Can A Government Increase the Rate of Economic Growth
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The rate of economic growth measures the annual % increase in Real GDP. The
long term trend rate of economic growth in the UK is about 2.5%. TO increase
this the govt will have to use supply side policies. However there may be
instances when increased AD will also be able to increase the rate of economic
If the economy is below full employment and there is spare capacity within
the economy. The govt can use demand side policies to increase the rate of
economic growth. For example the govt could use fiscal policy to increase the
rate of AD. This could involve cutting taxes and increasing the level of govt
AD= C+I+G+X-M. Therefore higher Government spending will increase AD and
lower taxes will increase disposable income thereby increasing Consumption and
Also the MPC could cut interest rates. This reduces the cost of borrowing and
reduces monthly mortgage payments. Therefore there will be an increase in the
level of borrowing, consumption and investment.
However demand side policies do have some problems, firstly there will be
time lags between changing taxes or interest rates and having an effect on AD.
Also if consumer confidence is lower interest rates may not have much effect on
increasing consumption. Also increasing AD can conflict with the govt objective
of low inflation. If the economy is close to full capacity higher AD will cause
Classical economists argues that higher AD will always cause inflation,
because the Long Run Aggregate Supply curve is inelastic.
In the classical model an increase in AD causes higher output in the short
run, however as inflation increases, wages and therefore the costs of firms
increase causing the SRAS to shift to the left. Therefore the economy returns to
the level of Full employment but with higher inflation. Therefore classical
economists argue that demand should not be used to increase the rate of economic
However this classical model is not necessarily correct. Keynesians argue
that an economy can be in a recession for a long time. This is because of low
consumer confidence reducing spending and the negative multiplier effect
reducing further the initial fall in AD. Therefore in a recession Keynesians
would argue that it is important to increase AD even if a re-flationary fiscal
policy causes a budget deficit.
Nevertheless both Keynesian and classical economists argue that to increase
the long run trend rate of economic growth it is necessary to increase
productivity and shift the LRAS to the right this can be done through supply
For example the govt can increase the incentive to work by cutting taxes and
reducing benefits. However there is no guarantee that lower taxes do increase
work incentives. The Income effect means people can work less to earn the same
amount of money. Also inequality may increase.
The govt can overcome market failure by increasing spending on education and
training, this will increase labour productivity and therefore efficiency in the
economy. However this policy will take time to have effect. Also govt
intervention may not be very successful because of poor information leading to
subsidising of the wrong types of training.
A third type of supply side policy could be to follow a programme of
privatisation and deregulation. Privatisation involves selling govt owned
industries to the private sector. The advantage of this is that the private
sector has a profit incentive to increase efficiency. However there are dangers
that a private monopoly may exploit consumers. The example of rail privatisation
also showed that privatisation may not be successful, private firms under
invested in the network because they took the short term view.
Deregulation involves increasing competition in an industry this has obvious
benefits of lower prices and better quality but is difficult to achieve in
industries such as rail and water.
Supply side policies may help improve productivity in the long term, there is
evidence that since the govts many supply side policies introduced in the 1980s
the economy has performed better with inflation remaining low despite growth
being strong. However there is a limit to how much the govt can increase
productivity many issues are beyond their control, for example it is difficult
for the govt to improve technology and working ethics. Also the rate of economic
growth is likely to be effected by global events over which the UK govt has no
About the Author
Richard Pettinger studied Politics and Economics at Lady Margaret Hall, Oxford University. He now works as an economics teacher in Oxford. He enjoys
writing essays on Economic and he edits an Economics Blog focused on UK and US economies: http://www.economicshelp.org/econ.html.
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Article Published/Sorted/Amended on Scopulus 2007-04-01 23:45:44 in Economic Articles