RI H1 Economics Lecture Notes 9 Supply Side Policy

2019 Y6 H1 Economics Macroeconomics 77 RAFFLES INSTITUTION YEAR 6 H1 ECONOMICS 2019 MACROECONOMICS POLICIES SUPPLY-SIDE POLICIES Outline of Content 1 Introduction 2. Definition of supply-side policies 3. Types of supply-side policies 3.1 Market-Oriented Supply-Side Policies 3.2 Interventionist Supply-Side Policies 3.2.1 Manpower Policies 3.2.2 Grants to Encourage R&D 4. Effects of supply-side policies 4.1 On Output and Price 4.2 On Employment 4.3 On Government Budget 5. Limitations of supply-side policies Appendix: Further Reading Appendix 1: CET 2020: Transforming the CET System to Build a Competitive Economy and a Career Resilient Workforce Appendix 2: Govt commits S$19b to new 5-year plan for R&D initiatives RIE2020 References: Abel, Andrew B., & Bernanke, Ben S., Macroeconomics, 4th Edition, Addison-Wesley Froyen, Richard T., Macroeconomics: Theories and Policies, 6th Edition, Prentice Hall Gordon, Robert J., Macroeconomics, 8th Edition, Addison-Wesley Lispey, Richard G, Steiner, Peter O, & Purvis, Douglas D, Economics, 9th Edition, Harper Collins Slavin, Stephen L., Macroeconomics, 8th Edition, McGraw-Hill Sloman, John, Economics, Prentice Hall Cook, Mark, & Healey, Nigel, Supply Side Policies, 4th Edition, Heinemann At the end of this lecture series, you should be able to: 1. Explain the general objectives of supply-side policy. 2. Explain the various types of supply-side policies – for example, supply-side tax cuts, , elimination of structural bottlenecks, promoting labour mobility and productivity. 3. Explain examples of supply-side policies implemented by the Singapore government. 4. Discuss how supply-side policies are used to influence output and employment, price levels. 5. Evaluate the effectiveness of supply-side policies – for example, accuracy and availability of information, time lags, uncertainty of outcomes, policy acceptability. @dream

2019 Y6 H1 Economics Macroeconomics 78 1 Introduction Prior to the Great Depression in the 1930s, public policy was shaped by the views of classical economists who advocated laissez-faire and the belief that recessions were short-run phenomena that corrected themselves through free market forces. Discretionary fiscal policy was seldom used to influence the performance of the macroeconomy explicitly. Following the onset of the Great Depression, the 1960s were the Golden Age of fiscal policy. However, during the 1970s, the problem was stagflation: the double trouble of higher inflation and higher unemployment. Demand management could not solve stagflation: an increase in AD would only worsen inflation while a decrease in AD would worsen unemployment. Thus, some economists began to focus on “supply- side policies” to ensure that material SOL is growing over time. 2 Definition of Supply – Side Policies Supply-side economic policies are mainly designed to improve the supply-side potential of an economy, make markets and industries operate more efficiently and thereby contribute to a faster rate of potential growth which can lead to lower general price levels and higher employment and more goods and services for people to enjoy. Referring to Figure 1 below, successful supply-side policies will shift the aggregate supply from AS1 to AS2. Most governments now accept that an improved supply-side performance is the key to achieving sustained economic growth while dampening inflation. Let’s assume that there is an increase in Aggregate Demand from AD1 to AD2 as shown in Figure 1. Without any supply-side growth, the increase in Aggregate Demand will result in a higher general price level from 0P1 to 0P2. To avoid inflation, the economy must achieve supply-side growth. With successful supply side policies, the Aggregate Supply curve shifts from AS1 to AS2. Inflation is avoided as general price level returns to 0P1 and higher actual (0Y3) and potential (0YF2) growth are achieved. Supply-side factors often help to explain why some countries grow faster than others. In the long run, the growth of an economy is determined by supply-side factors such as technological progress, capital accumulation and the size and quality of the labour force. In general, supply-side policies will lead to 1) A downward shift of the AS curve arising from a fall in the unit cost of production, e.g. reducing the power of labour unions (Figure 2); OR Y2 YF1 P2 Figure 1: Supply Side Policies and Growth General Price Level AS1 AS2 AD1 AD2 P1 Y1 Y3 YF2 Real National Income A rightward shift in AS represents an increase in a country’s potential growth Note: Supply-side policy on its own however is not enough to achieve sustained economic growth. It must be supported by a high enough level of aggregate demand. @dream

2019 Y6 H1 Economics Macroeconomics 79 2) A rightward shift of the AS curve arising from an increase in productive capacity, this is also known as potential growth, e.g. increased supply of labour through liberal immigration policy (Figure 3); OR 3) An outward shift of the AS curve, arising from both a fall in unit cost of production and an increase in productive capacity e.g. technological improvements and labour productivity (Figure 4). 3 Types of Supply-Side Policies 3.1 Market Oriented Supply-side Policies for Labour Markets 3.1.1 Reducing the power of trade unions The power of trade unions to push up wages would raise unit labour costs, assuming productivity growth is slower than wage growth, and contribute to higher cost of production and hence cost-push inflation. At the same time, firms will cut down on their use of labour as they cut back on their production of goods and services, leading to a fall in employment. Reducing the ability of trade unions to unilaterally raise wages can encourage firms to production facilitiest as wage cost can be monitored and projected more accurately. This will reduce the extent of cost-push inflation and reduce the extent to which AS will fall. At the same time, it helps to reduce / eliminate the incidence of work stoppages or industrial strikes so that loss of output due to strikes is prevented. This may attract foreign investment, increasing productivity and thereby shifting the AS curve to the right in the long run (Figure 3). At the Figure 4: Outward shift of AS AS2 YFE GPL Real NY AS1 Figure 2: Downward shift of AS AS2 YFE1 YFE2 GPL Real NY AS1 Figure 3: Rightward shift of AS AS2 YFE2 GPL Real NY AS1 AD1 AD1 AD1 YFE1 @dream

2019 Y6 H1 Economics Macroeconomics 80 same time, if productivity grows faster than wages, it will lead to a lower unit labour cost of production, thereby shifting the AS curve downwards. Some measures to weaken the power of militant trade unions include restrictions on close- shop policies and industrial strikes. In Singapore, the tripartite policy ensures a harmonious industrial relation between the employers (represented by the Singapore Employers Federation), the workers (represented by NTUC) and the government (represented by the Ministry of Manpower) Representatives from all 3 parties sit on the National Wage Council (NWC). Established in 1972, the NWC was designed to bring wage increases in line with national productivity growth. For more information on Tripartism Policy in Singapore, please visit website: http://www.mom.gov.sg/employment-practices/tripartism-in-singapore/Pages/default.aspx 3.1.2 Incomes policies (Wage Guides/ Flexible Wages/Wage Freeze) The basic wage guidepost is that wage rates in all industries should be flexible, i.e. rise in accordance with the rate of increase in labour productivity for the nation as a whole v