Explain supply-side policies and how they raise productive capacity, growth and employment

What this dot point is asking

The syllabus wants you to explain supply-side policies and how they raise the economy's productive capacity, growth and employment. The big idea is that, unlike fiscal and monetary policy which work on total spending (the demand side), supply-side policies work on the economy's ability to produce (the supply side), aiming to raise output without causing inflation.

The answer

What supply-side policies are

On a diagram, a successful supply-side policy shifts the economy's production possibility curve outward: the whole economy can produce more.

The main supply-side policies

Governments use several measures to raise productive capacity:

• Education and training. Better-educated, better-trained workers are more productive (higher human capital), so each worker produces more. This also reduces structural unemployment by matching workers' skills to the jobs available.
• Investment in infrastructure. Better roads, ports, airports and digital networks lower firms' costs and let the economy produce and trade more efficiently.
• Incentives to work and invest. Lower income tax can encourage people to work more, and lower business taxes or grants can encourage firms to invest in new capital.
• Encouraging competition and enterprise. Making it easier to start a business and encouraging competition can raise efficiency and innovation.

How supply-side policies help

By raising productive capacity, supply-side policies can:

• Raise economic growth over the long term, by lifting the economy's ability to produce.
• Reduce unemployment, especially structural unemployment, by giving workers the skills firms need.
• Reduce inflation pressure, because a bigger productive capacity means demand can rise without running into shortages that push up prices.

This last point is the key advantage over demand-side policy: supply-side policies can raise output without causing inflation, because they expand what the economy can produce.

The limitations

Supply-side policies have drawbacks:

• Time lags. They work slowly. Educating and training workers or building infrastructure takes years, so they cannot fix a current recession quickly.
• Cost. Many measures, such as schooling and infrastructure, are expensive, with a large opportunity cost.
• Uncertainty. It is not guaranteed that, say, lower taxes will raise effort and investment as hoped.

Examples in context

Example 1. SkillsFuture and training in Singapore. Singapore's SkillsFuture programme funds workers to learn new skills throughout their careers. By raising human capital and productivity, it lifts the economy's productive capacity and reduces structural unemployment, a clear supply-side policy suited to a fast-changing economy.

Example 2. Investment in infrastructure. Singapore's investment in its port, airport and digital networks lowers firms' costs and lets the economy produce and trade more efficiently. This raises productive capacity over the long term, supporting growth without adding to inflation, which is the hallmark of supply-side policy.

Try this

• Cue. Define supply-side policies. Measures designed to increase the economy's productive capacity, usually by raising the quantity or quality of the factors of production.

• Cue. Explain how education and training raise an economy's output. They improve workers' skills and productivity, so each worker produces more, which raises the economy's productive capacity and shifts the production possibility curve outward, increasing output.

• Cue. State one advantage and one limitation of supply-side policies compared with demand-side policy. Advantage: they can raise output without causing inflation, because they expand capacity. Limitation: they work slowly, over years, and are often costly.