MACRO - LS13 - Supply-Side Policies (Part 2)

Question 1

Evaluating supply side policies

Answer 1

• time lags
• cost
• no guarantee of success/targeted
• negative effects
• gov budget
• tax cuts
• ability to create employment/reduce unemployment
• effects on equity

Question 2

Time lags

Answer 2

• both types of policies have long time lags, take time to materialise
• interventionist also affect AD on short term, so in recession can help close the recessionary gap but could contribute to inflationary pressures

Question 3

Cost

Answer 3

• opportunity cost of supply side policies could spend elsewhere

Question 4

no guarantee of success/targeted

Answer 4

• may not work
• have to target the right area e.g. productivity, education
• can target wrong area but not know for a while due to time lags

Question 5

Negative effects

Answer 5

• policies that increase competition e.g. privatisation/deregulation can have negative effects of environment as increased scope of activities lead to negative externalities affecting environment
• also may lead to social harm if products deregulated etc..

Question 6

Arguments for interventionist policies

Answer 6

• argue that gov provisions is needed as it’s unlikely to be provided by market e.g. training, low interest rates, long repayment times, R&D support
• industrial policies allow gov to support industries that offer the greatest possibility for growth in the future
• also point to questionable growth preformance of many developing countries that used market-based policies in 1980’s

Question 7

Argument for market-based policies

Answer 7

• argue gov interference may lead to inefficiencies/resource misallocation, market policies can achieve growth without these disadvantages
• gov may lack the ability to chose the right industries to support
• also highlight how interventionist policies rely on government spending - may be oppertuinity cost and need large amount of taxes and large government sector
• large taxes provide disincentive to work, promotes inefficiency

Question 8

Tax cuts

Answer 8

• Tax cuts (incentive-related policies) are among the more controversial market-based policies, because of their questionable effects on work, saving and growth of potential output.
• Some economists question the strength of the supply-side effects, believing these to be small compared to the impact on aggregate demand
  E.g. increases in disposable income due to cuts in personal income taxes may result in the decision to work less if people prefer to use their extra (after-tax) income to increase their time for leisure.
• workers may decide to use their higher after-tax income to consume more rather than save, in which case the tax cuts may not significantly affect saving and investment
• whatever growth has occurred has been the result of both demand-side and supply-side effects of demand-side and supply-side policies, and it is very difficult to determine which policy has which effect

Question 9

Gov budget

Answer 9

• interventionist and incentive based policies negatively effect budget
• interventionist increases gov spending
• incentive policies often involve tax cuts, reduces government revenue
• all of this contributes to an increasing budget deficit

Question 10

Ability to create employment/reduce unemployment

Answer 10

• market based policies that focus on encouraging competition may increase unemployment in the short term
• In the case of privatisation, as privatised firms try to make their operations more efficient, they often try to cut costs by firing workers
• Contracting out to the private sector leads to government job losses, and job losses for the country as a whole if projects are contracted out to firms in other lower cost countries,
• also, economic deregulation has frequently led to increased unemployment, due to increased competitive pressures that cause firms to fire workers in order to lower their costs.
• It is possible that increased unemployment on account of these policies may be short term, and may be reversed over the longer term as the economy begins to benefit from the broader effects of supply-side policies.

Question 11

Affects on equity

Answer 11

• Interventionist policies that focus on investments in human capital that are broady distributed throughout the population are likely to have positive effects on equity over the longer term as educated, skilled and healthy workers are more likely to be employed. Also, policies that lower the natural rate of unemployment reduce inequality by providing incomes to previously unemployed workers
• Market-based policies tend to have negative effects on equity. Greater competition may have a negative effect if it results in some unemployment, which involves a loss of income. Labour market reforms involve changes in legislation and institutions that provide protection for workers with very low incomes and with income uncertainties
• Reducing protection results in lower incomes for some workers and increased job insecurity, and contributes to increasing income inequalities
• for incentive-related policies, tax cuts intended to create incentives to work, save and invest may also worsen income distribution. As high taxes create disincentives to work and save applies mainly to higher income groups who face higher average tax rates;
  So, to reverse this problem, tax cuts must be designed to affect the after tax incomes of higher income groups. But would reduce the redistributive effects of personal income taxes and makins income distribution less equal.
• with privatisation they are likely to rise prices compared to when government owned, less affordable increasing inequality