Lesson preview · Raising what the economy can produce
Supply-side policies
~7 min · Free to read
In January 2016, Singapore’s government gave every Singaporean aged 25 or over a credit of 500 Singapore dollars. People could spend it only on approved training courses. The point wasn’t to get people shopping. It was to give workers new skills, so that each of them could produce more in the years ahead.
Policies like this are supply-side policies. They aim to raise the economy’s capacity. That is the most it can produce when all its workers, machines and land are fully and efficiently used, with today’s technology. You can draw capacity as a production possibility curve (PPC): the line showing the most a country can make of two goods, in every mix. Supply-side policies try to shift that whole curve outward.
Key Term
Two kinds of supply-side policy
Interventionist policies: the government acts directly.
- Education and training: better schools, apprenticeships, courses like Singapore’s.
- Infrastructure: the roads, railways, ports, power lines and internet links that all firms use. Like machines, these are capital: things built to help make and move goods.
- Research: paying for science that leads to new technology.
Market-based policies: the government changes the rules so that markets work better.
- More competition: letting new firms into a market, including foreign firms, for example by cutting taxes on imports. Since 1997, under rules first agreed in 1992, any airline licensed in the European Union may fly any route inside it and set its own fares.
- Tax and incentive reforms: lower taxes on earnings or on investment, so that working and investing pay more. The aim is that more people take jobs and firms buy more machines.
- Labour-market reforms: making it easier for firms to hire and for workers to move to new jobs. Then workers end up where they produce most.
Key Term
Capacity, not spending
Demand management means changing total spending in the economy. A government cuts taxes or spends more, or a central bank cuts interest rates. People and firms buy more, and firms hire idle workers to keep up. That moves an economy from inside its curve towards it. It usually works faster than supply-side policy. But its job is to change spending, not to move the curve.
A slump in spending looks like the strike on this graph: the dot falls inside a curve that stays put. So demand management works on the dot: more spending can pull an economy with idle workers back to its curve. Supply-side policies work on the curve: only more or better resources, or better technology, push it outward.
On a business-cycle graph, where output rises and falls around a rising trend, demand management works on the wave. Supply-side policy tries to lift the trend itself.
Trap · Common Misconception
"Anything that boosts output is supply-side"
A one-off cash payment to every household can raise spending and output this year. But it adds no skills, machines or technology, so it’s demand management.
Some policies do both. Building a railway gives construction firms work now, which is extra spending. Once it opens, it moves people and goods faster for years, which is extra capacity.
Tax cuts can do both too. Any tax cut leaves people more to spend now. A lower tax on earnings or on investment can also add capacity over time.
Tip
Judging a supply-side policy
- Slow. Better schools help only once today’s pupils start work, which may be ten or more years away.
- Costly. Interventionist policies and tax cuts cost the government money now, and the gains come later. Changing the rules costs the government less, but some people bear the cost instead, as the next point shows.
- Unequal. Some people gain more than others. New rivals cut prices for buyers, but workers at the old firms may lose their jobs.
- Uncertain. Training may not match the jobs firms need. A tax cut may not lead people to work or invest more.
- Lasting. As an economy nears its curve, few workers or machines are left idle, so extra spending mostly pushes up prices. A bigger capacity lets output keep growing without pushing prices up.
Check yourself · no marks
A country’s unemployment is very low, and its factories are running flat out. The government wants output to keep growing without prices racing up. Should it use demand management or a supply-side policy?
Commit to one first. Guessing and being wrong beats reading the answer cold.
Practice · 1 / 6
Which of these is a supply-side policy?
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