Supply-side policies

📚The economics

Goals of supply-side policies

• Long-term growth by increasing the economy’s productive capacity (LRAS shifts right; the PPC shifts out).
• Improving competition and efficiency in product markets.
• Reducing labour costs and unemployment through labour-market flexibility (lowering the natural rate).
• Reducing inflation to improve international competitiveness: more capacity reduces inflationary pressure at any level of AD.
• Increasing firms’ incentives to invest in innovation by reducing costs.

Market-based supply-side policies

These rely on markets and incentives, reducing the role of government.

Policies to encourage competition:

• Deregulation: removing rules that restrict entry or raise costs (licensing requirements, red tape). Airline deregulation brought low-cost carriers and cheaper flights in Southeast Asia. Indonesia’s 2020 Job Creation (Omnibus) Law simplified business licensing.
• Privatization: selling state-owned enterprises to the private sector, where the profit motive is expected to raise efficiency.
• Trade liberalization: cutting tariffs and quotas exposes domestic firms to foreign competition and cheaper inputs (4.3).
• Anti-monopoly regulation: competition law to break up or prevent abuse of market power (2.11).

Labour-market policies (aimed at flexibility and lower labour costs):

• Reducing the power of labour unions, so wages reflect market conditions.
• Reducing unemployment benefits, to strengthen incentives to search for and accept work.
• Abolishing (or lowering) minimum wages: a minimum wage above equilibrium creates unemployment by raising labour costs.

Incentive-related policies:

• Personal income tax cuts, to increase incentives to work, take extra hours or enter the labour force.
• Cuts in business tax and capital gains tax, to increase incentives to invest, start firms and innovate, and to attract foreign direct investment. Indonesia cut its corporate tax rate from 25% to 22% in 2020.

Interventionist supply-side policies

Here the government directly invests or steers the economy, on the view that markets under-provide these things (they are merit goods or public goods with positive externalities).

• Education and training: raises human capital and labour productivity; retraining reduces structural unemployment (Indonesia’s Kartu Prakerja pre-employment card funds short training courses).
• Improving the quality, quantity and access to healthcare: a healthier workforce is more productive and works longer.
• Research and development: funding for universities and research institutes, R&D tax credits; raises technology and productivity.
• Provision of infrastructure: roads, ports, railways, power, internet (Indonesia’s toll-road network, the Jakarta–Bandung high-speed railway). Cuts transport and communication costs, links markets.
• Industrial policies: targeted support for industries seen as strategic: subsidies, tax holidays, special economic zones, local-content rules. Indonesia’s ban on exporting raw nickel ore (from 2020) to force processing at home, building a smelter and battery industry, is a prominent example.

Demand-side effects of supply-side policies, and supply-side effects of fiscal policy

• Many supply-side policies also shift AD in the short run: government spending on infrastructure, education and health is part of G; tax cuts raise C and I. So AD rises first, and LRAS shifts only later, when the road is built or the students graduate.
• Conversely, fiscal policy has supply-side effects: capital spending adds to productive capacity; tax structures affect incentives to work and invest. A stimulus focused on infrastructure raises AD now and LRAS later.

How effective are supply-side policies?

Supply-side policies and the macro objectives: they are the only policies that can deliver growth and lower unemployment (the natural rate) and lower inflation at the same time, because a rightward LRAS shift raises output while easing price pressure. But they work slowly, and do nothing for cyclical unemployment in a recession, when demand management is needed.