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Supply-Side Policies and Market Productivity

Introduction

Economic recessions are particularly troubling times for economies where growth is halted, incomes are lost, and households fail to afford products and services. A recession can be described as a tipping point in the economic cycle where an ongoing growth at the peak reverses and changes into an enduring market contraction (Amadeo, 2020). In other words, a recession represents a significant decline in the economic activity which lasts several months and is usually reflected through the changes in the real income, gross domestic product (GDP), and wholesale and retail prices among others. The governments make efforts to help the country in this situation, often through the use of various policies. In this case, the supply-side policies and their implications on market productivity are considered. These policies focus on aspects such as taxes, government benefits, and labor regulations

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Research has presented a divided opinion on the questions of whether the supply-side policies are the best solutions to help a country out of recession. In history, there are cases in which these policies worked, for example, Germany and the USA, and other cases where they were considered a failure, for example, France. However, it can be argued that the success of these policies depends on whether or not the extent to which the traditional Keynesian models are used and other factors such as inflation come into play to support the supply-side policies. This paper examines the effect of supply-side policies and market productivity during a recession. An argument that these policies are inadequate will be examined and solutions will be recommended.

Discussion and Analysis

Supply-side policies entail attempts by the government to boost economic activity to keep the economy functioning optimal. The arguments regarding their inadequacy to overcome a recession support the idea that these frameworks can only work in the short to medium term and that their effects are weak. These sentiments have been presented by Dosi et al. (2019), whose focus has been the relationship between these interventions and the characteristics of the labor market. These researchers explain that the supply-side policies intended to reduce unemployment are not independent of the labor market conditions. The question that remains, therefore, is whether these policies alone can be relied on during severe downturns, especially in structurally weak labor markets. The expected outcomes of measures intended to boost labor, for example, increasing training programs and helping people with job searches, is that employment will go up, and the national income will follow. Additionally, the availability of labor means more productivity of the markets, and the incomes can boost the aggregate demand. With this cycle, the decline in economic activity, which is the major event in a recession, is reversed, at least in theory.

Boosting employment as a means to recover from a recession works partially because other factors affect the economy. A discussion of the concept of secular stagnation from a supply-side perspective by Rachel and Summers (2019) can explain the unsustainability of such approaches. These authors argue that secular stagnation is common phenomenon among the industrialized world. Therefore, the cases of France, the US, and Germany used in this paper could be facing the same challenges where declines in neutral interest rates have also been attributed to other aspects. These include shifts investment and saving propensities as opposed to the liquidity properties of the treasury. The slow growth affects the living standards and reduces net investment, which in turn reduces the growth of productivity. Additionally, it can be expected that inflation would result from rising national income from labor. This inflation can neutralize any productivity, and the progress made in the short term may reverse until a new equilibrium is achieved, in which case this could be the secular stagnation.

Other supply-side policies focus on other macroeconomic elements targeted by the government. A case study of the United Kingdom presented by Minford and Meenaggh (2020) discusses policies targeting taxation and other regulations. The UK government implemented major reforms in the UK’s institutions, including reductions in marginal tax rates and regulation of hiring and firing laws (labor reforms), intended to remove barriers to entrepreneurship. The rationale was that such efforts will facilitate economic growth through the production function. In other words, these supply-side policies seek to improve market productivity, mechanisms that have thus far worked for the country. Additionally, the Plan for Growth developed in 2011, focused on enhancing the growth of startups through a reduction in tax and regulation burdens. Considering that no UK government has moved away from these reforms, it can be argued the supply-side policies can be effective.

However, the situation explained above is not from a recession but rather from a growing economy. The UK case study can only be used to illustrate the positive effect of supply-side policies in an economy not affected by a recession. Conflicting views on the working of the supply-side policies in economic crises can be examined by looking at cases where they worked and where they did not work. In the case of France, researchers such as Cohen-Setton et al. (2017) explain that the country deviated from the standard and decided to implement mandatory increases in wages. The deflation ended but the productivity stagnated. These researchers also refer to US policies during the great depression. The US implemented what was known as the National Industrial Recovery Act (NIRA). The standard Keynesian models used for policy analysis, according to Cohen-Setton et al. (2017), show that the program ought to have been expansionary considering the economic conditions witnessed during the depression. However, these researchers indicate that economists have suggested that the Act was not expansionary.

Different countries across the world responded differently using the supply-side policies. In France, the supply-side policies were implemented by the Leon Blum government who was elected in May 1936 (Cohen-Setton et al., 2017). These policies were compared to NIRA but at a far greater scale. The private sector wages were raised from 7% to 15%, workers were granted 2 weeks paid leave, and work wast confined within 40 hours without pay loss (Cohen-Setton et al., 2017). These policies isolated the demand-side resulted in a massive increase in inflation and prevented France from recovering from the great depression. As explained above, the supply-side policies may offer short to medium term solution before market forces revert the progress to a new equilibrium. Most importantly, productivity not matched by adequate aggregate demand, majorly die to hiked prices, means most supply-side policies fail to produce the desired results.

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Germany is one exception where the Social Democratic Party (SPD) implemented supply-side policies that deviated from the traditional Keynesian thinking. The government’s focus was to balance its budget and reduce its debt. According to Bremer (2020), the concerns about its reputation for economic competence resulted in the SDP supporting fiscal consolidation. Germany recovered quickly from the 2008-2009 crisis despite the government itself remaining in crisis due to the Eurozone crisis that kept a tight grip on the Euro (Bremer, 2020). Stimulus programs including taxes and benefits and economic liberalism practiced through privatization, deregulation was often supported by the left-wing. However, the right-wing supported different approaches to recovery. Overall, however, the extent to which the supply-side policies were deployed, differed from the US and France, something that made Germany an exemption. This is because Germany supported welfare but opposed economic liberalism and rigid budgetary policy. Deregulation and growing market liberalization allowed the adverse effects of inflation. Arguably, there was a balance between the supply-side and demand-side of the equation that has the effect of cancelling out the effects of inflation.

It can be seen, therefore, that the supply-side policies fail to boost productivity during a recession, an effect that they usually have during normal economic conditions as in the case study of the UK. During normal times, the policies focusing on taxes and labor make sure that that unemployment is kept at the minimum and that the households can boost the aggregate demand because the prices are maintained. In other words, inflation during a forced expansionary policy soon reverses the effects of these policies as explained in the case of France (Cohen-Setton et al., 2017). The traditional Keynesian model states that increasing government expenditure and lowering taxes stimulates demand and pulls an economy out of a depression. Without boosting demand, therefore, a supply-side policy alone cannot boost market productivity during a recession.

Solutions

As explained in the discussion above, supply-side policies fail to boost market productivity in the long-term because of inflation that reduced the aggregate demand. With lower aggregate demand, the production slows down and the market reverses back to recession. The major solution to this phenomenon is to implement demand management policies alongside the supply-side policies. A sample framework for demand management policies has been presented by Dosi et al. (2019) comprising government taxes, bank profits, and government benefits. The taxes and profits are at a fixed rate and the government benefit is calculated as a fraction of the average wage. As such, the unemployment benefit becomes that main tool to manage the passive labor market policies. It is argued that they work differently from boosting labor in that the current productivity is maintained alongside the aggregate demand to keep the economy running.

A comparison between supply-side and demand-side policies reveals that the two can supplement each other to lift the economy out of a recession. Dosi et al. (2019) present a study where the main conclusions reached include that the supply-side policies cannot reverse the perverse relationship between austerity and flexibility. Additionally, they conclude that the demand-side policies, specifically demand management, can mitigate inequality better and can improve and sustain growth in the long-run. For this reason, the solution proposed here is founded on the idea that consumption drives market productivity where aggregate demand drives up the aggregate supply. Assuming that the prices will be stable, that is, the government will regulate the prices to eliminate inflation, then the most likely response to aggregate demand is productivity growth and subsequently an economy is lifted from recession.

As mentioned above, the failure of the supply-side policies is caused by the movements in the inflation rates. Therefore, another solution that can help these policies achieve the objective for which they are implemented is to regulate aggregate prices to ensure that growing aggregate demand does not cause a rise in prices. During inflation, high uncertainty means corporations and consumers are unlikely to spend (Jain, 2017). This has the effect of negatively affecting the economy in the long run. Keeping inflation low during the implementation of supply-side policies will help reduce this effect. However, it is important to acknowledge that inflation tends to decline during a recession because sellers have unsold stock and the only way to boost sales is by reducing the prices. The rise in inflation is triggered by the rising costs of production from the labor regulations.

Conclusion

The supply-side policies are intended to improve productivity to keep the economy out of a recession. However, evidence from France and Germany presented above reveals that only short term growth in market productivity can be achieved with these policies. In long-term, however, other market changes, including rising inflation, will reverse these growth effects and the productivity declines again. It has been argued that better management of aggregate demand and inflation will help achieve long term market productivity. This is because aggregate demand can keep productivity levels high, thereby lifting the economy out of the depression. However, policies that increase the costs of production through labor regulations will negatively affect the aggregate demand through inflation. Keeping inflation low helps to sustain higher levels of production because the resulting movements in supply under stable prices keeps the economy running. Additionally, outcomes such as the growth in national income from the rising employment levels prevent the economy from reverting to a recession.

References

Amadeo, K. (2020). Causes of an economic recession. The Balance. Web.

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Bremer, B. (2020). The political economy of the SPD reconsidered: Evidence from the Great Recession. German Politics, 29(3), 441-463. Web.

Cohen-Setton, J., Hausman, J., & Wieland, J. (2017). Supply-side policies in the depression: Evidence from France. Journal of money credit and banking, 49(2-3), 273-317. Web.

Dosi, G., Pereira, M., Roventini, A., & Virgillito, M. (2019). What if supply-side policies are not enough? The perverse interaction of flexibility and austerity. Journal of Economic Behavior & Organization, 162, 360-388. Web.

Jain, E. (2017). Inflation and recession: Impacts over global economies and markets. IOSR Journal of Economics and Finance, 8(2), 1-5. Web.

Minford, L., & Meenaggh, D. (2020). Supply-side policy and economic growth: A case study of the UK. Open Economies Review, 31(1), 159-193. Web.

Rachel, L., & Summers, L. (2019). On secular stagnation in the industrialized world. Brookings Papers on Economic Activity, 105(5), 1-76. Web.

Appendix: PowerPoint Slides

Supply-Side Policies
Proposed Solution
Proposed Solution (Contd.)

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