Supply-Side Policies

Policy aimed to increase aggregate supply in an economy. Total output rises, which leads to a rise in real GDP. Through this, the country attains economic growth. Unemployment falls which leads to a rise in the average income of the people. When income rises, people spend more on goods and services. Aggregate demand rises in the country. To some extent, it also reduces cost push inflation. Inflation is caused due to fall in aggregate supply.

Types of supply side policies:

Market based supply side policies

Policies to encourage competition

Here there is no direct government intervention. Competition leads to increased efficiency and eliminates market failure. Government can adopt various strategies to reduce its control over the market and encourage competition (foster competition). 

• Deregulation/Regulation: 

The reduction or elimination of government power in a particular industry, usually enacted to create more competition within the industry. It is the relaxation of existing norms or rules so as to give some scope of private producers to work freely. Regulation is not welcomed by producers. For example, before 2005, foreign companies were only allowed to invest for up to a 40% stake in the insurance sector. After 2005, those rules were relaxed and foreign companies began investing more in the insurance sector.

• Privatisation:

The transfer of ownership of property or businesses from a government to a privately owned entity. It leads to greater efficiency as it is thought to come from the greater importance private owners tend to place on profit maximisation as compared to government, which tends to be less concerned about profits. Earlier, the government was the only producer. Now there are more private operators. This leads to a rise in competition and supply. Price reduces for consumers and increases the aggregate demand in the economy.

• Trade liberalisation: 

This involves the removal or reduction of restrictions of trade barriers on the free exchange of goods between nations. Trade liberalisation ultimately lowers consumer costs, increases efficiency and fosters economic growth. Palm oil is produced in Indonesia and Malaysia. Nepal used to get crude palm oil and sell refined palm oil to India at a higher price. After the new government took over Nepal, they supported China and so, India imposed over 100% tariff on Nepalese imports. However, the palm oil supply from Nepal to India was less than 5%(example of regulating imports+increasing barriers - leading to a decrease in aggregate supply)

• Anti-monopoly regulation: 

Encouraging competition. This can avoid monopolies being formed and thus stimulate competition among firms, leading to greater efficiency. This furthermore reduces the barriers of entry thus, promoting competition. This competition proves to be beneficial for consumers as they get lower prices and better quality of products. 

Labour market reforms

All these reforms aim at making the labour market more flexible. For example, when it is cheaper for firms to hire and fire workers, they will be more likely to hire.

• Reducing the power of labour unions - if trade unions pressurise producers, it will increase the cost of production if they ask for higher benefits and wages. So, the trade unions powers are reduced. Companies will not be distressed.

• Reducing unemployment benefits - unemployment benefits are monetary benefits to unemployed people to fulfil their basic needs. This would demotivate people to work and put pressure on the taxpayers. If unemployment benefits are reduced, people would be compelled to go to work.

• Removing minimum wages - if the government chooses to remove minimum wages, the cost of production for firms reduces and encourages producers to produce more.

• However, these policies can worsen the condition of poor people as well as increase inequality.

Tax support policies

Cutting the income tax - people will have more income, this will motivate them to work harder to retain more income and produce more. This increases productivity. The idea is that leisure becomes more expensive after the tax cut and so people start working more - Laffer curve and substitution vs income effects.

Cutting the corporate tax - firms get to keep more of their profit, that is incentive to take the risk and invest and find more efficient ways of production.

Direct government involvement in the economy

Education and training: Quantity and quality of skilled labour force increases. This leads to a rise in productivity and in turn, it leads to a rise in aggregate supply. Education and training requires a huge investment. The government will provide subsidies to organisations in the private sector to set up educational institutions. A disadvantage would be opportunity cost. The money used to set up educational institutions and subsidise education could have been used somewhere else. Budget deficit could also occur, where government spending exceeds revenue.

Subsidy Support: 

Subsidy is a financial assistance provided by the government to producers to reduce their cost of production and make the product more affordable. Subsidise those production houses that export commodities to other countries. This means that they can sell their products at a lower price to the international market and increase competition. Government also subsidises research and development. This brings in new technology, new production processes, etc., which increases productivity and total output.

Providing subsidies to the consumer aims to make goods and services more affordable to them. This is part of the welfare initiative by the government.

Extra Points:

1. Infrastructure provision - lead to helping the production process, better roads, telecommunications

2. Provision of R&D - finding new production processes and technologies reduces cost of production and increases output

3. Industrial policies