ECN60204 Macroeconomics

Supply-side
Policies and the
Macroeconomy
Sloman & Wride Ch23
p684…
 Supply-side Policies

After this lecture you should be able to:


Gain an understanding of the factors contributing to long-run growth
in potential output.

Understand and explain the different approaches to policy
implementation

Understand and explain the different methods of supply-side policies
Economic Growth & Supply-side Policies

Supply side policies became popular from 1980s:

 Growing disillusion with welfare economics and perceived de-
stabilising influence of unions of the 1960s and 70s

 Growing concerns over fall in output per worker (labour productivity)

 The “socialist economic” experiment was largely deemed a failure

 Growth of Reaganism and Thatcherism in 1980s

Re-birth of conservative, “right-leaning”,

market-oriented views on economic policies
Supply-side Policies & Macroeconomic Objectives

Supply side policies are designed to:

 increase potential output (potential GDP)
 Achieve long run economic growth
Supply-side policies and other macroeconomic
objectives
 unemployment
 reduce labour market imperfections
 increasing labour mobility across occupations and
regions
 reducing union power
 control inflation
 reducing or controlling monopoly power
 By introducing incentives to increase productivity
 Sources of Long Run Economic Growth

 Technological progress and innovation - size and

composition of capital stock, research and development
(patents and copyrights)
 Human Capital: training and education - development of
skills and flexible working practices
 Physical capital – size of capital – suitable for developing
countries with focus on building infrastructure
 Rise in population (remember Lecture 1 - this has its
problems)
 Sources of Long Run Economic Growth
in the AS-AD Model
 Economic Growth As quantity of
labor grows, capital is accumulated,
and technology advances, potential
GDP increases.
 The LAS curve shifts rightward to
indicate the increase in potential
GDP – allowing full employment to
rise

 Rise in productivity allows for the
SAS to follow with production rise
AD’
AD
 Price initially remains constant
when both curves shift by same
proportion & eventually falls
(theoretically possible but not
realistic) allowing for a higher More plausible desired outcome is that if
sustainable level of real GDP AD (eg expansion fiscal policy) does not
outstrip AS, prices remains stable at P=115
 Approaches to supply-side policy
“re-birth”of “right-leaning”
economic policies in
1980s, Republicans
 Market-based approach to supply-side policy (Reagan), Conservatives
(Thatcher), Bush Snr
 market-orientated supply-side policies
Bush Jr in 2000s

 Keynesian approach to supply-side policy More “left-leaning” economic

 interventionist supply-side policies policies 1990s - Democrats,
Clinton, Obama (2009 -)
Less “left-leaning”, more
 'Third-Way' supply-side policies
“centred” policies, New Labour in
UK - Blair (1997-2007)
 The link between demand-side and supply-side policies

less “centred”, more right leaning (?)

Conservative: Cameron (2010)
Market Oriented Supply Side Policies
Reagan, Thatcher, Bush -
therefore governments should
Proponents argue that: spend less and intervene less
 Fiscal policy is limited and only monetary policy is

effective
 For “free enterprise” & market orientated policies that

encourage private ownership & reward initiatives

 Economic efficiency can only be achieved in

competitive markets
 For absolute minimum government intervention
 Why Market-Oriented Approach is
best: The Supply-Side Effects of
Taxes Rises
“Right-leaning” market oriented policy
proponents argue that intervention &
welfare economics require tax rises to
finance heavy government expenditure

Full Employment and

Potential GDP wage rate
$30/hour

A tax rise - supply of

labour decreases

© 2010 Pearson Addison-Wesley

 Why Market-Oriented Approach is
best: The Supply-Side Effects of
Taxes Rises
Increases the before-tax wage
rate

But the after-tax real wage rate

falls.

The quantity of labour Tax wedge

employed decreases. = $15

The gap created between the

before-tax and after-tax wage
rates is called the tax wedge

© 2010 Pearson Addison-Wesley

 Why Market-Oriented Approach is
best: The Supply-Side Effects of
Taxes Rises
When the quantity of
labour employed
decreases, …

potential GDP decreases.

The supply-side effect of a

rise in the income tax
decreases potential GDP
and decreases aggregate
supply.

© 2010 Pearson Addison-Wesley

Market-orientated supply-side policies

1. Reducing government expenditure

2. Income tax cuts
3. Curbing power of trade unions
4. Curbing automatic welfare entitlement
5. Policies to encourage competition
6. Abolish capital & exchange controls
7. Reducing red tape
 Market-oriented supply-side policies
Curbing the power of trade unions to achieve:
i. Greater flexibility in wages and
ii. Greater flexibility in work practices & labour mobility
iii. more efficiency in labour markets

To achieve above, governments in late 70s and 80s:

i. Curbed closed shop practices (closed shop practices
limits labour mobility)
ii. Restricted secondary picketing (i.e. limit strikes)
iii. Provided for union balloting (i.e. voting of union leaders)
iv. Introduced secret balloting on strike proposals ((limit
power of unions)
© 2010 Pearson Addison-Wesley
Market-orientated supply-side policies

Curbing automatic welfare entitlement

 Market-oriented economists argue welfare benefits
causes frictional unemployment
 Is a main cause of higher natural unemployment
rates
 People caught in a ‘poverty trap’
The effect of a cut in welfare on the numbers unemployed
Remove or reduce
Labour market
unemployment ASL1 ASL
(Real) wage rate

2 Employment if
benefits
N frictional &
structural U = zero

With high welfare

benefits, natural
b a unemployment at a – b
We1
We2
e d
Assumption:
natural unemployment
wage rates are
flexible downwards falls from a – b to d – e

ADL
O Number of workers
Recap: Market-orientated supply-side
policies
1. Reducing government expenditure

2. Income tax cuts

3. Curbing power of trade unions

4. Curbing automatic welfare entitlement

Privatisation
5. Policies to encourage competition Deregulation
Increasing efficiency of
6. Abolish capital & exchange controls the public sector

7. Reducing red tape

 The case against intervention

Excessive Intervention cause problems:

1. Excessive subsidies supports inefficient production, distorts
prices & markets
2. Poor management & inefficient use of public money:
 investment grants more likely to go to high-profile (mega)
projects rather than to the those more deserving
 Contracts awarded to the politically connected rather than to
those based on merit
3. a lack of genuine market opportunities for supported industries
Poor implementation Multimedia
Corridor Project
The Case for Intervention
Interventionist Supply-side Policies

Advocates interventionist use of industrial

policy

eg government sponsored policies on R &

D, training programs, re-location of firms to
areas of high unemployment, etc
Interventionist Supply-side Policies
Industrial policies may take the following forms:
Selective intervention (as opposed to nationalisation or
central planning) Multimedia Development Corridor program
allocated RM119mil. Focus on creating
1. Direct provision innovative digital economy (Budget 2011)
2. Grants & other forms of assistance – R & D, loan
arrangements for small & medium sized companies,
tax incentives & rebates for training & investment
3. Rationalisation / industrial re-organisation eg
mergers in banking industry Merger – Bank Bumiputra,
4. Advice & persuasion Bank of Commerce, UAB,
Southern Bank – CIMB,
5. Indicative Planning
Interventionist Supply-side Policies
MIER (Malaysian Institute of
Economic Research) 1985

6. Information eg formation of research institutions

The 1Malaysia Training Program -
7. Training Schemes
allocation of RM500mil (Budget 2011)
8. Regional & urban policy – on siting & location of
industries on areas targeted for selective
development
Kuala Lumpur International
Financial District with tax
incentives for firms (Budget 2012)