In Economics, Supply Side Policies are policies aimed at increasing Aggregate Supply (AS), a shift from left to right. Successful policies lower the natural rate of unemployment. They enhance the productive capacities of an economy while improving the quality and quantity of the four factors of production. However, supply side policies are difficult to implement and take time to take effect.
Examples of Supply Side Policies
1. Labor Market
Lowering wages frees up the labor market, which makes a lower paid job more attractive. To lower wages, the government would need to abolish minimum wage laws, decentralize trade union power, reduce of unemployment benefits, lower income tax and make hiring/firing easier and cheaper for firms. However, these policies are very politically unpopular and aren’t likely to be implemented.
2. Capital Markets
By increasing competition between banks to make loans more attractive, and reducing financial crowding out and by making savings more attractive, governments create more money for banks to use for investment.
By lowering marginal tax rates and encouraging share ownership amongst employees.
4. Competition and Efficiency
Through the removal of monopolies, by encouraging privatization, freeing up trade and implementing inward investment policies.
Better education and training to improve skills will improve labor productivity.
Impact of Successful Supply Side Policies
In the diagram below, we can see a shift in Aggregate Supply from S1 to S2, which shows the impact of a successful supply side policy.
1. Lower Inflation
Shifting Aggregate Supply to the right will result in a lower price level. By making the economy more efficient, supply side policies help reduce cost push inflation.
2. Lower Unemployment
Supply side policies can help reduce structural, frictional and real wage unemployment and therefore help reduce the natural rate of unemployment.
3. Improved economic growth
Supply side policies can increase the sustainable rate of economic growth by increasing Aggregate Supply.
4. Improved trade and Balance of Payments
By making firms more productive and competitive, they are able to export more.
Long Run Effects of Supply Side Policies
In the short run, we see Short Run Aggregate Supply (SRAS) shift from SRAS1 to SRAS2 (an increase in AS), and in the long run this will result in an increase in Aggregate Supply from LRAS1 to LRAS2.
Production Possibility Curve with a Successful Supply Side Policy
In terms of a production possibility curve, it would shift capabilities from ‘A’ to ‘B’.
Disadvantages of Supply Side Policies
1. Time Lag
A supply-side policy can take a long time to work. For example, improving the quality of human capital, through education and training, normally takes years to reap tangible benefits.
They can be costly to implement. For example, the provision of education and training is highly labor intensive and extremely costly.
Many supply side policies are politically unpopular and therefore unlikely to be implemented. For example, unions wield significant political influence and would oppose any negative labor market changes like breaking up unions and abolishing minimum wages.