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Year 1 Macro: Supply-Side Policies


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This is a revision presentation on supply-side policies with a particular focus on the UK economy

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Year 1 Macro: Supply-Side Policies

  1. 1. Supply-Side Policies
  2. 2. Supply-Side Economic Policies They are policies that improve productive potential / capacity of an economy. Illustrated by an outward shift of LRAS (or of the PPF) • Supply-side policies focus on improving the structural long- term performance of an economy • There are different approaches to supply-side reforms • Market-led policies – designed to make markets work better and give the private sector more freedom • State / government intervention in markets to overcome different types of market failure • Supply-side reforms can affect both short-run and long-run aggregate supply – but the focus is usually on LRAS • Time lags involved with supply-side reforms can be long
  3. 3. Some Key Supply-Side Challenges for the UK Economy Persistent Productivity Gap High rates of youth unemployment Deep and widening regional economic divide in the UK Large trade deficit and declining exports as a share of UK GDP Excessive reliance on consumption as a driver of GDP Competitive Threat from Emerging Economies Low capital investment & research & development Rising inequality / relative poverty
  4. 4. Recent UK Government Supply-Side Policies Privatisation of the Royal Mail Patent Box Tax Incentive Modern Apprenticeships including the Youth Contract Welfare Caps / and other Welfare Reforms Shale Gas Tax Cut Incentives Large Fall in Corporation Tax Launch of UK National Infrastructure Plan Launch of Green Investment Bank
  5. 5. Main Objectives of Supply-Side Policies 1. Improve incentives to look for work and invest in people’s skills 2. Increase labour and capital productivity 3. Increase occupational and geographical mobility of labour to help reduce the rate of unemployment 4. Increase investment and research and development spending 5. Promote more competition and stimulate a faster pace of invention and innovation to improve competitiveness 6. Provide a strong platform for sustained non-inflationary growth 7. Encourage the start-up and expansion of new businesses / enterprises especially those with export potential 8. Improve the trend rate of growth of real GDP to help support improved living standards and regional economic balance Key concepts to focus on when discussing S-SPs are incentives, enterprise, technology, mobility, flexibility and efficiency
  6. 6. Forecast Contributions to Potential GDP in the UK -4.0 -2.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 2015Q4 2016 Q2 Q3 Q4 2017 Q2 Q3 Q4 2018 Q2 Q3 Q4 2019 Q2 Q3 Q4 2020 Q2 Q3 Q4 2021 Population: natural change Participation rate: natural change Population: net migration Participation rate: net migration Unemployment rate Average hours Hourly productivity
  7. 7. Countries with Highest R&D Spending (% of GDP) Country (% of GDP) 2005–2012 South Korea 4.0 Israel 3.9 Finland 3.5 Sweden 3.4 Japan 3.4 Denmark 3.0 Germany 2.9 United States 2.8 Selected other countries Netherlands 2.2 Singapore 2.1 China 2.0 United Kingdom 1.7 Norway 1.7 Brazil 1.2 Russian Federation 1.1 Source: HDI report 2015, UNDP
  8. 8. Difference between Production & Productivity There is a clear distinction between production and productivity • Production • Value of output of goods and services e.g. measured by GDP or an index of production in specific industry • Productivity • A measure of the efficiency of factors of production • Measured by output per person employed • Or output per person hour • An increase in production DOES NOT automatically mean an increase in productivity - it depends on how many factors of production have been utilised to supply the extra output
  9. 9. Competitiveness Issue for UK: The Productivity Gap Labour productivity can be measured by GDP per hour worked and per worker, and growth in GDP per hour worked. This chart shows GDP per worker for G7 countries in 2015 86.0 100.0 106.0 111.0 114.0 115.0 119.0 138.0 0.0 20.0 40.0 60.0 80.0 100.0 120.0 140.0 160.0 Japan UK(=100) Canada Germany Italy France G7 exc. UK US GDP per worker employed
  10. 10. UK Productivity Growth has disappointed since 2007 Real output per person employed in the UK and G7 (excluding the UK) 80.0 85.0 90.0 95.0 100.0 105.0 110.0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Index of Constant price GDP per hour worked, 2007 = 100 UK G7 exc UK
  11. 11. Why does the UK economy lag on productivity? Low rate of new capital investment in the UK Banking crisis affecting lending to businesses Possible slowing rates of process innovation Persistent and deep skills shortages in key industries Relatively low levels of market competition Low aggregate demand & high spare capacity – under-utilizing resources
  12. 12. Economic Advantages of Higher Productivity 1. Lower unit costs: Cost savings for businesses can bring lower prices, encouraging higher demand, more output and an increase in employment 2. Improved competitiveness and trade performance (BoP) 3. Higher profits: Efficiency gains are a source of larger profits for companies which might be re-invested 4. Higher wages: Businesses can afford higher wages when their workers are more efficient 5. Economic growth: If an economy can raise productivity then the trend growth of national output can pick up 6. Productivity improvements mean that labour can be released from one industry and be made available for another
  13. 13. If Supply Side Policies Work 1. Achieve a sustained improvement in the possible trade-off between inflation and unemployment (see Phillips Curve) 2. Be more flexible in response to external demand and supply-side shocks such as rising energy prices 3. Raise living standards through stronger long term economic growth / an increase in underlying trend rate of growth 4. Reduce unemployment by lowering the natural rate of unemployment (less frictional & structural unemployment) 5. Improve competitiveness in global markets and achieve a stronger balance of trade in goods and services In general, a stronger supply-side performance allows a government to meet more of the key macro objectives
  14. 14. Showing Long Run Economic Growth using AD-AS General Price Level Real GDP GPL1 AS1 Y1 AD1 Yp1 LAS1 An increase in a country’s productive potential causes an outward shift of LAS. Short run supply increases because of lower unit costs An increase in productive potential allows an economy to operate at a higher level of AD LAS2 AS2 AD2 Yp2Y2
  15. 15. Pro-Market (Private Sector) Supply-Side Policies These policies focus on reducing the size of the state and in extending the role of market forces in allocating scarce resources • Cutting government spending (including welfare) and borrowing • Lower business taxes to stimulate capital investment spending • Lower income tax rates to improve work incentives • Reducing red-tape to cut the costs of doing business • Improving the flexibility of the labour market including reforming employment laws and encouraging more part time work • Competition policies i.e. deregulation & tough anti-cartel laws • Privatisation of state assets – i.e. transferred to private sector • Opening up an economy to overseas trade and investment • Opening up an economy to inward skilled labour migration
  16. 16. The Rise of Zero Hours Contracts in the UK Economy 0.0 0.5 1.0 1.5 2.0 2.5 3.0 0 100 200 300 400 500 600 700 800 900 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Zero Hours Contracts do not guarantee a minimum number of working hours each week In employment on a zero hours contract (thousands) Percentage of people in employment on a zero hours contract • People on “zero-hours contracts” are more likely to be young, part time, women, or in full-time education when compared with other people in employment. • On average, someone on a “zero-hours contract” usually works 26 hours a week Total (thousands) % of people in work
  17. 17. State (Government) Driven Supply-Side Policies Supporters argue that an interventionist state can have a powerful and positive long-term effect on supply-side performance • State investment in public services and critical infrastructure • A commitment to a minimum wage and/or living wage to improve work incentives & productivity in the labour market • Higher taxes on the wealthy to fund public and merit goods • An active regional policy to inject extra demand into under- performing areas / regions of persistently high unemployment / low per capita income – e.g. the Northern Powerhouse Project • Selective import controls to allow domestic industries to expand • Management of the exchange rate to improve competitiveness • Nationalisation of and/or tougher regulation of key industries
  18. 18. UK Minimum Wage and Living Wage 6.95 7.10 7.35 7.65 7.90 7.20 7.60 8.05 8.50 9.00 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00 2016 2017 2018 2019 2020 £ per hour National Minimum Wage (NMW) National Living Wage (NLW) Source: OBR, March 2016
  19. 19. Regional Policy – The Northern Powerhouse Project The UK government wants to achieve a greater degree of regional balance in the economy to help supply-side potential growth • Main goal of the Northern Powerhouse idea is to have a more balanced regional economic recovery • The North of the UK has a relatively higher concentration of public sector and manufacturing jobs and has grown less quickly since the end of the recession, living standards are below the national average • Key aim is to increase long-term growth in the major cities of the North including Liverpool, Manchester, Leeds and Hull • Policy options include: • Investment to improve transport connections • Supporting science and innovation including the universities • Backing specialist clusters of businesses including high tech sectors such as life sciences and marine engineering
  20. 20. Research and Development (R&D) R&D is focussed on the creation and improvement of products and processes, based on scientific research – applied to market needs • R&D expenditure in the UK in 2014 represented 1.67% of GDP • The biggest barriers to innovation are • Risk aversion – research is expensive, rewards are uncertain • Uncertainty about firms’ ability to exploit research profitably • A lack of high-skilled workers in key research industries • Top EU companies: Nokia, Volkswagen, Bosch and Siemens • The top UK firms are GlaxoSmithKline and AstraZeneca • The level of research spending is not necessarily a guide to the pace and success of innovation. Many businesses do not patent all of their most innovative ideas but keep them as trade secrets
  21. 21. What is Innovation? Innovation is putting a new idea or approach into action. Innovation is 'the commercially successful exploitation of ideas' • Product innovation • Small-scale, frequent subtle changes to the characteristics and performance of a good or a service • Process innovation • Changes to the way in which production takes place or is organised • Innovation has demand and supply-side effects in markets and the economy as a whole Austrian economist Joseph Schumpeter coined the term creative destruction. This is a term that refers to the complete upheaval of the established order in the pursuit of innovation.
  22. 22. What is Human Capital? Human capital is a measure of individuals’ skills, knowledge, abilities, social attributes, personalities and health attributes. These factors enable individuals to work, and therefore produce something of economic value. • Human capital in the UK economy can be improved by: 1. Sustained gains in average educational attainment – in the academic year ending 2015, 53.8% of pupils that left school in England achieved 5 or more GCSE A* to C grades, including Maths and English 2. Expanded access to and quality of in-work training and opportunities for life-long learning 3. Higher real incomes that allow people to consume more knowledge products including online courses 4. Inflow of migrants with above average skills & qualifications
  23. 23. International Patent Filings in 2014
  24. 24. International (External) Competitiveness External competitiveness is the ability to sell goods and services at competitive prices in a foreign country • Cost competitiveness – differences in unit costs between producers – reflected in prices • Non-price competitiveness – product quality, design, reliability and performance, choice, after-sales services, marketing, branding and the availability and cost of replacement parts • Non-wage costs: • Costs of meeting environmental / health regulations • Environmental taxes e.g. carbon taxes and waste taxes • Employment protection laws and health and safety laws • Requirements to provide pensions for employees
  25. 25. Policies to Improve International Competitiveness Improving functioning of Labour Markets • Investment in all levels of education and training • Encouraging inward migration of skilled workers • Improvements in management quality Critical (Core) Infrastructure Investment • Better motorways, ports, hi-speed rail, new sewers • The Northern Powerhouse project • Communications e.g. super-fast broadband, 4G networks Supporting Enterprise / Entrepreneurship • Improved access to business finance e.g. for start-ups • Incentives for business innovation and invention • Reductions in business red tape Macroeconomic Stability • Maintaining low inflation / price stability to help confidence • A sustainable and more competitive banking system • A competitive exchange rate v major trading partners
  26. 26. Evaluating the Effectiveness of Supply-Side Policies 1. Supply-side policies can have long time lags but this depends on the type of policy and also the country involved 2. The level and growth of aggregate demand is also important in making business investment and innovation viable – this is a valid Keynesian issue – demand helps to utilise extra supply 3. Some supply-side policies (e.g. cutting higher-rate income taxes) might lead to greater inequalities of income & wealth – again it depends on which taxes are changed and by how much 4. State intervention to “pick winners” in different industries/sectors may be ineffective – i.e. are risks of government failure 5. Sustainability issues arise if policies raise a country’s long term growth rate – leading to increased externalities such as pollution – although some supply policies directly address this! 6. Supply-side policies look to achieve relative improvements e.g. In productivity – but other countries will be making gains too!
  27. 27. Supply-Side Policies