The Effectiveness of Supply-Side Policies (DP IB Economics)

Revision Note

Written by: Steve Vorster

Reviewed by: Jenna Quinn

Supply side policies aim to increase the long-run aggregate supply
These policies often take years to complete, but once completed, they add extra productive potential to the economy
Examples of these kinds of policies include building new roads, new airports, new ports, new hospitals, new schools, new hydroelectric dams etc.
These types of supply-side policies require government spending on an annual basis for as long as it takes to complete the project
- This government spending is a component of aggregate demand and helps to boost the national output in that year
- E.g. to build a new port, the government has to hire a firm to complete the project, pay their workers, and pay for the materials (cement, sand, trucks, steel etc)
- This government spending boosts aggregate demand in the short term
It has been argued that the best government spending is that which boosts AD in the short term but increases LRAS in the long term

Many fiscal policies have the ability to improve the productive potential (supply-side) of an economy
- E.g. Education subsidies to help the poorest households constitute an annual expenditure for the government. However, in the long term they help to improve human capital which boosts productivity and output
- The fiscal policy is short term (annually) however the supply-side impact occurs in the long term

The benefits of supply-side policies far outweigh the negatives, yet many economies fail to fully develop their supply-side policies due to a process of constant political change - and an associated change in government priorities

An Evaluation of Market Based Supply-side Policies

Advantages

Disadvantages

Improved resource allocation: increasing the productive capacity of an economy requires more efficient use of its resources, including labour
No burden on government budget: with an emphasis on freeing up markets and allowing market forces to drive efficiency and resource allocation, there is no requirement for government spending

Equity issues: E.g. the distribution of income worsens as labour market reforms and wage policies lower worker's wages
Time lags: there are significant time lags between expenditure and seeing the benefits
Vested interests: can result in less effective outcomes e.g. there are many examples of privatisation occurring in such a way that the government's preferred bidders obtained an asset at a knock down price
Environmental impact: large infrastructure projects almost always have some negative externalities associated with their creation e.g. dam in a gorge to create a hydro electric dam damages the natural environment and eco system

An Evaluation of Interventionist Supply-side Policies

Advantages	Disadvantages
Direct support of sectors important for growth: Subsidies to specific industries increase the rate of growth of an economy Direct support reduces unemployment Direct support can increase the level of exports Improvements in living standards: Improvements in Infrastructure can raise the quality of life for all citizens	Costs: they are expensive to implement and are paid for using tax revenue - or increased government borrowing Time lags: due to the long-term nature, changes in government often result in changes to budgets and scope of projects and the end result may be less effective than it could have been

Last updated: 12 March 2024

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