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Discuss whether governments should rely solely on supply-side policies to achieve its macroeconomic aims. [15]


(Please see previous post on JC Economics Essays on macroeconomic aims and conflicts.)

Explain the possible conflicts in the achievement of macroeconomic aims when using demand-management policies. [10] 

In the light of these macroeconomic conflicts, discuss whether governments should rely solely on supply-side policies to achieve its macroeconomic aims. [15]

This paper argues that in the light of these conflicts, supply-side policies which focus on shifting the SRAS and LRAS can be used by governments to avoid these macroeconomic conflicts. However, on the other hand, supply-side policies also have limitations and may also result in other macroeconomic conflicts. Hence, it may not necessarily be true that governments should rely solely on supply-side policies.

On the one hand, it can be argued that there are some important reasons why governments should rely solely on supply-side policies.

Firstly, supply-side policies should be used to avoid conflict between achieving full employment and price stability. Since expansionary demand management policies will always lead to inflationary pressures, especially as the economy approaches full employment, supply-side policies should be used instead. If governments focus on increasing productivity of the economy, for example, through subsidising R&D efforts and retraining programmes, the LRAS of the economy will increase  and shift to the right. This allows the economy to achieve both actual and potential growth, while keeping general price levels low. There is thus no conflict between increasing real output and employment and price stability.

Secondly, supply-side policies should be used to avoid conflict between achieving healthy balance of payments and price stability. Since currency depreciation to keep exports competitive may result in imported inflation, supply-side policies should be used to maintain export competitiveness instead. For example, the government may choose to encourage firms to invest in R&D, through the use of tax rebates, in order to use more efficient production techniques. This can cause costs of production to fall and prices of exports can remain competitive. For example, the US government has anti-monopoly laws to encourage more competition. This may give firms more incentive to improve the quality of their products and exports can also be more competitive if their quality is superior to products made in other countries. These would help boost the demand for exports and increase export revenue. The demand for imports might fall if local consumers prefer buying domestic goods. Import expenditure may fall too. This causes the current account and hence the balance of payments to improve. At the same time, because of the increase in R&D across industries, the productive capacity of the economy may increase and LRAS may increase. This helps to keep general price levels low. Hence there is no conflict between achieving a healthy balance of payments and price stability.

However, when (X-M) increases, AD would increase and if the economy is approaching full employment level, there would be inflationary pressures. Thus the extent to which price stability can be achieved depends on the pace of the increase in LRAS. If the LRAS is increasing at the same pace as AD, price stability can be maintained. If AD rises much faster, the conflict with price stability would still arise.

Thirdly, supply-side policies should be used to avoid conflict between achieving healthy balance of payments and economic growth. When expansionary demand management policies to help achieve economic growth, there will be an increase in import expenditure, resulting in a worsening current account and hence balance of payments. However, if supply-side policies are used to attract FDI to promote economic growth instead, the capital and financial account is likely to improve. For example, the government might lower corporate tax rates or offer foreign firms incentives such as tax rebates in order to attract them. They may also reduce the red-tape to make application processes for new foreign businesses more efficient. If there is a net inflow of FDI, the capital and financial account will improve and this may offset the worsening current account. Hence, balance of payments may improve. However, it should be noted that, in the long run, the current account of the balance of payments may worsen even more as profits from foreign firms are sent back to their home country.

On the other hand, supply-side policies also do have their limitations and hence governments should not rely solely on them. While it is true that supply-side policies can help to some extent to avoid some of the conflicts in achieving macroeconomic aims, they also have their shortcomings. For example, supply-side policies like encouraging firms to invest in R&D can not only be costly, they may take a long time before any effects are seen, and even then, the success of these policies is very uncertain. Subsidising R&D can cause a strain on the government budget, depending on how substantial the subsidies are. Since R&D efforts tend to be costly, firms would probably only be incentivised to invest in R&D if the subsidies are significant. This is in contrast with demand management policies like MP where the government need not tap on budget reserves. Furthermore, there is no guarantee that R&D efforts would lead to increase efficiency. The effects of research can be uncertain and often takes many years before a breakthrough brought about by technology or discovery of new methods can be seen. Hence, it may be wise to also make use of some demand-management policies which may have more certain and immediate effects. This is especially so if the economy is facing a recession and needs to get out of it quickly. If there is severe demand-pull inflation, the government may need to take quick action to reduce AD in order to reduce general price levels. Using supply-side policies to shift the LRAS may take too long, especially if the policies are targeted at increasing productivity through technology, training and R&D. If AD is in the Classical range and there is demand-pull inflation, shifting SRAS downward, for instance by subsiding costs, may not help either, since there is no more spare capacity to increase output even if costs are reduced. The inflation will thus not be alleviated. Thus it would not be wise to solely rely on supply-side policies.

It would be better to argue that both demand management and supply-side policies can be used together. While expansionary fiscal or monetary policies can be used to stimulate AD and growth, supply-side policies can be used to ensure that LRAS can continue to increase so that when the economy recovers from the recession, the general price levels may still be kept relatively low.

Furthermore, when using supply-side policies, there may also be conflicts in the achievement of macroeconomic aims which arise and hence governments should not rely solely on them. When supply-side policies such as investment in more R&D and technology are used, there are also other conflicts which may arise. Hence it may not be wise to solely depend on supply-side policies as they also bring about unintended consequences. For example, in Singapore, with the government’s push to increase productivity through encouraging more firms to use technology, for example through the Productivity and Innovation Credit Scheme (PIC), not all workers will be able to adapt. Some workers without the relevant skills may find themselves out of a job. Also, with the rise in the use of technology, some workers may be replaced by machines. If these workers do not have other skills which are relevant to the changing needs of employers, they will face structural unemployment. Hence, pursuing actual and potential growth quickly via supply-side policies may result in a conflict with achieving low unemployment.

However, this does not mean that supply-side policies should not be used. Instead, there can be other policies put in place to mitigate these unintended consequences. For example, governments can put in place retraining programmes and provide subsidies to firms to encourage them to upgrade the skills of their employees.

In the final analysis, in the light of these conflicts, whether or not governments should rely solely on supply-side policies depends on the macroeconomic aims the government is trying to pursue; the prevailing economic conditions; and the nature of the economy. First, if the government wants to achieve sustainable economic growth, it would be wise not to depend only on supply-side policies. This is because supply side policies tend to help achieve potential growth but can be slow in achieving actual growth. If both demand management and supply-side policies are used, actual and potential growth can be achieved together. This helps ensure sustainable economic growth. Some conflicts between macro-economic aims can be avoided when using supply-side policies as discussed above. Hence, supply-side policies alone may be adopted where appropriate. However, it is important to note that supply-side policies may also result in other problems and hence in those instances, relying solely on supply-side policies may not be appropriate. Second, if the economy is facing cost-push inflation, the government may want to rely solely on supply-side policies to increase SRAS in order to reduce general price levels. Using demand management policies in such a situation may be inappropriate because while general price levels may fall with contractionary fiscal or monetary policies, there will be a conflict with growth as real output falls. If the economy is facing a severe recession, the economy is likely to be operating rather far away from the full employment level. This means that expansionary demand management policies are unlikely to cause a conflict with price stability. Thus, the best measure may be to use expansionary fiscal or monetary policies which has quicker and more certain effects than supply-side policies. Third, if the economy has a small multiplier, the effectiveness of demand-management policies may be limited. For example, in Singapore, due to high MPM and MPS, the multiplier is small, any increase in government spending would lead to a small increase in real national income. Thus the government tends to focus on the use of supply-side policies, and depend on external demand instead. However, this does not mean that the Singapore government relies solely on the use of supply-side policies. A mix of both demand management and supply-side policies are considered too.

JC Economics Essays: Once again, special thanks to W for her kind contribution of this well-written economics essay. However, this economics essay was not done under timed examination conditions and was planned and argued carefully. An economics student who delivers this level of content and argumentation within the examination conditions would easily and likely score a grade A. 

This economics paper discusses the pros and cons of relying on supply side policy, and tackles the question through a few important angles. What are these perspectives? Do test yourself to see if you understand the various arguments made and the perspectives through which the arguments were made. 

There are also, of course, many good points to learn from this paper. First, it directly addresses the question. It also has many strong arguments followed up with examples, which suggests that the candidate has learnt her economics material well. It makes many good analytical points by logical, reasonable argument, and does not reply on assertions and stating points. Remember to always argue a point or make a point in your essays. This economics essay is also very well written and crafted, and is clear cut, accurate, and to the point; however, on the other hand, perhaps some economics diagrams could have been drawn. What economics diagrams would you have drawn in this case, and why? Economics essays often benefit from a relevant, well labelled, and accurate diagram that illustrates and analyses a point. Thanks for reading and cheers!

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