No doubt personal and business tax cut should increase aggregate supply and, therefore, produce non-inflationary real output growth. If savings are highly responsive to the real interest rate, tax cut that increases the real return to savings would be effective. These business tax cuts aim at offsetting the inflation-induced increase in the effective tax rate on business profits. So total tax revenues will neither rise nor fall. Failure to cut spending, together with tax reduction will lead to high government budget deficit. Human capital, much like physical capital, enhances an economy’s ability to produce goods and services. Such capital refers to the knowledge and skills that workers achieve through education and training which lead to skill formation, improved efficiency and enhanced productivity. In some of the African countries, namely, Congo, Guinea, Ivory Coast, Cameroon, Gabon, Gambia, Mali, Guinea, Togo and Guinea-Bissau, the governments have adopted the policies to increase population. The 2015 innovation package and the decision to implement most of the Harper Review competition policy recommendations were standout initiatives. 17/11/2019 02:57 PM. Disclaimer Copyright, Share Your Knowledge However, if the economy is already close to full capacity (trend rate of growth) a further increase in AD will mainly cause inflation. At the same time the government can play an active role in promoting a few specific industries which are the carriers of rapid technological progress, called knowledge-intensive industries or sunrise industries. In the case of Eurozone countries, devaluation is needed (see: competitiveness in Europe), but it is much harder to devalue and leave the exchange rate because of the likelihood of capital flight. This led to the Barber boom – rapid economic growth. (iv) Encouraging research and development (R&D): The government may also stimulate productivity growth by affecting rates of scientific and technical progress. In this case, the economy at Y1 has spare capacity. Free trade agreements with China, Japan and South Korea will offer real, if modest, benefits. This is likely to encourage tax evasion and avoidance. In the 1970s, the UK economy suffered because of poor industrial relations. Sustainable Economic Growth: Sustainable economic growth is a rate of growth (an increase in real output in an economy) which can be maintained without creating other significant economic problems. The diversification and job creation efforts require to focus on prompt and bold market-friendly reforms that can reduce the costs of doing business, improve skills in the labour force, make the public sector more efficient, privatise key enterprises, and enable competition and entry of firms in sectors with latent comparative advantage. The income effect states that higher taxes make people work longer hours to achieve their target income. For example, a piece of equipment that could have been depreciated over a 10-year period can be allowed to be depreciated over a 5-year period. There are many factors that affect economic growth. The disadvantage of devaluation is that it can lead to short-term economic pain. More flexible labour markets can thus provide a long-term boost to investment. The UK also benefited from leaving the exchange rate mechanism in 1992. Answers Mine. A tax cut imparts the needed dynamism to the economy. Based on that measure of cost-effectiveness: Higher-impact policies. So we can't say that the economy will improve with one factor alone. One way of doing this is to curtail government purchases. Health policies are designed to educate society and improve the current and long-term health of a country. However, to ensure that demand is not overly stimulated, the economy is not overheated and to keep the budget deficit as small as possible, there is need to cut non-plan revenue expenditure in areas such as housing and income support programmes (including subsidies) so as to reduce the magnitude of public debt. Lower interest rates may not always boost spending. It is necessary to avoid an economic boom, where growth proves unsustainable and inflationary. The government can directly increase the rate of saving by increasing its own saving, called public saving. 1. … The alternative strategy for improving economic growth is to use supply-side policies. Demand Side Policies are attempts to increase or decrease aggregate demand to affect output, employment, and inflation. More flexible labour markets could increase job insecurity and lead to harmful effects on labour productivity. This policy in these developing countries is based on the belief that continued population growth is the key to economic devel­opment. For countries stuck in a fixed exchange rate. In a liquidity trap, where lower interest rates fail to boost demand, the Central Bank may need to pursue more unconventional types of monetary policy. The Unemployment Rate (Percent) Source: Congressional Budget Office; Department of Labor, Bureau of Labor Statistics. The application of supply-side economic policies in the 1980s under the dynamic leadership of Ronald Reagan has proved conclusively that tax cuts increase labour supply and, therefore, output. In order to ascertain whether an economy is at, above, or below the Golden Rule steady- state, we have to compare the net marginal physical product of capital (MPK – δ) with the rate of growth of output (n + g). Altering the Saving Rate 2. However, there is a trade-off. However, government intervention may be desirable in some cases, notably in the early development stages of technologically innovative products, such as computers and CAT scanners. Since social benefit from such investment exceeds private benefit the government has to take the lead in making investment in human capital or subsidise such investment. Lower marginal tax rates improve incentives for labour supply, saving and investment. Another criticism of monetary policy is that cutting interest rates very low could distort future economic activity. Search. 2014). A danger of industrial policy is that wrong industries may emerge due to favouritism shown by the politicians. So it is necessary for the government to generate a surplus in the budget to ensure that public saving is positive. N. G. Mankiw and David Romer in explaining international differences in living standards have demonstrated clearly that human capital is at least as important as physical capital. Privatisation and deregulation. Managing AD to avoid boom and bust cycles can help provide a longer period of economic expansion. However, such programmes are justified if benefits exceed costs. Reducing the basic rate of income tax from 23% to 22% would have a v… There needs to be increased access to financial services to manage incomes, accumulate assets, and make productive investments. Economic growth leads to higher GDP per capita, more public and merit goods, and more employment. For instance, it has often been argued that the best governments can do is to eliminate the obstacles to the smooth functioning of market forces and provide information to […] Lower income tax will increase disposable income and encourage consumer spending. Issues of stabilization and growth cannot be separated. Most such policies encourage the private sector to allocate substantial amount of resources to techno­logical innovation. In contrast, if the economy is operating with too much capital, then MPK – δ < n + g, and the rate of saving has to be reduced. Economic growth and inflation have an inverse relationship. It is argued lower income tax can boost the incentive to work and increase labour supply. Supply-side policies include: Lower Income Taxes. Various public policies are designed to promote technological progress. And one way of doing this is to reduce tax rates because taxes on saving reduce the return to saving. These attempt to increase productivity and efficiency of the economy. - Regulation and supervision to ensure that banks are well capitalised and make sufficient provisions increases the robustness of … Apart from giving support for basic science and technology, the government can encourage technological development through industrial policy. So the government should make more investment on such policy. But, unless there is sufficient demand, firms will be reluctant to increase production and set up new business ventures. The aim of expansionary fiscal policy is for the government to offset the fall in private sector spending. ... and is expected to increase to a striking 55 percent by 2050 as demographic trends accelerate. Meaning that when the economy grows, inflation falls and when inflation increase, the economy slows down. A fall in the exchange rate makes exports cheaper and imports more expensive. It encourages people to work hard, save more and take more risks (i.e., invest more in venture capital). So there is a case for a ‘stimulus package’ consisting of public investment in infrastructure, worker retraining and partnership between business and government to move resources from ‘sunset’ industries (i.e., industries losing comparative advantage) to sunrise industries (i.e., industries gaining comparative advantage). Demand Side Policies can be classified into fiscal policy and monetary policy. This amounts to negative public saving1. Therefore, although in theory, it was cheap to borrow, it was hard to actually create credit. With an adversarial attitude, it was difficult to promote more labour efficient production processes. Aggregate Demand is made up of Consumer Spending + Government Spending + Investment + Net Exports (exports-imports). One crucial form of human capital, ignored by the Solow model is entrepreneurial skill. Increasing exports ranks among the highest priorities of any government wishing to stimulate economic growth. Health policies can have positive long-run effects on not only human capital, but also economic growth as a whole. Some specific regulatory measures may be to decontrol petroleum markets, abolish licensing regulations, reduce monopoly control and stop excessive monopoly hunting and to introduce a cost-benefit analysis of government expenditure. In the late 1980s, there was a loosening of monetary and fiscal policy. This can be done by the patent system which gives protection to intellectual property rights for a specific time period. However, long-term sustainable growth ultimately depends on supply-side improvements because balance of payments and inflationary problems are less likely when the productivity of factors improves. Technological Progress 5. Expansionary fiscal policy– cutting taxes to increase disposable income and encourage spending. You are welcome to ask any questions on Economics. – A visual guide The fear is that increasing the money supply could cause inflation. In general, demand-side policies aim to change the aggregate demand in the economy. If the economy is already growing, then higher government borrowing can crowd out the private sector. The Coalition’s first term economic policy achievements were a mixed bag. Share Your Word File But the best way to reduce inflation is to increase production. Expansionary monetary policy (now usually set by independent Central Bank) – cutting interest rates ca… Economic Growth And Its Effect On The Economy Essay 2093 Words | 9 Pages. For example, in the 1980s, the UK pursued several relatively successful supply-side policies (privatisation, reduce the power of unions, lower income tax). According to the Solow model of growth, the rate of saving and investment is a key determinant of a country’s rate of growth and standard of living of its citizens. For example, in 1972, the UK chancellor, Anthony Barber announced a ‘dash for growth’. For promoting investment in human capital the government has to make investment on such capital. Aging may slow economic growth in advanced economies (photo: Zero Creatives Cultura/Newscom). While the private sector invest in plants, machinery, computers and robots, the government invests in various forms of public capital, called infrastructure. In short, the potential has existed for adequate, widespread wage growth over the last three-and-a-half decades, but these ec… Alternative policies — such as a tax break for all research and development spending — promote technology without requiring the government to target specific industries. The problem with expansionary fiscal policy is that it leads to an increase in government borrowing. How to improve things “South Africa’s economic growth has decelerated because of declining global competitiveness, growing political instability, and … TOS4. In the 1980s, other countries began to show signs of convergence. Here we detail about the ten major economic policies which are followed in India and has played a major role in the growth of Indian economy. It is because they are people with the ability to build a new product, business or introduce something new to the market. There is a strong connection between productivity growth and human capital. In reality, we find that the potential for beneficial spillovers in these cases is very large. • Financial sector policies can also influence how shocks are propagated. Without quantitative easing, the recession was likely to be deeper, though QE alone failed to return the economy back to a normal growth projection. For example, if you invested in better education and training, it could take several years for this to lead to higher labour productivity. In 2009, UK interest rates were cut to 0.5%, but spending remained subdued. Demand side policies are important during a recession or period of economic stagnation. Reduction in Government Regulation 6. Others, such as signing the Trans-Pacific Partnership (TPP) and accelerated environmental project approvals, carr… Highly regulated labour markets, with excessive regulation, may discourage firms from employing workers and setting up in the first place. More detail on the effect of lower interest rates. Therefore, this shows monetary policy can be ineffective in boosting economic growth. Rising import prices increase inflation and reduce standards of living. The government can also save more by reducing the budget deficit. These low-interest rates encouraged people to take on ambitious loans and mortgages; this was a factor behind the US housing bubble. However, this argument is often exaggerated. Notes: Data are quarterly and are plotted through the fourth quarter of 2016. Expansionary fiscal policy is also criticised by those who fear it is an excuse to permanently increase the size of the government sector. In the Solow model the saving rate determines the steady-state levels of capital and output. To boost AD, the Central Bank (or government) can cut interest rates. Devaluation can help restore competitiveness and boost domestic demand. Penner focuses on a growth agenda that includes: Enhancing the rate of growth of hours worked by increasing the size of the labor force through more high-skilled immigration and … Industrial Policy. The government can also affect national saving by influencing private saving — saving of the household sector and the corporate sector (i.e., retained earnings of corporations). The Policies are: 1. Demand-side policies cannot increase the rate of growth above the long-run trend rate without causing an unsustainable boom and bust. One criterion for evaluating fiscal policy options is the impact on the economy per dollar of budgetary cost. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. This needs to be done during a recession or a period of below-trend growth. growth will be lower. In general industrial policy is not desirable because, in choosing industries to target, governments have frequently backed the wrong industries; the costly attempt to develop those industries which are unlikely to show much promise in the long run. Personal income tax cuts increase personal saving. Before publishing your Articles on this site, please read the following pages: 1. This is despite real GDP growth of 149 percent and net productivity growth of 64 percent over this period. Flexible labour markets. However, in 2009-12, the depth of the financial crisis means there is no immediate danger of a housing bubble, so it was appropriate to keep interest rates at zero. Therefore cutting interest rates, at the wrong time, can contribute to a future housing and asset bubble which will destabilise economic growth. These attempt to increase productivity and efficiency of the economy. However, this argument is often exaggerated. There is, however, still strong disagreement on how governments should intervene. Lower Income Taxes. But, there was no economic miracle, when growth went above the long-run trend rate of 2.5% – it proved unsustainable and led to boom and bust. It is argued lower income tax can boost the incentive to work and increase labour supply. increase, increase decrease, increase increase, decrease. Share Your PDF File If the government generates a budget surplus it can repay some of the debt and stimulate investment. However, if the economy is already close to full capacity (trend rate of growth) a further increase in AD will mainly cause inflation. Click the OK button, to accept cookies on this website. So the aim of government policy should be to eliminate wasteful or outdated regulations and to make necessary regulations more efficient and flexible. Supply side policies are relevant for improving the long run growth in productivity. The tax policy should be such as to encourage capital formation by increasing the after-tax return to investment. The consequent inflation may act as a growth-retarding factor. Lower interest rates will also reduce mortgage interest payments, increasing disposable income for consumers. They find that a 0.1 percentage point increase in annual economic growth would reduce deficits by roughly $300 billion over a decade, mostly through higher revenues. Politicians often over-estimate the potential for supply side policies to improve the long term growth rate. Estimates from both the Office of Management and Budget and CBO suggest that faster economic growth would improve the fiscal outlook. To finance this extra spending, the government have to borrow from the private sector. It is possible, if income taxes were excessive, then cutting them may encourage people to work more. But even without Simpson Bowles, here are a few common-sense proposals which would reverse the “new normal” with policies focused on economic growth. Government Policies to increase economic growth are focused on trying to increase aggregate demand (demand side policies) or increase aggregate supply/productivity (supply side policies) Demand side policies include: Fiscal policy (cutting taxes/increasing government spending) Monetary policy (cutting interest rates) Supply side policies include: Fiscal Policy Options for Increasing Economic Growth and Employment in 2012 and 2013. Though evidence from 2009-12 suggests that the inflationary impact was minimal. However, to keep tax reform from reducing tax revenues, there is need to remove many reductions and eliminate a number of tax shelters. So an… It is possible, if income taxes were excessive, then cutting them may encourage people to work more. The following points highlight the six main public policies to promote Economic Growth. Borrowing constraints refer to the limits imposed by lenders on the amounts that individuals or small firms can borrow. So a judicial policy is to tax households on the basis of their consumption rather than on the basis of their savings. Alternatively, raising taxes to reduce deficit or increase the surplus will also increase national saving by forcing people to consume less. Light regulation promotes growth and reduces shock persistence. Privatising industries can increase efficiency as private firms have a greater profit incentive to cut costs and boost productivity. Moreover, such growth would increase tax base and, therefore, increase tax revenues to offset, largely, or even completely, the revenue loss due to the lower tax rates. The economic growth of the Tigers has been phenomenal, typically averaging 5.5% real per capita growth for several decades. For example, Argentina and Iceland both had rapid devaluations, which in the medium term helped their economic recovery. then demand-side policies can play a role in increasing the rate of economic growth. Quantitative easing involves increasing the money supply and buying bonds to keep bond rates low. It is because more saving means less consumption in the short run. The government can affect human capital development through educational policies, worker training and health programmes. 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