Supply-side policies

Market-based and interventionist policies to raise productive capacity and shift LRAS: productivity, incentives, training and infrastructure and their strengths and weaknesses.

The productivity puzzle.

UK output per hour in April to June 2026 was 0.7% higher than a year earlier, on the ONS flash estimate. Since the 2008 financial crisis, UK productivity has grown far more slowly than it did before, and this slow growth is a main reason why real wages have grown so little.

What can a government do to raise the economy’s productive capacity?

Source: Office for National Statistics, Productivity flash estimate and overview, UK: April to June 2026.

Supply-side policies.

Supply-side policies aim to raise the productive capacity of the economy by improving the quantity or quality of the factors of production, or how well markets work. They shift LRAS to the right.

Productivity is output per worker or per hour worked. Higher productivity is the main source of long-run growth.

There are two kinds: market-based policies, which free up markets and sharpen incentives, and interventionist policies, where the government acts directly.

Market-based and interventionist.

Market-based

• Cutting income tax, to raise the incentive to work.
• Cutting corporation tax, to raise the incentive to invest.
• Deregulation and privatisation, to increase competition and efficiency.
• Making labour markets more flexible, such as reforming benefits to encourage work.

Interventionist

• Spending on education and training, to raise the quality of labour.
• Spending on infrastructure, such as transport and broadband.
• Funding or tax credits for research and development.
• Industrial policy, supporting key industries.

Do supply-side policies work?

• Strength: they raise capacity, so they avoid the inflation that comes from just boosting AD.
• Strength: they tackle structural unemployment, which demand-side policy cannot fix.
• Weakness: long time lags, so they cannot fix a recession quickly.
• Weakness: government failure: money may be spent on the wrong projects or skills.
• Weakness: tax cuts may not raise work or investment if people value leisure or firms lack confidence.

Think first

The government pays for more apprenticeships and training.

Which curve does this mainly shift in the long run?

Better skills raise productivity: each worker can produce more. That raises the economy’s productive capacity, so LRAS shifts right. The spending also adds to AD in the short run.

Step by step

1. The economy starts in long-run equilibrium at Y1, where AD meets SRAS1 on LRAS1.

   Check: Labour productivity is measured as:

   How much each worker or hour produces.

2. Supply-side policies raise productive capacity: LRAS shifts right to LRAS2, and lower costs shift SRAS right too. Real GDP rises and the price level falls: growth without inflation.

3. Supply-side policies can help most macroeconomic objectives at once: more growth, lower inflation, lower unemployment and more competitive exports.

   Check: Which is an interventionist supply-side policy?

   The government acts directly to raise capacity; the others free up markets.

4. Summary: supply-side policies shift LRAS right, raising long-run growth while easing inflation. Demand-side policies move AD; supply-side policies move capacity.

A common mistake

A cut in income tax raises AD through consumption, but it also raises the reward for working, which can increase the supply of labour and shift LRAS right. That is why it counts as a market-based supply-side policy.

Exam question

Explain how spending on education and training could increase long-run economic growth.

Model answer

Spending on education and training raises the skills of the labour force, its human capital.

Better-skilled workers are more productive: they can produce more output per hour. Training can also help people who are structurally unemployed gain the skills employers need, so more people are in work.

Both raise the productive capacity of the economy, so LRAS shifts to the right.

[Diagram: LRAS1 to LRAS2 and SRAS1 to SRAS2; equilibrium real GDP rises from Y1 to Y2 and the price level falls.]

So potential output rises, which is long-run economic growth, without adding to inflationary pressure. However, the benefits take years to appear.