The difficulty with supply-side

This is for the Grecians who have recently looked at the Irish model for Supply-side success.

The problem with supply-side policy is that there is no guarantee of success and the mechanism by which they work is uncertain.

To use a fairly clumsy analogy, you start with a ball of wool that you want to become a sweater, but it is quite possible for the amateur knitter to end up with a bad scarf.

The article below is from 2010, but has some important lessons on the short comings of Irish supply side policy.

The Bloomberg article is here

Supply side lessons from France

France has seen an unprecedented level of capital flight in recent months. The cause - the heavy taxes proposed for high earners by President Hollande. Profit and company payroll taxes are already very high in France and the 75% proposed income tax rate seems to have pushed many to move their money.

The Daily Telegraph article shows the extent of the flight but there are important lessons to be learned.

Many people in the UK have doubted the wisdom of cutting the 50% income tax rate to 45%. There is a feeling that it is 'fair' for the rich to pay more than the middle income earners. This may actually be a reasonable point, but the argument is that the disincentive effects of high tax reduce overall economic performance and so make everyone worse off in the long run. While 75% is a lot more than 50% in tax terms there seems to be credible evidence that incentives do matter.

France has been incredibly slow to adopt supply-side reforms. The French industrialist Louis Gallois has delivered a report calling for 'shock therapy' to help improve French competitiveness. His plan includes cutting payroll taxes for employers, spending cuts and higher consumer taxes. There seems little political will to do this. Hollande is an old fashioned socialist who has no experience of government and ideals are yet to be overcome by reality for him. France carries some of the highest labour costs in the world and with a rapidly expanding trade deficit and 27% youth unemployment the Gallois Report may be the thing that comes back to haunt him at the next election.

A further important point to note is the fall in the French money supply that has resulted from the capital flight. This is potentially serious as it represents a deflationary force in an economy already in recession. Falling money supply is going to reduce AD and prevent recovery. In situations like these deflation is the last thing the economy needs and so the French cannot ignore the loss of confidence the capital flight represents. Like so many socialist leaders before him Hollande must realise that it is not possible for a country to be the sole master of its economic policy.

The Telegraph explains the crisis here

Reuters reports Gallois proposals here

A policy conflict with no easy answers

The government wants to cap benefit rises at 1% a year for the next three years. It's beings strongly criticised as being unfair.

The arguments are actually about two issues. Long term supply-side incentives and income distribution. The first is much more straightforward to explain than the second.

One of the biggest problems faced by those out of work is the difference between in-work and out-of-work income. When the difference between the two is small the incentive to take a job is less and may prompt some people to remain on benefits rather than take a job. This is known as the unemployment trap.

During the period since 2008 the incomes of those in work have risen only slowly and at less than inflation, and for some nominal wages fallen. But benefits have gone up in line with inflation, which in some years has been well above target. So the difference between in and out-of-work income has narrowed. The government argue that the cap on benefits will restore the balance and raise incentives to work.

The case on income distribution can be argued both ways. Those on benefits are the least well off in the UK and it has been long established that they will be guaranteed an income that allows them to at least take a part in the normal activities of society. Therefore raising benefits by less than inflation represents a real cut in their incomes and breaks this social contract.

However against this the case can be made that the faster rise in benefits than in wages has led to an unintended change in the UK's distribution of income. While those on benefits will be worse off through this measure they will simply join the rest of society in the experience of recession. The distribution of income will be restored to the one that existed before.

There is no doubt that the distribution of income is the macroeconomic target which gets the lowest priority. The question really is do we want to prioritise long-run efficiency or compassion. No easy choice.

The BBC explains the measure and the arguments here

A contribution to the supply-side debate from an academic

I have dealt before with the question of immigration and the impact on the supply side of the economy.

Here is a contribution from an academic, Sir Andre Geim, a Nobel prize winning physicist. He makes the point that the present UK immigration policy is likely to harm the economy. The points are well made and I won't repeat them here.

The supply side of the economy can be damaged in the long term by inappropriate short term policy. The problem is that the long term nature of supply side policy means it is difficult to see the benefits and this allows the Daily Mail/Express/Sun to play to the base instincts of popular culture.

The Independent reports Sir Andre's comments here

Who carries the cost of a flexible labour market?

Today it was reported that over 3 million people in Britain are underemployed. The exact meaning of this is covered by an ONS video which is embedded in the Daily Telegraph article below, but essentially it means workers who do not work full time.

Inevitably those who are underemployed want to work more hours, usually because they need the higher income.

The rise in underemployment is bad news for those who would like more work and can't get it. They are clearly worse off. For many the data confirms their fears that the true cost of the recession is far higher than the unemployment figures suggest and solves, partly, the puzzle of why unemployment has risen so little in the recession.

For those who advocated the relaxation of labour market rules in the 1980's and 90's the figures will come as a vindication of that supply side policy. Because of the greater flexibility of the market some workers have accepted lower wages and shorter hours rather than becoming unemployed. The pain of the recession is spread more evenly and the economy has not suffered as much disruption as it would have with mass redundancies (which are the alternative to shorter hours).

Some would argue that the unemployment figures are a misrepresentation of the current economic situation, but for most economists it is a welcome sign that the supply side reforms of the Blessed Margaret continue to help the economy.

The Daily Telegraph cover the story here

Supply side policy failure

Supply side policy is known for its long lag time and the uncertainty of its outcomes. Today we have evidence of this in the measures implemented to reduce long term unemployment.

The 'Welfare-to-work' programme aims to help those who are long term unemployed return to work. Those who have been out of work for more than six months find it especially difficult to find work. They have become disenchanted and detached from the workforce, as they loose the skills and habit of work and become more distant to current work practises. Perhaps it is needless to say that as the period of unemployment becomes longer these problems worsen.

So the government have been paying for additional help, through private sector organisations, to get the long term unemployed back to work. They do this by a variety of methods that often includes training.

A report has shown that the number of people helped find a job is just 3.53% of those on the welfare-to-work programmes have found jobs.

Is this policy a waste of money? In a period when the government spending much more than it anticipated would a policy of doing nothing and simply paying the benefits be a better idea?

The BBC cover the story here