Evaluate the effectiveness of market-based supply-side policies such as privatisation and

deregulation (25 marks).

Possible Answer
Supply-side policies increase the productive potential of the economy. Privatisation means
the transfer of a state-owned firm to private individual(s), deregulation is the removing of
government rules.

Supply-side policies such as privatisation can help reduce current account deficits. Take the
example of the privatisation of Royal Mail. Privatisation means a private firm has taken over
the service of mail delivery. Compared to government ownership, a private firm has the
incentive to maximise profits instead of social welfare. So the private firm may cut average
costs, reduce X-inefficiency as it now has an incentive to cut costs and in doing so, increase
productivity. In the case of Royal Mail, this has meant lower delivery times for mail.

This means the LRAS shifts right from LRAS to LRAS1 and the SRAS shifts right from
SRAS to SRAS1 reducing the price level from PL to PL1. This leads to higher economic
growth. A lower price level increases export competitiveness, so export demand increases
and import demand decreases, so the balance of trade improves and so does the current
account. To increase profits, private firms have an incentive to improve the quality of the
product and customer service in order to attract more customers. As the firm becomes more
efficient over time, it may be able to increase demand for its products and grow, thus
increasing sales and hence employment.

However the success of privatisation depends on how the firms try to increase their profits.
To maximise profits, firms could reduce the quality of the product, which would in fact
reduce export demand and hence worsen the current account deficit. Alternatively the firms
may choose to fire workers to cut costs and increase profits, increasing the rate of
unemployment. Royal Mail cut 1600 jobs after the privatisation. Higher unemployment
would generate costs for the unemployed individuals, forcing some into poverty.

Particularly if the firm’s activity is concentrated in a particular area, higher unemployment

could also mean lower spending in local shops, causing a negative multiplier effect. This
could harm the level of local economic activity. While for Royal Mail, job losses are likely to
span across the country, for the privatisation of steel firms such as British Steel under
Thatcher, jobs and hence job losses concentrate in areas such as in Corby (where local
unemployment reached 30% at the time).

Another market-based supply-side policy is deregulation. Deregulation reduces costs for

firms in terms of the costs paid to lawyers or staff to stick to the regulations. Firms may also
face lower costs because of the reduced risk of being fined for overstepping the regulations.
This will increase the short-run and long-run aggregate supply in the market, because of the
possibility of increasing profits from producing more. Also deregulation may remove barriers
to entry, allowing more firms to enter markets and further increasing short-run and long-run
aggregate supply.
Hence the productive potential of the economy improves and so does real GDP. This will also
increase employment, as labour demand is derived demand from demand for goods and
services. Take the example of the Deregulation Bill in the UK, which altered 182 different
parts of regulation, for example eliminating health and safety rules for self-employed workers
in low-risk jobs. Self-employed workers would see lower costs and hence higher productive
potential. This piece of deregulation covers 800,000 workers.

However the success of deregulation depends on the reason for the regulation in the first
instance. While some regulations could be excessive, others could be necessary. For example
deregulation of health and safety may increase the harm to self-employed workers. This could
lead to higher accident rates, more time off work and hence lower productivity.

It could also cause higher government spending on NHS care for those who have accidents at
work because of deregulation. In this case the regulation may have had a purpose of
preventing the negative externalities generated by work in terms of accidents and healthcare
costs. Because of the number of workers affected (800,000) a significant bill for the NHS
could even worsen the government budget deficit, which is already large because of spending
on welfare schemes during the pandemic and also Test and Trace.

Overall market-based supply-side policies can be effective in achieving economic growth,

however they may come with tradeoffs in terms of reduced protection for workers in terms of
risks to jobs or health and safety. For these policies to be successful, they need to be well
targeted. For example privatisation should only take place for firms that are likely to be able
to grow as a result and hence increase employment.
Deregulation should only occur where the regulations were excessive, for example one could
argue that the deregulation of health and safety rules for low-risk self-employed is likely to
be effective as the cost of deregulation, in terms of increased accident rates and NHS costs,
is likely to be low. The costs may also differ in the short run versus the long run. In the short
run, privatisation could cause painful job losses but over time, if the firm becomes more
productive, makes more sales and grows, it could end up hiring more workers than it had
initially fired.