Introduction

In the last article we discussed why governments use supply-side policies to grow GDP, and we looked at market-oriented supply-side policies in more detail i.e. those aimed at removing the barriers to a perfect market to increase productive and allocative efficiency.

In this article, we focus on interventionist supply-side policies, in particular:

1. What they are;
2. Why a government might want to use them; and
3. Specific examples of interventionist supply-side policies.

What are interventionist supply-side policies?

Interventionist supply-side policies are those in which a government intervenes in the market for the supply of goods or services.

This includes influencing the supply of particular factors of production (land, labour, capital and entrepreneurship).

Why use them?

There are a few reasons governments might want to use interventionist supply-side policies, including:

Market inefficiencies

‍A perfect-market, in which all resources are allocated efficiently and which achieves productive efficiency, is just a model against which economists can test their theories. The perfect market model has a number of assumptions which may not fully exist in reality.

Some of the main characteristics of a perfect market (these differ depending on commentator) are:

1. Homogenous goods (i.e all goods and services are the same). In reality not all goods and services in the market are the same;
2. Large numbers of buyers and sellers, with no individual buyer or seller having the market power to unilaterally set prices. However, in reality, this is not the case, and some markets might be dominated by a small number of suppliers (oligopoly) or, indeed, one supplier (monopoly);
3. Buyers and sellers have perfect information i.e. of the prices of goods and services, the characteristics of those goods and services, risk factors etc. Whilst the internet has made it easier to compare products, consumers don’t necessarily have perfect information, particularly for complex products which might not be fully understood or comparable;
4. Perfect mobility of the factors of production (land, labour, capital, entrepreneurship) i.e. they can move freely within the market and can be used for whatever purpose an economy requires. However, this does not hold true in reality:
   1. In relation to land (which includes natural resources), it is static and it cannot all be used for the same purpose. For example, some land might be more suited for industrial purposes, others for residential housing etc;
   2. In relation to labour, workers have different skills, qualifications and expertise, and so may not be able to move freely between sectors and industries. For example, without significant retraining, it is unlikely that a plumber can do the job of a vet, and vice versa. Further, workers may not be geographically mobile, and may be tied to certain areas for personal reasons;
   3. When discussing capital, we mean human made assets used to produce / supply goods and services, such as machinery, tools, and factories. In reality, machinery and tools etc cannot be used to create all types of goods or services. They will be specialised, and therefore cannot be moved around and used to produce / supply all types of goods and services that an economy might require. For example, machinery to create typewriters might not be able to create laptops and tablets which, in a modern economy, might be the type of goods required to grow aggregate supply.

These examples of reality show imperfections in the market which can be the target of interventionist supply-side policies. By way of example, to grow aggregate supply, the limiting factor in a particular economy might be the lack of employees with certain skills, or a certain kind of machinery. The government could intervene in those areas.

Insufficient research and development

Firms motivated by profit in the short to medium term might not be particularly interested in investing in research and development, especially in areas there is little certainty of an outcome, or no guaranteed profit from research and development efforts even in the prospect of success.

However, such research and development might be required to increase aggregate supply in the long-term (by increasing the quality of the factors of production). That's not to say private firms do not invest in research and development – they do, for example pharmaceutical companies often sponsor PhDs and conduct research of their own. However, purely private sector reliance might not be sufficient for an economy to grow aggregate supply in the long-run.

Negative externalities

In some cases, if the free-market is allowed to operate unfettered, it may result in negative externalities i.e. negative side-effects. For example, unregulated financial markets could result in consumers having products they do not understand, and that are not suitable or appropriate for them. Or unregulated chemical production could result in unfettered pollution of the environment.

Interventionist policies to fix these could include regulation, criminalisation of certain acts etc. Such policies are interventionist, but are not supply-side policies because their main aim is not to grow aggregate supply. Accordingly, we do not discuss them in further detail below, but they are worth being aware of.

Types of interventionist supply-side policies

Now that we've discussed why a government might want to use interventionist supply-side policies, we can look at some specific types of policy.

Nationalisation

In specific industries, the free-market might not be achieving the best outcomes. Rail might, for example, be one of those industries, because it doesn’t naturally lend itself to many different suppliers running the same routes: Would there be multiple tracks? Whose trains would get priority? Who would be responsible for the upkeep on the track? Such industries might be more suited to a monopoly, however there are potential risks to consumers when monopolies are being operated.

Accordingly, in such industries, it may be more conducive to productive and allocative efficiency, and growing aggregate supply whilst protecting consumers, to nationalise an industry. By way of example, in the UK the entirety of the rail track is owned and maintained by National Rail. However, National Rail franchises out areas of track to private companies to operate rail services. This is a hybrid nationalised model, and some people still call for a fully nationalised model due to issues with train services in the UK.

However, there are also potential downsides to nationalisation. One of the common arguments levelled at nationalisation and the public sector generally is that it is inefficient. There is no profit motive, and therefore no ultimate desire to ensure things run smoothly and efficiently. Excessive red-tape is another argument often made against the public-sector generally.

Rationalisation

This is where governments mandate mergers and the consolidation of businesses, with the intention that this will make them more efficient through the reduction of duplicated costs, which will increase overall profits that can be used to improve consumer outcomes. In theory, this increases the quality of the factors of production, because fewer resources will be required to supply the same amount of goods or services, or even more.

Further, as costs are cut, resources might be freed up for use elsewhere in the economy, thereby increasing aggregate supply.

Rationalisation may be most effective in industries where there are many suppliers / producers, but where this is not beneficial to productivity and consumer outcomes. It could be argued that banking is a prime example of this. The barriers to entry for a bank are high (staff required, computer systems, capital, regulatory compliance etc) and it is an area in which consolidation could bring down costs per customer serviced, which would also free up resources for use elsewhere in the economy.

Further, banks are at their most useful when they have large amounts of capital to lend (for example consumer mortgages, and business loans). Banks get much of their capital from depositors, and if a bank only had a small number of deposits it might struggle to do the most good in respect of its lending function. An example of nationalisation in the sector happened in 2020, when the government of India ordered the merger of several majority state-owned banks. Further, in the UK, banks are already organised like this, with a small number of large players (although in recent years we have seen an increase in number of challenger banks).

However, there are potential downsides to rationalisation / consolidation of market share. Re-read the articles on imperfect competition and remind yourself of these.

Government grants

Governments may provide funding in certain industries and for various activities, with the intention that this will increase the quality and/or quantity of factors of production and therefore aggregate supply e.g. research and development within life sciences.

Training and development

A government will want to ensure that its labour force has the requisite skills to ensure its economy can grow. Improving the skills of a labour force through training and development increases its quality, thereby growing aggregate supply.

Further, an economy might require a specific set of skills to grow, and training and development can be targeted in those areas. For example, the limiting factor to growth within a particular economy might be the lack of engineering expertise, and a government could focus its efforts here. In the UK, the government offers grants for people to train to be teachers in science, technology, engineering and mathematics (STEM) subjects; the intention is that this will increase the skills of our future labour force in those areas.

Conclusion

You should now understand what interventionist supply-side policies are, why they are used, and different types of interventionist supply-side policies. In summary:

• Interventionist supply-side policies are those in which a government intervenes in the market for the supply or demand of goods or services;
• Such policies can be used to address real-world market inefficiencies, enhance areas which are beneficial for long-run economic growth but which are not adequately catered for by the private sector, and/or to address negative externalities caused by the free market;
• Some common types of interventionist policy include (amongst others):
  • Nationalisation;
  • Rationalisation / consolidation;
  • Government grants; and
  • Training and development.

There are some objections to the use of interventionist policies, such as the lack of profit motive in nationalised companies, or the argument that the market allocates resources efficiently and interventionist policies lead to the inefficient use of resources.

In reality, governments will often use a mix of market-side and interventionist supply-side policies following detailed analysis and evaluation of what effect these policies will have.