Supply Side Policy
TYS 2023 Q6
Discuss whether expansionary supply-side policies would be effective in achieving the macroeconomic policy aims of an economy. [15]
Introduction
The government aims to achieve four macroeconomic goals: economic growth, low and stable inflation, low unemployment, and a healthy balance of payments (BOP). Expansionary supply-side policies, implemented in both the short and long run, can effectively meet these objectives. However, supply-side policies also face limitations and constraints, which this essay will further discuss
R1: Explain how supply-side policies would be effective in achieving sustained growth and low inflation.
The government can implement supply-side policies to improve labour's quality, quantity, and mobility, thus enhancing the economy’s productive capacity. For example, the Singapore government increased the retirement age from 62 in 2017 to 63 in 2022 and plans to further raise it to 64 by 2026. Raising the retirement age retains more workers in the labour force, thereby increasing the quantity of labour. Additionally, retaining senior, experienced workers enhances the quality of labour due to the workforce being more experienced, and the older workers can also improve the quality of labour for the younger workforce through knowledge transfer. This results in an increase in Long-Run Aggregate Supply (LRAS), shifting the LRAS curve from LRAS₀ to LRAS₁ and increasing full employment output from YF₀ to YF₁.
Furthermore, higher retirement ages also increase the disposable income of senior workers, boosting their purchasing power. This rise in disposable income encourages greater consumption(C). Since consumption is a component of Aggregate Demand (AD), an increase in C shifts AD rightward from AD₀ to AD₁, creating a multiplied rise in national income from Y₀ to Y₁ through the multiplier effect. Thus, supply-side policies effectively contribute to both actual and potential economic growth, hence achieving sustained growth which is the steady continuous rise in national output or Gross Domestic Product (GDP).
Assuming that the increase in LRAS outpaces the increase in AD, this would lead to a fall in General Price Level (GPL) as seen in the fall of GPL from P₀ to P₁, helping the economy bring down high inflation and achieve non-inflationary growth.
EV1: Limitations of SS-side policy
However, shifting mindsets presents a major challenge, as many workers prefer early retirement and may not be receptive to policies extending their working life. Older workers might view extended employment negatively, thereby reducing the actual increase in labour supply and limiting productivity improvements. Thus, the effectiveness of policies like retirement age increments and retraining heavily depends on workers' acceptance and willingness to continue working, potentially constraining actual and potential economic growth as the increase in quantity and quality of labour might not be significant.
R2: Explain how supply-side policies would be effective in achieving a healthy BOP
To achieve a healthy balance of payments (BOP), the government can implement the Productivity Solutions Grant (PSG). This grants subsidies up to 50% of the cost for small and medium-sized enterprises (SMEs) to adopt pre-approved IT solutions, automation tools, and equipment, targeting sectors like retail, manufacturing, and logistics to enhance operational efficiency. This helps to improve both the current account, and the capital and financial account which are both components of Balance of Payments.
By lowering the cost barrier, PSG increases the quantity of capital as more firms invest in modern machines and digital technologies. Simultaneously, these technologies improve the quality of capital, enabling faster, more accurate, and higher-volume output. This shifts the Long-Run Aggregate Supply (LRAS) curve rightward from LRAS₀ to LRAS₁, indicating increased productive capacity.
This also increases productivity and hence reduces unit production costs. As a result, firms can pass on these cost savings to consumers in the form of lower prices and become more competitive internationally, enhancing export price competitiveness. Assuming demand for exports is price-elastic, a fall in the price of exports will lead to an increase in export revenue (X). Additionally, R&D supported by PSG enhances product quality, boosting non-price competitiveness, making exports more attractive due to superior quality and uniqueness, leading to an increase in the demand for exports and hence export revenue. At the same time, locals will switch over from Imports to the more competitive local goods, leading to a fall in Import Expenditure (M). Thus, both improved price and non-price competitiveness boost net exports (X-M), enhancing the current account (BOT) component of the BOP.
Moreover, increased productivity and advanced technological infrastructure attract foreign direct investments (FDI), strengthening the capital and financial account of the BOP. Countries with modern infrastructure and high productivity attract greater FDI inflows, improving overall economic stability and further supporting a healthy BOP.
EV2: Limitations of SS-side policy
However, the effectiveness of supply-side policies such as PSG in achieving a healthy BOP might be limited. Firstly, implementing PSG and similar policies requires substantial government funding, leading to significant opportunity costs. Government spending on these grants and subsidies restricts the availability of funds for other essential sectors, such as healthcare, education, and infrastructure. Additionally, the process of research and development supported by these policies is lengthy and complex, requiring considerable time for testing, proving, and implementation, thus limiting immediate impacts. Consequently, in the short run, supply-side policies may not effectively address urgent economic challenges like severe BOP deficits.
Conclusion
In conclusion, supply-side policies typically involve longer implementation and realization timeframes, making them more suitable for long-term economic planning. For short-term economic stabilization and immediate issues such as recessions or inflation, demand-management policies may be more effective. Ultimately, the appropriateness of supply-side policies depends on the specific root causes hindering an economy from achieving its macroeconomic goals. While developed countries with sufficient resources and stable fiscal positions can effectively utilize supply-side strategies, developing countries might initially benefit more from demand-management approaches, addressing urgent short-term economic concerns before progressively adopting long-term supply-side measures.
