Supply-side policies are government economic policies aimed at making industries and markets operate better and more efficiently so that they contribute to the greater underlying rate of GDP (gross domestic product) growth. Any policy that improves a country’s economy’s productive potential and its ability to produce, is within the umbrella of supply-side policies.
Improving the performance of firms:
Measures to improve competition and efficiency in product markets, especially in global markets, are also a significant part of the supply-side policy. Example of measures include:
- The government may help to improve supply-side performance by giving assistance to firms. This is to encourage them to use new technology and innovate.
- Privatization of state industry was a central part of the supply-side policy. This helped contribute to the spread of an enterprise culture. As long as privatization is accompanied by measures to promote competition, there are likely to be efficiency gains for the firm. Also, productivity gains for the employees.
- Supply-side performance can also be improved if there is a constant supply of new firms. Small businesses are often innovative and flexible and can be helped in a number of ways, including start-up loans and tax breaks.
Improving the productivity of factors:
Measures to improve factor productivity, which is the marginal output generated by factors inputs, include the following:
- Using the tax system to provide incentives to help stimulate factor output. Rather than to alter demand, is often seen as central to supply-side policy. This commonly means reducing direct tax rates, including income and corporation tax. Lower income tax will act as an incentive for unemployed workers to join the labor market. Also, for existing workers to work harder. Lower corporation tax provides an incentive for entrepreneurs to start and so increase national output.
- Other supply-side policies include the promotion of greater competition in labor markets. This is through the removal of restrictive practices, and labor market rigidities, such as the protection of employment. For example, as part of supply-side reforms in the 1980s, a series of measures including limiting worker’s ability to call a strike reduced trade union powers. Also, enforced secret ballots of union members prior to strike action.
- Measures to improve labor mobility will also have a positive effect on labor productivity and supply-side performance. This improves labor market flexibility.
- Better education and training to improve skills, flexibility, and mobility – also called human capital development. Spending on education and training is likely to improve labor productivity and is an essential supply-side policy option. A government may spend money directly, or provide incentives for private suppliers to enter the market. The government may also set and monitor standards of teaching, and force schools to include a skills component in their curriculum.
- The adoption of performance-related pay in the public sector is also an option for the government to help improve overall productivity.
- The government can encourage local rather than central pay bargaining. National pay rates rarely reflect local conditions and reduce labor mobility. For example, national pay rates for Postmen do not reflect the fact that in some areas they may be in short supply, while in other areas there may be surpluses. Having different rates would enable labor to move to where it is most needed.
Advantages of Supply-side policies:
- Supply-side policies can help reduce inflationary pressure in the long term. This is because of efficiency and productivity gains in the product and labor markets.
- They can also help create real jobs and sustainable growth through their positive effect on labor productivity and competitiveness. Increases in competitiveness will also help improve the balance of payments.
- Finally, the supply-side policy is less likely to create conflicts between the main objectives of stable prices, sustainable growth, full employment and a balance of payments. This partly explains the popularity of supply-side policies over the last 25 years.
Disadvantages of Supply-side policies:
- However, the supply-side policy can take a long time to work its way through the economy. For example, improving the quality of human capital, through education and training, is unlikely to yield quick results. The benefits of deregulation can appear after new firms have entered the market. Also, this may also take a long time.
- In addition, the supply-side policy is very costly to implement. For example, the provision of education and training is highly labor-intensive and extremely costly, certainly in comparison with changes in interest rates.
- This is because they may reduce the power of various interest groups. For example, in product markets, profits may suffer as a result of competition policy.n labor markets, the interests of trade unions may be threatened by labor market reforms.
- Finally, there is the issue of equity. Many supply-side measures have a negative effect on the distribution of income, at least in the short-term. For example, lower taxes rates, reduced union power, and privatization have all contributed to a widening of the gap between rich and poor.
If the productive capacity in an economy increases, the resulting lower prices will boost the competitiveness of the nation’s exports. This should, in turn, lead to an improvement in the country’s current account position.
Supply-side policies may have an adverse impact on income and wealth distribution, resulting in a wider wealth gap – the difference between the wealthiest and poorest people in a country gets larger.
In their quest for sustainable economic growth, most governments today use a combination of supply-side and demand-side economic policies.