Discuss how demand side policies and supply side policies may be used to increase short and long term economic growth.
Demand side policies are policies that are made by the govt in order to stimulate any or all of the components of aggregate demand. This refers to the deliberate changes in govt expenditure and income so as to achieve desired economic objectives such as economic growth and the reduction of unemployment. Also, supply side policies are policies that the government imply as to increase the productivity of a country and shift the aggregate supply curve outwards.
One way of increasing the component of consumption expenditure by the govt is by reducing direct and indirect taxation. When the govt reduces taxes such as income tax, it directly increases consumers’ disposable income. The govt may also increase welfare benefits such as children’s allowance, unemployment benefits or pensions, which would have a similar affect. The reduction of indirect taxes, such as surcharges on utility bills or possibly other taxes linked to products/services of inelastic demand, could also have a positive effect. A problem that may arise in this case would be that consumers would save rather than spend the money.
The use of fiscal policy in stimulating investment may take many forms. Reducing direct taxes like corporation tax, and indirect taxes on raw materials and power provision, also helps to increase retained profits and stimulate new investment and employment. Govt may also increase its expenditure in terms of direct or indirect assistance to firms (example upgrading of industrial estates, promotion in foreign markets, fiscal incentives for investing in alternative sources of energy, educational grants and training schemes etc.)
A third and direct component of AD is govt expenditure. A govt in order to increase employment and stimulate economic growth may opt for an expansionary fiscal policy and what is called a cyclical deficit, which occurs when the govt purposely lowers tax revenue and raises its expenditure. This can be done in a number of ways; either by helping directly businesses or/and investing in the social infrastructure such as roads, schools, airports, IT, port facilities, public areas – in order to both increase local investment as well as to attract foreign one.
On the other hand, governments may also use supply side policies. These policies are aimed at improving an economy’s productive potential and its ability to produce. Hence, it contributes to the economic growth that it is aiming for. We can divide these policies into two categories, which are market based policies and interventionist policies.
Interventionist supply – side policies are those in which the government has a fundamental role in encouraging economic growth. It may do this in several ways, such as:
Investment in human capita – one major way the government may do this is through the investment in education. This way, the govt is creating more skilled workers, and is increasing the availability of the labour force, thus decreasing the rate of unemployment. With better education and training also comes improved skills, flexibility and mobility. This is essentially used for the improvement of labour productivity. Therefore, with more investment in this comes more efficiency, which leads to more production. This all creates a multiplier effect. The real income of employees will improve, thus giving them more purchasing power.
Research and development – one way of increasing a company’s output is through research and development. A company must constantly be aware of the changes and improvements in technology in order to be up to date and to be able to produce its maximal output levels and methods of production. The way in which the govt may encourage this type of research is through the reduction on taxes.
If the profits are made due to the research, then the govt will reduce the taxes on this profit made. This will push more companies into researching for better and faster equipment to be used, and hence the potential for the economy’s output. The main definition for this is a tax credit. When a company manages to increase the output, then the govt can grant patents and copyrights to their goods and services, thus further increasing the company’s abnormal profits and mark-up.
Direct support for business policies – the govt may use some policies to improve the competition in some markets through anti-monopoly laws and by helping small and medium size firms to grow through financial means. This also acts as an incentive for more entrepreneurs to start up their own business. This all contributes to the increase in the national output.
Secondly there is the market based supply side policies. These are the policies which focus on the markets to operate more smoothly with as little govt intervention. These policies affect the structures, institutions and rules that govern economic stakeholders. These may be:
Tax – using this system will provide incentives to help stimulate output. This may come in different ways, such as a reduction in tax rates in income and corporation taxes. A lower income tax may act as an incentive for unemployed people to enter the labour force or else for current employees to work more. Also, a lower corporation tax means that owners are encouraged to start more business and hence increase national output.
Lowering or eliminating minimum wage – due to the minimum wage, companies must pay their employees a certain wage. But if this is reduced or eliminated, the costs of production will decrease, and therefore the company will be able to invest the amount saved into machinery and other assets that will affect the total output. But there is a disadvantage to this. If minimum wages are decreased, employees have the right to go to their respected trade unions, and after meetings have been conducted and no agreement is settled, employees may strike, leaving the company with totally no output.
Reduction of trade union power – if the trade unions are not allowed the amount of power that they have today, they cannot increase the wages of their employees to a level greater than if there were no trade unions. With this, comes a lower labour cost and production cost, which then can lead to investment in other assets.
Reduction in unemployment benefits – the govt pays people a certain amount for not working. If this amount is reduced, then the unemployed will be seeking a new job as they will be better off if they actually worked. Even though the time lost cannot be made up for through the production that they are about to do now, it still contributes to the potential economic output, and also to economic growth.
And finally, privatisation – this means that the govt sells a publicly owned firm (owned by the govt) to a private company. The main goal for a private company is to create abnormal profits. Therefore, the factors of production in the new owners will be working much more efficiently and harder to be able to cut down on costs of production and also to produce more goods or services. Government owned firms have different goals to those of privately owned ones. These goals consist of decreasing the unemployment rate, or providing a service to an isolated market.