. No more sleeping at your desks!

No more 3 hour workdays!

Private financing of public sector projects

Need a highway or airport built? Supply-siders want private firms to build, finance and

operate public services, and then allow the government to buy these services from the

private firm. The thinking here is that private firms will be

more efficient and the government sector will be reduced

Outsourcing

Rather than the government employing armies of accountants, information technology

workers and other professionals, supply-siders want government to hire private firms to

provide these services. Increased efficiencies and competition should

result from outsourcing of this work according to supply-siders

Deregulation (2 kinds)

Economic deregulation involves removing government controls on price and output in

industries such as airlines, broadcasting, energy, and financial services.

Again the argument is that with less government involvement, more competition

and inefficiencies will result.

Deregulation (2 kinds)

Social deregulation involves removing some of the protections for consumers in areas such as

product safety, pollution control and injuries in the workplace.

Supply-siders argue that all these protections for consumers are unnecessary, cost businesses too much money to comply with, and result in less

output by firms due to the excessive costs

Restricting Monopoly Power

Supply-siders want to take away monopoly power from firms, by breaking them up and ensuring more competition in the industry.

They also try to prevent mergers of companies who could achieve monopoly

power if they were permitted to join together.

Lowering personal income taxes

Supply siders argue that cuts in personal income taxes will have an even greater effect on aggregate

supply than on aggregate demand.

How does that work you ask?

Lowering personal income taxes

Supply-siders argue that if the tax rate on individuals is lowered, people will take home more

money and then: be motivated to work more hours,

motivate unemployed people to go back to work, delay retirement dates.

All these can shift LRAS to the right

Lowering taxes on interest income

Supply-siders argue that if interest income is not taxed, people will save more money,

therefore increasing the funds available for businesses to borrow which will lead to

greater capital expenditures and more output. The wealthy like this idea

Lowering business taxes

Supply-siders argue that cuts in business taxes lead to increased spending on capital

goods and more money to spend on technology and research and development.

This should also lead to increased output Business owners like this idea

Increasing labour market flexibility

Supply side economists argue that making the labour markets more competitive will lead to

increased levels of aggregate supply. They point to several ways this can happen….

No more minimum wage!

Supply-siders argue that if minimum wage was eliminated, wage rates would fall to the

equilibrium level, companies would hire more workers at the lower rate, company profits would increase, which would then lead to

increased investment on capital goods, and long-term economic growth

Whaddya think?

Down with Unions!

Supply-siders argue that unions keep wage rates above the equilibrium rate, having the same detrimental effects on the economy as

minimum wage. Less union labour would mean lower wage rates, more workers

employed, greater business profits, and long-term economic growth Whaddya think?

Reducing unemployment benefits

Supply-siders argue that unemployment benefits are too generous and discourage people from looking for work. If we reduce

unemployment benefits, lazy people will get motivated to work, find jobs, and increase the

level of output in the economy. Whaddya think?

Reduce job security

Supply-siders argue that job security for workers makes them lazy and unproductive. Put a little fear into a worker and he/she will

work harder, it will be easier to fire unproductive workers, and economic output

will result Whaddya think?

Liberalizing international trade

Supply-siders argue that increased global trade and capital flows increase competition

and improve allocation of resources. We’ll talk more about this later in the course,

but it is a key point of supply-side economic policy

Interventionist supply-side policies

Market oriented supply-side policies argue that if markets are free, efficiencies will result.

Supply-siders also argue for some government intervention to affect the aspects of the economy that the market itself will not

act upon. Such as…..?

Training and Education

Improvements in training and education lead to more productive workers. Improving the

quality of our factors of production is one way towards achieving economic growth, right?

Hard to argue with that one isn’t it?

Improved Health Care

Healthier workers are more productive workers and another improvement in our

quality of factors of production. Hard to argue with that one isn’t it?

Research and Development

R & D leads to technological innovation and large potential gains in economic growth. Tax incentives to businesses in this area, as well

as patent protection for inventions are all supported by supply-sider economists

Hard to argue with that one too isn’t it?

Support for infant industries

Supply-siders argue for the support of small, growing firms through tax breaks, grants,

subsidies and other programs. Small companies can become giants very

quickly, right Mr. Google?

Infrastructure

Investments in infrastructure such as roads, airports and telecommunications can increase

efficiencies in production as costs are lowered.

Hard to argue with that one isn’t it?

Other interventionist policies

Provision of job information Support for adolescent industries

All of the above interventionist policies are known as industrial policies because they are designed to support the industrial sector of the economy and

shift LRAS to the right. These might not be provided by the free market so government must

be involved.

Criticism of interventionist policies

Some argue that any government involvement in the market is likely to do more harm than good.

Others argue that using government tax money to support industries could be more wisely used elsewhere, and requires a higher level of taxation that they would like.

So what say you, are there any supply-siders in the room?

Me neither!