Supply Policies’ Role in Economic Growth

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Table of Contents

Introduction
Balanced economic growth
Definition of supply side policies
Market-based policies
Interventionist policies
Conclusion
Works Cited

Introduction

Attaining economic growth is one of the fundamental macroeconomic policies that governments pursue in the quest to achieve sustainability. Munasinghe argues that countries appreciate the significance of attaining equitable and balanced growth (207). Different theories have been formulated in the quest to explain the concept of economic growth. One of these theories is the balanced economic growth theory.

The objective of this paper is to analyze a number of economic concepts. First, a definition and explanation of the balanced economic growth is provided. Secondly, the paper defines the supply side policies. It also explains the different types of the supply side policies. Thirdly, the paper explains how the supply side policies are used in attaining balanced economic growth. Additionally, an evaluation of the effectiveness of the supply side policies is assessed. Finally, the paper gives a conclusion and recommendations based on the undertaken analysis.

Balanced economic growth

Oosterbaan, Stevenick, and Windt posit, “The balanced economic growth theory accentuates the significance of a minimum volume of the investment program and the importance of balanced development across the different economic sectors” (237). Thus, the balanced growth concept underscores the importance of establishing an equilibrium point whereby the different Gross Domestic Product (GDP) components such as the capital stock, real rate of interest, and output grow at a similar rate over time. The balanced growth concept is based on the hypothesis that aggregate “output can be written as a function of the total inputs of capital and labor with diminishing returns to each input and constant returns to scale overall” (Oosterbaan, Stevenick, and Windt 238). However, the aggregation should be based on the Cobb-Douglas production function.

Moreover, the concept of balanced economic growth is founded on the assumption that the rate of growth with reference to labor is equivalent to the population growth rate. Based on this assumption, one can argue that the rate of economic growth is hindered by the population growth rate. Alternatively, Temple affirms that the balanced growth economy can be defined as an ideal economy whereby different economic variables grow at an equal rate to the growth rate in the labor variable (3).

Definition of supply side policies

The supply side policies entail the attempts undertaken by governments in an effort to stimulate productivity and ensure that the long-term aggregate supply [LRAS] curve shifts to the right as illustrated in graph 1 below. The outward shift of the LRAS curve leads to an increase in the potential output. From the graph, the shift in the LRAS to LRAS2 leads to an increase in the size of the output from Y1 to Y2.

The shift in the LRAS to LRAS2 leads to an increase in the size of the output from Y1 to Y2.

According to Tucker, the supply side policies are focused on stimulating a country’s productive capacity (295). Labor productivity is one of the most important elements in the supply side policies. The policies underscore the importance of establishing flexible labor markets. Despite the flexibility aspect, the role of the government in the implementation of the supply side policies cannot be ruled out. In some instances, government intervention is necessary in order to overcome market failure. Thirlwall supports this view by arguing that the objective of the supply side policies is to make industries and markets more efficient, hence contributing to a high rate of economic growth (341).

Implementing the supply side policies is paramount to attaining sustainable economic growth without increasing the rate of inflation. Glanville and Glanville cite the increasing capital and labor productivity and the promotion of a sustainable non-inflationary growth as some of the core supply side objectives (316). By implementing the supply side policies, the balance of trade and payments are improved substantially. Furthermore, Glanville and Glanville argue that applying supply-side policies can enable a country to deal with unemployment and cost-push inflation (316). There are two main categories of the supply side policies, which include the market-based policies and the interventionist policies.

Market-based policies

One of the most effective market-based policies focuses on encouraging competition. Different strategies can be adopted in achieving this goal. The first approach involves the privatization of firms in the public sector. The purpose of privatization is to entrench a high level of operational efficiency within the public entities. According to Thirlwall, state-owned entities are mainly characterized by operational inefficiencies due to high administrative costs, bureaucratic procedures, and unproductive labor force (340).

Through privatization, governments can increase the operational efficiency of the public entities. The second strategy that governments can adopt in order to foster competition entails deregulation, which involves reducing the extent of government control amongst the public entities. Thirlwall contends that government control hinders competition, thus leading to an increment in operational inefficiency (340).

The deregulation strategy can be implemented by eliminating output and price controls. Deregulation can also be implemented by allowing private entities to venture into industries characterized by oligopolistic and monopolistic tendencies. Conversely, the deregulation can be undertaken by implementing the concept of ‘social regulation’. The strategy underscores the importance of protecting consumers against negative externalities that might lead to harm such as product safety.

Another market-based policy that governments can consider entails eliminating monopoly power. This goal can be attained by implementing legislations advocating the large monopoly firms to be subdivided into small units. Additionally, the strategy can be implemented by restricting the formation of firms with monopolistic tendencies such as the creation of large mergers and acquisitions. Furthermore, market-based supply-side policies further accentuate the significance of enacting trade liberalization.

Interventionist policies

Direct government intervention is essential in preventing market failures by ensuring that public goods such as defense, training, technological research, and health programs are provided to the public. The lack of government intervention would result in the under-provision of public goods.

One of the interventionist supply side policies entails investing in human capital. The purpose of this type of supply side policy entails developing a flexible and highly skilled workforce. Through this approach, the probability of exploiting the prevailing technological advances in promoting a high level of productivity will be enhanced substantially. Glanville and Glanville argue that human capital is essential in increasing output (318). Governments can adopt different approaches in the quest to invest in human capital. For example, governments can offer vocational training schemes, educational facilities, and health care. On the other side, governments can provide subsidies to private investors in order to promote human capital development.

The second supply side policy focuses on investing in technology. This policy is founded on the assumption that inventing in new and effective production technologies is critical in stimulating the growth of aggregate supply. Investing in physical capital plays a fundamental role in promoting the level of productivity of a country’s labor force. Thus, the outcome involves an increase in the volume of the output.

The third type of supply side policy entails formulating the regional policy. The purpose of the regional policy is to stimulate equitable distribution of industries and human capital. Grant and Vidler opine that problems “can arise if a country has congested and depressed areas” (330). The depressed areas are comprised of regions characterized by poor quality jobs, low per capita income, lack of adequate entrepreneurial skills, and high rate of unemployment. Moreover, the depressed areas experience a high rate of outward migration, hence suppressing the size of the available labor force. In order to deal with this challenge, the supply side policies such as improvement in wage level and factor mobility can change the extent of depression. Subsequently, new firms would prefer entering these areas due to the availability of low-cost labor.

The supply side policies also involve providing incentives in order to exploit the expected rewards from factors of production. One of the incentives that governments should consider is tax cuts. Grant and Vidler argue that offering businesses tax cuts promotes their risk taking by investing in new areas, hence stimulating equitable growth across different regions (330). This approach will lead to the LRAS shifting outward. Tax cuts should further involve lowering personal income taxes, hence increasing the amount of disposable income available to individuals. This aspect means that consumers have a high amount of income to expend in different economic sectors, hence stimulating growth. Additionally, incentives can also entail reducing the tax on interest income and capital gains (Thirlwall 341).

Labor market reforms also comprise another critical interventionist supply side policy. In order to sustain growth in aggregate supply, it is important for governments to ensure that the wages and salaries paid to the workforce are responsive to the prevailing supply and demand changes. Glanville and Glanville suggest that reducing “the power of trade unions and abolishing minimum wages will reduce the wage level and make wages more responsive to changes in demand and supply” (321).

According to Thirlwall, abolishing minimum wage contributes to a reduction in the level of unemployment, hence leading to the attainment of the desired level of equilibrium (341). Implementing such legislations leads to an increment in the rate of wage flexibility. This aspect arises from the view that the efficiency with which organizations hire the required talent from the market is improved considerably. Through this approach, governments will be in a position to minimize the labor costs and the level of unemployment. Furthermore, governments should consider weakening the trade unions’ power. Thirlwall contends that trade unions often succeed in pressurizing for high wage increment (341). However, weakening the power possessed by the labor unions is critical in ensuring that wages are directly correlated to the market forces of demand and supply.

Other reforms that should be considered in the labor market entail unemployment benefits such as transfer payments. Unemployment benefits tend to reduce the individuals’ drive in seeking new employment. Therefore, the negative effect of such transfer benefits is that individuals stay for long duration without seeking employment. Thus, the supply of labor is suppressed substantially. It is essential for governments to implement reforms that stimulate the attractiveness of the labor market, hence increasing their productivity. Thirlwall posits, “Reducing unemployment benefits is expected to lower unemployment as it would encourage the unemployed to look for work” (341).

Conclusion

Promoting balanced growth is critical in fostering sustainable economic growth. The balanced growth concept underscores the importance of ensuring that the various components of the GDP grow at an equal rate. By fostering balanced growth, economies are in a position to promote equitable economic development across the different regions. Subsequently, the probability of attaining equitable distribution of wealth is increased substantially. Governments can adopt different approaches in order to achieve balanced growth. One of these approaches entails the formulation of effective supply side policies, which entail the attempts undertaken by governments in an effort to stimulate productivity, hence the economy’s productive capacity. By implementing the supply side policies, governments are in a position to promote the establishment of a flexible labor market.

Governments have the option of implementing two main categories of supply side policies, viz. the interventionist and market-based policies. The interventionist policies emphasize on protecting the occurrence of a market failure, for example by providing public goods. Examples of such policies entail investing in human capital training, technology development, and the formulation of regional policies in order to promote equitable economic growth. Furthermore, interventionist policies also involve enacting reforms in the labor market and the provision of tax incentives such as tax cuts.

Conversely, the market-based policies underscore the importance of fostering a free market by encouraging competition. Some of the approaches adopted in implementing these strategies entail deregulation and privatization. In order for governments to be effective in implementing the supply side policies, it is imperative for the relevant authorities to assess the most effective strategy for attaining balanced economic growth. The choice of the policy should be based on the prevailing economic environment. Furthermore, it is essential for governments to evaluate progressively the effectiveness of the adopted policies in stimulating balanced economic growth.

Works Cited

Economics Online: Supply-side policy 2015. Web.

Glanville, Alan, and Jacob Glanville. Economics from a global perspective: a text book for use with the IB Diploma economics program, Dolton: Glanville Books, 2011. Print.

Grant, Susan, and Chris Vidler. Economics in context, Oxford: Heinemann, 2000. Print.

Munasinghe, Mohan. Macroeconomic policies for sustainable growth: analytical Framework, New York: Edward Elgar Publishing, 2009. Print.

Oosterbaan, Michael, Thijs Steveninck, and Nicholas Windt. The determinants of economic growth, Boston: Springer, 2000. Print.

Temple, Jonathan. Balanced growth, Bristol: University of Bristol, 2005. Print.

Thirlwall, Anthony. Growth and Development: With Special Reference to Developing Economies, Basingstoke: Palgrave, 2005. Print.

Tucker, Irvin. Macroeconomics for today, Mason: Cengage Learning, 2010. Print.

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