Growth Theories: Economic Perspectives

Growth, in terms of economics, is the monetary and overall productive progress of an economy with time, which is, most of the time, captured by the most widely used economic indicators, that is the Gross Domestic Product of a country. The increase in the GDP of a country, in general indicates towards the increase in the productive capacity of the country, in terms of goods and services produced within the domestic boundaries of the same within a particular period. This may be a consequence of more efficient usage of the scarce resources on part of the economy (Statistics 2013).

For achieving efficiency in economic growth, a country needs a set of robust policies and a framework facilitating their proper implementation. These economic policies may be demand side and supply side policies. Demand side policies have been in practice for a longer time period, in the global framework, emphasizing on the notion that higher growth can be achieved by increasing demand, which can be done by monetary injections or other fiscal stimuli (Sterner 2012). The demand side policies, including many patrons (Keynesian economics being one of the primary ones) have a vision that by rising demands of the consumers, productivity activities can be increased, which in turn may help in facilitating economic growth of the nation (Coddington 2013).

In contrast to the above mentioned policy framework, the supply side economics deals with economic problems with the primary tool of aggregate supply. According to this comparative newer economic growth concept , the path of economic growth of a country can be paved by increasing their supply side capacities and efficiency to produce the goods and services with the help of the scarce resources (Canto, Joines and Laffer 2014). Keeping this in consideration, the assignment tries to analyze the credibility of the supply side economics in fostering growth in the economy of the UK, in the light of the growth theories present in the economic framework.

Growth Theories: Economic Perspectives 

The economic growth phenomenon has been explained from different perspectives with the help of theoretical framework of growth, which in its turn has experienced considerable dynamics with time and changes in the patterns of economic growth across the world (Lewis 2013). The primary growth theories and their evolution with time are discussed in the following sections:

Mercantilism 

One of the primary economic growth theories, the Mercantilist Theory, which has its origin prior to the industrial revolution, put forward a simple argument that collection of the precious metals and expanding the domains of the export activities can help to improve the conditions of any economy in general (Heckscher 2013).

Mercantilism

Classical Theory 

One of the most popular and relevant theories existing in the aspect of economic growth is that of the classical model of growth theory. The main notion of the theory is the achievement of state of stationary condition from unstable ones. Over the years, economists like Adam Smith, Ricardo and Mill have advocated the theory, which have the following ground assumptions:

1. a) The main determinants of profit are the total productivity of labor and the wages prevailing in the economy, which in turn is dependent on the marginal productivity of the labor in the economy.
2. b) An economy is said to be progressing if there is high levels of accumulation of capital in the economy, which leads to increase in the output of the country. The level of profit in the country determines the capital accumulation in the economy.
3. c) The wage levels in the short run may lie above the subsistence level in the market, which in turn encourages growth in the population. In the long run, however, with the increase in the population, wage levels come down to the subsistence wage, which again leads to a stagnancy in the growth of the population (Negishi 2014).

                                                     Classical Growth Theory

As can be seen from the above figure, the total product curve (after taking out the rent) is shown by the OP curve, whereas OS shows the subsistence level of wages paid. As can be seen, with the population increase to OR1 from O, the total productivity is increased by the level of R1P1. However, an equal successive population increase is followed by lesser increase in the productivity. The profit level (S1P1), at the population level of OR1, shows the total accumulation of capital in the economy.

The capital accumulation leads to an increase in the demand for labor in order to expand the productive operations. The population increases with the economic expansion, which continues until the wage touches the level of subsistence (W in this case), which in the above figure can be seen to be present at the point of intersection of the OS and the OP curves. This is the point of classical dichotomy, where remains no scope for further capital accumulation in the economy (Aspromourgos 2013).

Neo-Classical Theory 

The Classical economic framework advocates the free operations of market with no interference from the governing authorities in this aspect. The successors of the classical economists, namely Hicks, Robson, Swan and Solow contributed individually in creating different forms of economic growth models, which clubbed together falls under the Neo-Classical growth theories in economics (Feiwel 2012).

One of the primary models lying under the domain of these theories, the Harrod-Domar Model asserts that the economy, by nature, tends towards instability, which according to the Neo-Classical theories is mitigated at the level of flexible ratio of capital and output. The primary assumptions of the neo-classical theory of economic growth are as follows:

1. a) In the long run, there exists constant returns to scale in the economy, where remains no scope of technical progress.
2. b) There exists scope of substitution between the two productive factors, the labor and the capital, in the economy.
3. c) The payments of the factors are equal to their marginal productivity (Henry 2012).
4. d) In the full employment situation, the savings is equal to the net investment, which is equal to the stock of capital.

                                                                  Neo-Classical Model of Growth

Classical Theory

As can be seen from the above diagram, the growth of the stock of capital in the economy is shown  by sQ/K. This is dependent on capital output ratio. Here, n is the labor curve and q1 is the output. The stable equilibrium is determined at the point E, before which, there exists excess capital growth over output growth, while after the point the capital growth surpasses the growth of the output.

Modern Theories of Economic Growth 

In the modern economic framework, the new growth economists, including Robert Lucas and others, have emphasized on the need for growth of the human capital for facilitating progress of the economy. Thus, the new models of economic growth elaborate the contribution of higher skill, education, knowledge and technological innovations in the economic advancements of the country. Thus, the new economic theories puts importance on the increment of the productivity of labor and capital and to increase the knowledge and technological base of the economy and also advocates the presence of free market in the economy (Ruccio and Amariglio 2016).

Keeping these economic theories in consideration, the implications of the supply side economic policies on the facilitation of economic growth of the economy is elaborated in the following sections:

Contribution of supply side policies in the growth of the economy 

The main notion of the supply side policies in the economic framework is to facilitate the economic growth of the country by increasing the aggregate supply of the economy which can be explained as follows:

As can be seen from the above figure, in the short run situations, given a constant demand situations, the productivity increasing supply side economic policies tend to increase the aggregate supply in the economy, which is shown by the rightward shift of the AS curve. This results in the increase in the output from Y0 to Y1 and also results in the decrease in the price from P0 to P1 (Allen, Tainter and Hoekstra 2012). However, in the long run, the aggregate supply curve being vertical, the situation is elaborated as follows:

As can be seen from the above diagram, in the long run, due to the presence of the vertical supply curve, any increase in the demand leads to a rightward shift in the demand curve, which does not increase productivity and only leads to an increase in the price level in the economy. In such scenario, the only way to increase the output by offsetting the price hike is by increasing the aggregate supply (Ehrenberg and Smith 2016).

Neo-Classical Theory

In this context, there are two branches of thoughts, which are elaborated as follows:

a) Free Market Policies 

This type of supply side policies involve the policy tools like privatization, deregulation and curbing the influence of the trade unions and thus, these policies tend to emphasize on the need for competitiveness in the market. Privatization, being a part of such strategies, refers to the redistribution of the public assets to the private sector, which due to its profit objective brings in efficiency in the overall market (Boettke 2012). Another method to bring in efficiency in the supply side framework is the method of deregulation, by which the barriers to enter in the market is decreased in order to encourage competition. This in its turn leads to efficiency in the market.

Another way to increase labor productivity and efficiency in the market is by reducing the tax burden of the residents of the country. Decreased tax encourages people to work harder by giving them incentives to earn more. Decrease in the corporate tax burdens also encourages commercial activities, thereby increasing both the scopes of profit and productivity in the economy. Reducing trade union’s influence helps the economy to achieve efficiency by reducing the unrests and strikes often caused by them with the agenda of claiming higher wages for the employees. Reduced bargaining-power of the unions help in keeping the wages at the subsistence level provided no unemployment is created (Skousen 2016).

b) Interventionist Policies 

Often the free market of an economy is found to work inefficiently, which requires the intervention of the government in such scenarios. Government intervention is also required in those low profit greater social welfare domains in which the private sector usually do not indulge. These are as follows:

Building strong educational framework-  For increasing the productivity of any country, it is important to improve the educational base. Education increases the positive externality and therefore, is not generally taken up by the private sectors. In this aspect, the intervention of government is necessary.

Health Care Providence- For a productivity workforce, it is necessary to ensure proper health conditions of the same. However, the private health care facilities being comparatively expensive, the intervention of the public sector for providence of the same is important for increase in the productivity of the same.

Infrastructure Development- For any increase in the economic activity, proper infrastructural and transport, communication channels are required. These aspects being areas of high positive externalities are required to be taken up by the public sector as profit maximizing private sector do not find much incentive to venture in these sectors (Edler et al. 2012).

Modern Theories of Economic Growth

Keeping the above discussion in consideration, the following section of the report discussed the supply side policy framework in the context of the United Kingdom.

UK: Supply side policies 

The economy of the UK has seen ample amount of demand side activities for the purpose of economic progress. However, in reality, these demand side activities did not achieve any impressive growth rate of the economy as the growth rates never surpassed the long run trend, thereby resulting in cyclical fluctuations in the economy. The government of the country tried to bring in economic progress by introducing large tax reductions (1972) in order to facilitate demand increase. Though the policies succeeded partially in leading to a boom in the economy, however, it was accompanied by considerable inflation, thereby crowding out the growth. The demand-side policies (both monetary and fiscal policies), taken by the governing authorities in the late 1980’s, resulted to severe inflation (Warren 2014).

These failures of the demand side policies to bring in the desired sustainable economic progress in the UK, led to the notion of the need for a different framework of policies in the economy, which in turn influenced the policymakers to emphasize on the supply side dynamics of the country.

Policies taken by the UK (Supply-side): 

To bring in economic prosperity, the economists of the country shifted considerably to the supply side policies, some of the crucial ones being as follows:

Income Tax cut- The government of the country, during 1980s, cut the income tax heavily from the existing level of 60% to as low as 40%, much of which was done to increase the well being of the residents. The government compensated the same by increasing the different indirect taxes existing in the economic framework.

Privatization- In the recent periods, the government of the country has started encouraging the privatization of different industries, which were initially under the control of the public sector only. This includes industries like telecommunication, electricity, water and gas. This has been done to increase the competition and efficiency in the economy, which is expected to increase the quality and reduce the price of the same. In the recent times, privatization of rail has also been done, though the government has been facing problems regarding privatization of the water industry ( MacAvoy et al. 2012).

Deregulation- As discussed in the above sections has also been undertaken by the government of the country in order to increase the supply side productivity of the country. Different monetary institutions have been permitted by the government to participate in banking activities, which has resulted in the competition and efficiency in the financial sector and has also encouraged borrowing of money and investment activities (Mullineux 2012).

Trade Unions- The bargaining power of the trade unions, which were considerably high in the earlier periods, have been considerably decreased by the government with the help of stricter laws.

Scopes of improvement in the supply side policy framework 

Although the government of the country has undertaken several steps towards supply side policy framework in the country, there are still scopes for improving the overall productivity of the economy by undertaking the following supply side dynamics:

• To increase the output of the economy, the governing authorities of the country can use the tax system appropriately. The primary notion behind the same is that the decrease in the income or corporate taxed can motivate the labors as well as the commercial players to work more by providing them more profit incentives, which is expected to increase the productivity of the nation as a whole.
• The supply side dynamics can be improved by improving labor mobility across the economy, which can be achieved through implementation of proper infrastructural frameworks.
• The government of the UK can emphasize on building of a robust human capital base as the same has positive implications on the efficiency aspect of productivity of the economy. The government can bring increase in the human capital by building properly widespread and productive education and training framework. Monitoring the teaching standards can be done by the government or in a public private partnership basis, which may help in skill development and long term sustainability of economic development of the economy.
• Pay for performance system, which is highly prevalent in the private sector, can also be incorporated in the public sector in order to increase the efficiency of the same.

Conclusion 

From the above discussion, it can be asserted that in the current economic situations in the UK and also in similar global economies, with the inefficiency of the demand side policies in the aspect of economic progress, it has become important for the governments to emphasize on the supply side policy framework. In this context, the government of the United Kingdom has started taking considerable steps though there remains huge scopes of advancements in the supply side policy frameworks development.

References 

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Boettke, P.J., 2012. Living economics. Oakland, CA: Independent Institute.

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