Paste your Supply-Side economics theory is an economic concept that encourages the lowering of tax rates and deregulating the economy to boost economic growth; and to achieve this the government have to boost the economy by injecting money into the economy, by creating employment and goods or services, which helps to create demand. With its core emphasis on how to improve the productiveness of the economy. To an extent it encourages government to intervene in the market so as to succeed and overcome some market failures issues. It is at variance to Keynesian theory, which states that demand is what drives the economy. It tends to be associated with free market economics. These economists are more incline to highlight profits making. This economy theory was first used in 1970 in the United States.
Just like any other economic theories, supply-side economics tries to describe both macroeconomic phenomena and, based on these details, suggest policy recommendations for unwavering economic growth. In overall, supply-side theory has three mainstays: tax policy, regulatory policy and monetary policy. However, the single idea behind all three pillars is that production (i.e. the "supply" of goods and services is most important in determining economic growth. Which implemented accordingly will transform the economy and put recession and depression at bay. (Harper, 2005)
When there is a shortfall in the economy and the government wants to avoid recession it tend to use Supply-Side Economic Policy to stimulate savings, production of goods and investments into the economy, by reducing taxation for the benefit of everyone, and it’s also called trickle-down economics. It also help in inducing the level of collective amount, to be supplied, in the economy. Thus it is government attempt to use Supply-side economic theory to increase productivity and shift Aggregate Supply (AS) to the right. (Economicshelp.org. 2016).
Diagram 1 Diagram 2
The two diagrams above shows how supply side policy will look like with stimulus from the government, for both Long Run and Short Run aggregate supply, with reduction in and taxation and increase in its expenditures. There is a shift to the right as long run Aggregate Supply. Supply-side policy may also shift LRAS to the right if productivity improvements are sustained and vice versa if it’s not sustained. (Econknowhow.blogspot.co.uk, 2011)
To enable and stimulate free market economy, it is required that the government cuts back on its interference by doing the following:
Privatization: it is believed that private sector are more efficient in running business that the government hence it requires that the government relinquish its control of companies to the private sector on the basis that private sector runs businesses with profit in mind and will tend to reduce cost of running the industry and improving efficiency. This involves selling state owned businesses to the private sector.
Reduction In Taxation, both income and corporate taxes, as done by the Labour government of Gordon Brown during the last recession in 2008, has been argued by various economic think tank that lower taxes is an incentives for business to invest more capital into the economy which will lead to increase in productivity and in return could increase labour force as companies will have enough to employ more people, this reduction could lead to more output and give more spending power to workers thereby putting more money into the economy. “A fair assessment would conclude that well-designed tax policies have the potential to raise economic growth, but there are many stumbling blocks along the way and certainly no guarantee that all tax changes will improve economic performance”. (Gale and Samwick, 2016)
The Deregulation of the Economy. To increase competition within the economy, which in leads to increase in productivity, the government has to reduce or remove barriers to enter into business in the form red tape. This theory discourages monopoly, of any sort in the market. Competition is inclined to lower prices and better quality of goods and service.
Trade Unions, as it is often accused being another stumbling block to free market flow. It is believed in some segment of the economy that less time businesses spent dealing with striking staffs or negotiating with trade union the more time it has to focus on what it does best: increase in productivity efficiency. This could lead to reduction in unemployment. Though without trade union businesses might take their employees for granted. A classic case being the current dispute between junior doctors and the NHS.
Manpower Training in schools and in businesses can improve labour efficiency and increase aggregate supply. Some market failures are attributed to inadequate provision for proper training in work force. To get people into proper training the government may to subsidize appropriate education and training schemes. To do this, it will cost money for the government intervene, could lead to cuts in spending and/or higher taxes. The effect may not may not be felt immediately and government may subsidize the wrong types of training.
State Welfares Reduction is another way for states with benefit schemes to get people to into employment market because if there is less money to give out those capable of working are more likely to take up employment. (Mankiw, Taylor and Ashwin, 2013)
Providing good and accurate information about the economy will lead to reduction in employment and market liberalization. To liberalize financial markets is another option available as it will encourage individuals to setup businesses and have access to financial assistance from banks and other financial institutions and this in turn will encourage and allow more competition and lower borrowing costs for consumers and firms, as prices tend to fall where there is healthy competition in the market.
Another issue is that of tariff barriers. This are duties imposed on, especially imported goods which effectively create an obstacle to trade. To allow for capitalist free trade there must be no trade barriers. This barriers are imposed for different reasons; some for health reasons (especially for food products like during the mad cow disease epidemic) while some are imposed to protect employment and local industries, thus the government can use this as a way to encouraging local producers to produce more by restricting the importation of similar good which can radically effect the cost of production and employment, or not have any to allow for competition which could either be good or bad for the economy, a good example is the current crisis engulfing the British steel industry where Tata Steel is unable to compete with cheap imported steels especially from China. World Trade Organization has been championing the cause for countries to lift trade embargos. (McMahon, 2016)
Another way of reducing government interference in business is by removing unnecessary red tape and bureaucracy which add to a firms costs. Though all business and organization do need some level of bureaucracy. Some red tape are there to act as guidelines for business, but when it becomes an obstacle to smooth running of business then there is need for change. As the size of the organization grows, so does its tendency for bureaucracy. Thus bureaucracy is as a unique procedure that the business of government use to organize its day to day affairs. Because these organizational rules are made in a general way, without application to a specific set of circumstances, the rules may not always apply to the situation. When this occurs, the organization may attempt to fit the response to the rule. Unfortunately, the predetermined actions that result from the structure don't always fit the event. (Bigelow, 2016)
Another option for the government is to improve on transportation and any other thing that come with it. When there is a good transport system the cost of business operation is reduce and increase investment and reduce operational cost. Though business will like to be free of government interference but when it comes to transport infrastructure, government intervention is needed, and this is as a result of market failures. It should be noted that the efficiency of business operation in developed countries is quite different from that of developing economy where transport infrastructures is below par.
Deregulation of the labour market is needed to boost competition by reducing government regulatory interference; thus this is the “reduction or elimination of government power in a particular industry, usually enacted to create more competition within the industry”. This is could be also in line with privatization of industry and to discourage monopoly. This is part of directives from the European Union to increase competitiveness, e.g. make it easier for companies to enter the market and be able to hire and fire workers. Areas that have been deregulated by the government are telecom sector and transport sector especially aviation industry. This has the tendency to benefit small businesses. (Investopedia, 2003)
In the 1980s and the preceding years that follows, supply side theory contributed to the longest economic boom in the world economic especially in the United States and subsequent transformations that followed its implementation around the world. According to statistic released in the U.S. by the National Bureau of Economic Research, the years from 1982-1999 was one continuous mega-economic growth, this boom also stretched for 25 year up to 2007, which saw a “tripling in the net wealth of U.S. households and businesses from $20 trillion in 1981 to $60 trillion by 2007. When adjusted for inflation, more wealth was created in this 25 year boom than in the previous 200 years”. (Laffer Center, 2011)
References
1. Bigelow, L. (2016). The Disadvantages of Bureaucracy in Organizations. [online] Smallbusiness.chron.com. Available at: http://smallbusiness.chron.com/disadvantages-bureaucracy-organizations-16119.html [Accessed 19 Mar. 2016].
2. Econknowhow.blogspot.co.uk. (2011). EconKnowHow: Supply Side Economics. [online] Available at: http://econknowhow.blogspot.co.uk/2011/10/supply-sideeconomics-supply-side.html [Accessed 29 Apr. 2016].
3. Economicshelp.org. (2016). Supply Side Policies | Economics Help. [online] Available at: http://www.economicshelp.org/macroeconomics/economic-growth/supply-side-policies/ [Accessed 20 Mar. 2016].
4. Gale, W. and Samwick, A. (2016). Effects of Income Tax Changes on Economic Growth. [online] The Brookings Institution. Available at: http://www.brookings.edu/research/papers/2014/09/09-effects-income-tax-changes-economic-growth-gale-samwick [Accessed 16 Mar. 2016].
5. Harper, D. (2005). Understanding Supply-Side Economics | Investopedia. [online] Investopedia. Available at: http://www.investopedia.com/articles/05/011805.asp [Accessed 6 Apr. 2016].
6. Investopedia. (2003). Deregulation Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/d/deregulate.asp [Accessed 3 Apr. 2016].
7. Laffer Center. (2011). Supply-Side Economics. [online] Available at: http://www.laffercenter.com/supply-side-economics/ [Accessed 26 Apr. 2016].
8. Mankiw, N., Taylor, M. and Ashwin, A. (2013). Business economics. Andover: Cengage Learning.
9. McMahon, M. (2016). What are Tariff Barriers? (With pictures). [Online] wiseGEEK. Available at: http://www.wisegeek.com/what-are-tariff-barriers.html [Accessed 15 Mar. 2016].
Task 2
Fiscal policy and monetary policy denote to the two most widely recognized "apparatuses" available to the government used to influence a country's economic activity. In every economy both fiscal policy and monetary policy are used the government to pursue a policy of encouraging higher economic growth and control, or reduce, the level of inflation. Both policies are not similarly good as ways to motivate the economy. Fiscal policy used by government to generate revenue through taxation and as well as its expenditure spending to stimulate the economy and influence aggregate demand in the economy. Fiscal policy can be used to stabilize the economy over the course of the business cycle. Monetary policy on the hand is the changing of the interest rate and inducing the money supply into the economy.
Whereas monetary policy deals with the money supply, lending rates and interest rates and is often administered by a central bank and other monetary organs of the government. This policy is based on the economic growth of the country. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in bank reserves. (Investopedia, 2003) [200]
While fiscal policy is achieved through government and it involves changes on the amount it plans to spend within the fiscal year as well as the amount of taxation it intend to charge individuals and businesses. For the government to increase demand and economic growth, it will have to cut tax and increase spending though this might lead to a higher budget shortfall. But to reduce demand and reduce inflation, the government can increase taxation and cut back on public spending with could lead to a reduced budget deficit. [89]
Under monetary and Fiscal Policies there are two types of sub-policies to look at: Expansionary and Contractionary policies.
• Expansionary Policy is used in increasing the monetary supply in order to lower unemployment, increase private-sector borrowing and lending; and consumer outgoings, and stimulate economic growth. And use to measure the GDP and economic growth. Expansionary policy looks into government spending increases and cut in taxation; the objective of this policy is to close the gap in recession, reduce the rate of unemployment and help in stimulating the economic growth. Expansionary fiscal policy is intended to motivate the economy in time of expected economic shrinking. This is achieved by increasing aggregate demand done by increasing government expenditure or a decrease in taxation. Expansionary fiscal policy can leads to a more government budget deficit or a smaller budget surplus.
• Contractionary Policy is used in reducing the amount of growth in the money supply or complete reductions in its supply so as to regulate inflation; though essential, it can also slow economic growth, increase unemployment and depress borrowing and spending by consumers and businesses. Contractionary fiscal policy designed to reduce government expenditure, increase taxation. This policy is intended to curtail the economy during inflation induced expansion, this is achieved by increasing aggregate demand through reduction in government expenditure or with increase in taxation. Unlike Expansionary policy, Contractionary policy can leads to a lesser budget shortfall or a higher budget surplus. (Amosweb.com, 2016) [236]
The main mechanisms of fiscal policy are variations in the level, structure of taxation, and government spending in many of its economic sectors. These changes can affect the following variables, amongst others, in an economy Aggregate demand is the demand by household and business for the country’s scarce resources and less the demand for resources from other countries. This is equated as the total spending for goods and services within the fiscal year. The formula for calculating aggregate demand is: AD = C + I + G + (X-M)
• C: this is the amount the consumers are spending in the economy and what goods they are spending on such as foods and non-food items.
• I: this is the capital investment on capital good like machines, infrastructure.
• G: this refers to the net government expenditure i.e. spending which include public goods and merit goods.
• X: this is the export of goods and services. This is the service the government sold, or purchased by other countries.
• M: Imports of goods and services from other countries. Imports are a withdrawal of demand (a leakage) from the circular flow of income and spending. (Tutor2u.net, 2014) [189]
In diagram 1 opposite, Aggregate Demand (AD) changes depending on the level of government intervention into the economy. If the government cuts taxation the economy will grow hence the AD moves from AD to AD1; but when there is an increases taxation and decrease in public spending, the AD, as shown in diagram 2 below, will shift from AD to AD2, thus indicating a shrinking economy. (Bryan's Blog, 2013) [68]
To stimulate the economy through monetary policy the following tools has to be applied and implemented properly:
1. Bank Reserve: in most countries Banks are obligated to hold, in their reserve with the Central Bank, certain proportion of their deposits, Cash Reserve Ratio, in reserve in order to guarantee that there is always sufficient cash to meet withdrawal requirements of their customers. By changing the CRR requirement for banks, the Central bank can regulate the quantity of lending in the economy, hence the money supply.
2. Notes and Coins Minting: this involve flooding the market with newly printed bank notes and coins
3. Interest Rates: this is the cost of borrowing money. By influencing interest rates, the government can make it easier or harder to borrow money. If the cost of borrowing is low and people and businesses can afford it then there will be more borrowing, which will lead to more economic activity. For example, businesses tend to borrow at lower rate than higher rates, and at lower rate people tend to spend their money rather than save it because they get so little return on their savings. This is done in Britain through Monetary Policy Committee.
4. Currency Pegging: in times of hyperinflation or runaway inflation some economies tend to use this policy to pair its currency against a stronger currency. Weak economies can decide to peg their currency against a stronger currency. This is used mostly when other resources to regulate the economy are not working.
5. Open Market Operation: the Central banks can generate currency supply into the economy with sales of government bonds to the public. Though this will lead to increase in the level of debt been own by the government, but will also “increases the money supply and devalues the currency causing inflation. However, the resulting inflation supports asset prices such as real estate and stocks”.
6. Quantitative Easing (QE) is an unconventional form of monetary policy where a Central Bank creates new money electronically to buy government securities or any other financial assets with sole aim of directly increasing private sector expenditure in the economy and return inflation to target just to lower interest rate and escalate monetary supply. By supply more capital into the economy financial bodies are compel to increase lending. This policy is “considered when short-term interest rates are at or approaching zero, and does not involve the printing of new banknotes”. (Diffen.com, 2014)[403]
The main purpose of monetary policy as applied by the central banks is to encourage all out workable economic output, and nurture an unwavering price system. To achieve a stable system, means keeping inflation as low as possible as that’s the main purpose of monetary policy. Inflation reduces the strength of currency and has negative effect on economic growth, but with low inflation coupled with stable system, household and businesses have less to worry about in terms of any sudden or unexpected changes in pricing with any financial decision they make.
To achieve this, Central Banks has to be independent of politicians so as to be able to make decisions without biased. Though most Western economies have independent from politicians same can’t be said for emerging and developing economies. If central banks are free of interference, it can use these policies lower inflations in long run but will have effect on employment and economic output in the short run. One disadvantage of this policies can also be seen in the conflicts that arises during implementation. In “reducing interest rates to expand the money supply and stem rising unemployment rates during a recession, for example, could spark future inflation if monetary policy remains expansionary for too long. The best monetary policy seeks to strike a balance between these short- and long-term goals”.