Sunday, 26 May 2013

Welcome!

Hi Firms!
I am the Finance Minister and I'm going to educate you about how to operate more efficiently,i.e. introducing to you supply side policies! :) Supply side policies (SSP) are macro-economic policies which improve the supply-side potential of an economy as they target the aggregate supply of markets, thus contributing to a faster rate of growth of real national output.
In my next few blogposts, I will be introducing several SSP, namely those that affect the short run and long run aggregate supply curve.

Every blogpost will be organized according to these framework:

1) Macroeconomic problem
2) Diagram
3) Using of the diagram to explain how SSP can solve the problem
4) Examples
5) Limitations

We hope that through this framework, you would understand the government's rationale behind each SSP. 




Explaining unemployment



Unemployment is a situation where people in the labour force who are willing and able to work are unable to find a jobs. As a result of unemployment, our country is not fully utilizing its resources and may lead to significant consequences especially in Singapore where natural resources is limited and human resources are vital.  The video above could help us to understand the various types of unemployment, where then later I would explain how the use of supply-side policies can help to solve these economic problems.

Cyclical unemployment



Cyclical unemployment occurs during a recession and in order to tackle this problem, short-run supply-side policies managing wage/income will be adopted so as to lower business costs. 


Figure 1 

ig. 1 depicts a picture of slow growth due to deficiency in demand as seen from how the AD curve cuts near the horizontal range of AD-AS Curve. The use of short-run supply-side policies can shift the SRAS curve from SRAS(0) to SRAS(1). The actual growth of the economy is increased from Y(1) to Y(2). Though it is not very significant as Aggregate Demand is still weak due to consumer pessimism etc, it helps to keep some business from going bust and thus save some jobs. 

An example would be the Central Provident System. The CPF system being a compulsory savings plan requires both the employees as well as the employers to make monthly contributions to each employee's CPF account. At 25% each, the CPF effectively drives a wedge between effective wages and labour costs. Traditionally, higher wages simply imply higher labour costs and lower wages imply labour costs are lower. During recession, the government simply reduces the CPF contribution of the employer. This is particularly effective as the employees' take home salary remains the same while cost of production is trimmed significantly, allowing firms like you to retain most employees with minimal retrenchments.

By changing the size of the wedge, I am able to lower labour costs and hence production costs without affecting disposable income, thereby cushioning the effects of a falling aggregate demand on cyclical unemployment. Also, the Ministry of Finance can cut costs of utilities and rent through rebates to ensure firms are still profiting. 

There are limitations to this policy though. If CPF contribution is cut, lower-income families will be impacted negatively. CPF is supposed to be a safety net for the people in terms of financing housing/medical and savings for retirement. Such cuts could really suffocate lower income households as they are unable to pay their monthly housing loans via CPF and have to top-up using cash.


Structural Unemployment


 Structural Unemployment 

Structural unemployment occurs a result of skills mismatch in the market. To solve this problem, long-run supply side policies are needed to increase the productive capacity of the economy. 



Fig 1. shows how the usage of long-run SSP shifts the LRAS curve from LRAS (0) to LRAS (1). There is growth in the potential capacity of the economy. As a result, the full employment level of national income rises from Y(f0) to Y(f1). At the same time, AD also increases from AD(0) to AD(1) as long as long-run supply side policies usually involve government spending or increase investment. As a result, the economy experiences an increase in output from Y(0) to Y(1) with little impact on general price (in this case there is no impact and the non-inflationary economic growth is achieved). 

In Singapore, the government fund upgrading courses which can help structurally unemployed persons pick up new skills in terms of language, IT, management and entrepreneurial. Some examples include courses provided by Community Clubs across Singapore as well as upgrading courses provided by the Continuing Education and Training Centres (CET) which is accredited by the Singapore Workforce Development Agency (WDA). With the newly acquired skills, workers would be able to increase their labour productivity and hence enable firms to lower their unit cost of production. This may be an added incentive for firms to retain workers during times of recession. 


However, there are limitations to this long run SSP. The main concern lies with the attitude, aptitude and age of the workers who are sent for the courses. Without a good attitude towards learning, an aptitude and flair for learning new skills, and the ability to internalise the skill set learnt quickly, level of productivity may not have increased as desired and hence render the policy ineffective. Usually there is great resistance in acquiring new skills, especially among the older workers. Furthermore, workers who are lacking in basic education and literacy may find the acquisition of new skills to be extremely difficult. In the 2000 census, only about 20% of Singaporeans aged 55 and over at least Secondary education    qualifications.




Frictional Unemployment

Frictional unemployment arises since employees spend time searching what they believe will be the best match available. This unending flow of people into and out of the labour force and the process of job creating and job destruction creates the need for people to search for the jobs and for firms to find suitable employees.

In other words, frictional unemployment arises because of the lack of perfect information in the labour market as it takes time for workers to be matched with suitable jobs.

To deal with frictional unemployment, policies could be made to improve labour market information and help improve efficiency of the labour market. For example in the US, state governments set up websites to help collate potential employees's details and match them to the needs of prospective websites to help collate employee's details and match them to the needs of prospective employees. The Singapore government tries to  include job fairs that the CDC in Singapore organize regularly to bring together employers of the same industries to hold a mass recruitment exercise where workers can seek out their most suitable jobs.


These policies aim to improve the labour market information and helps to shorten the period of searching jobs of the employers. However, there are some limitations as much of the success of these policies lies with the attitude of the job seekers, whether they are keen to get employed sooner. Moreover, with the job fairs, frictional unemployment may not be solved quickly since workers has more to choose from and vice versa, and would in fact lengthened the job searching process.

However, we are not that concerned about this problem of frictional unemployment! In fact, this type of unemployment may be beneficial for our economy as it provides a better match between workers and their jobs, which would in fact make the economy far more efficient since everyone is doing a job which they are most suited to do.




Explaining inflation


Inflation is a situation where there is a increase in a general price level of a given basket of goods over a period of time. We try to limit inflation because when price increases, the standard of living of Singaporeans drop as when the same amount of money is spent on consuming goods, less quantity and quality of goods could be consumed.  The video above could help us to understand the various types of inflation, where then later I would explain how the use of supply-side policies can help to solve inflation. 

Import-Price-Push-Inflation

Import-Price-Push-Inflation

This problem occurs mainly for countries that import many raw materials and finished goods from other countries. When the general price level in other countries rise, the price of imports rises and this cost would then be passed by firms onto consumers. Import-price-push-inflation could also happen due to depreciation of the importing country's currency, which makes the imports more expensive in terms of domestic currency.



Solutions

One short-run policy would be to appreciate the domestic currency gradually and modestly so as to make imports relatively cheaper. This will lower the cost of production of exports and shift the SRAS to the right, leading to a reduction in price levels.

An example would be Singapore, which is heavily dependent on imports of raw materials and necessities due to limited natural resources.

Another short-run policy would be to set a price ceiling. In times of impending imported inflation(rapid rises in oil), the government can implement price controls to prevent cost-push inflation from setting in. They can set price ceilings on important essentials such as food and fuel to ensure basic survival of the citizens.

There are limitations to these policies though. For appreciation of Singapore's currency, it may cause exports to be less price competitive due to a stronger $S. As for the price policy, the effectiveness is greatly reduced due to the possibility of black markets arising when shortage of goods occur.

There are also some long-term supply side policies. One possibility would be to look at cheaper alternatives. If there are none present, the country would have to develop its own through research.This may be done using technology to help make manufacturing processes more efficient or develop substitutes for oil. Education is also key in letting the general population know that energy and water resources must be conserved so as to limit demand for such essential resources. This would help curb rise in prices.

These policies are not perfect though as R&D efforts require high capital and labour with no guarantee of success. It may be better to divert the resources used to other aspects of the economy. It is also difficult to come up with any close substitutes for petrol, compounded by the need for a change in mindset and attitude.


Profit-push Inflation

Profit push inflation

Profit-push inflation is when there is too much concentration of market power. When there is too much market power by one firm or group or firms, prices will rise. During periods of rising costs, monopolies raise the prices of their goods by an amount that is far more than what is required to offset the increase in the cost of production.


Solutions

Our short run policy would be the implement price controls such as marginal-cost-pricing and average cost pricing.

Our long run policy would be to control market power by adopting legislative measures to prevent to prevent and curb the growing market power of firms. This is followed by the process of deregulation which helps to increase the level of competition in the market.

For example, our government introduced the Competition Act in 2004 which led to the creation of the Competition Commission. This commission primary task is to ensure that the firms are not engaging in anti-competitive behaviour that would eventually lead to rising prices. Also, industries producing essential services that are associated with "natural monopoly" are being regulated by the government. For example, the public transport sector is regulated by the LTA by the PTC (Public Transport Council). Such regulation balances between the profit incentives that make these industries efficient as well as the costs of living and buisness costs.

Deregulation is a pro-competition policy that allows for more players into a particular sector of the economy. For example, in 1997, M1 and Starhub entered the telecommunications sector to provide competition with the incumbent monopoly SingTel. Deregulation encourages more competition in the supply of goods and services. If the government can more competition, this should have the effect of increasing national output and reducing cost-push inflation. Increased competition can lead to increased efficiency, more consumer choice and lower prices. Firms will find more incentives to cut costs in their pursuit of profit maximization.

Although deregulation may lower costs through the introduction of competition, this may come at the expense of the quality of the goods and services unless closely mentioned.


Wage-push inflation

Wage-push Inflation 

This type of inflation is caused by rising wages. Since wages is a factor of production, as it rises, cost of production increases. Thus, this shifts the short run Aggregate Supply to the left. As a result, general price level of goods increase as producers pass on the high costs of production to domestic consumers by jacking up the prices. For example, industrialized Western economies such as the UK and Germany saw the rise of trade union power in the mid-20th century, which made wage-push inflation a main concern for these economies.

Solutions

One short run policy would be intervention by the government on wage setting with an aim to influence the rate of inflation. For example, government passes legislation to limit rises in wages. It operates through the SRAS curve and is classified as a SSP. This can take various forms such as wage freeze or wage reduction in the public sector.

In Singapore, the National Wages Council (NWC) determines the appropriate wage increase with the economy's well being as its priority. Also, the NWC meets annually to make recommendations for wage increases. This ensures that wage increases do not exceed productivity gains, thereby maintaining unit labour costs. This will prevent the SRAS curve from shifting to the left, thus eliminating wage-push inflation.

However, there are limitations to this policy. The allocative function of the price system tend to interfere with effective wage controls. Factor prices must be allowed to fluctuate freely and fully in response to changing market conditions, i.e. to changes in demand, factor supplies or technology in order for allocative efficiency to be sustained through time. Effective wage controls would prohibit the market system from making these adjustments.

One long run policy would be skills upgrading which aim at raising the level of labour productivity. If the increase in labour productivity is higher than wage increases, the unit cost of production will decrease and hence the SRAS curve will shift to the right, hence lowering the rate of inflation.


Conclusion

From the blog posts, I hope there would be more understanding on the supply-side policies. Ultimately, our ideal growth policy is to grow the economy at a sustained rate without it being too fast or too slow. In order to achieve this aim, aggregate demand must grow in tandem with aggregate supply, therefore this policies must be calibrated so as to promote both actual and potential growth at the same time. 

Signing off, 
Finance Minister