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What’s it: Structural policies are government policies that influence the potential output and influence the private sector’s choice to allocate economic resources. Long story short, it is an economic policy to influence long-run aggregate supply.
Imagine a government taking steps to not just jumpstart the economy in the short term, but to build a foundation for long-run growth and prosperity. That’s the core idea behind structural policies. These are government interventions designed to influence the potential output of an economy, essentially shaping its ability to produce goods and services over the long term.
In simpler terms, structural policies aim to nudge the private sector – businesses and households – to make choices that boost the economy’s productive capacity. This can involve a variety of measures, from improving education and infrastructure to reforming tax systems and regulations. By addressing underlying issues that might be hindering long-term growth, structural policies aim to create a fertile ground for sustainable economic expansion.
Objectives of structural policy
Structural policies focus on the big picture—an economy’s long-term health and growth. Unlike monetary and fiscal policies, which focus on short-term issues like inflation or recession, structural policies aim to address deeper, more fundamental challenges.
Here’s why these policies are crucial:
- Resource allocation: Resources like skilled labor, raw materials, and technology are essential ingredients for economic production. Structural policies can influence how efficiently these resources are allocated by businesses and households. For instance, investing in education equips the workforce with valuable skills, potentially making them more productive.
- Addressing supply-side issues: A healthy economy thrives on its ability to produce goods and services. Structural policies target the supply side of the economy, focusing on factors that can increase this production capacity. This could involve measures like improving infrastructure (roads, bridges) to facilitate the movement of goods or streamlining regulations to make it easier for businesses to operate.
- Beyond short-term fixes: While monetary and fiscal policies might offer a quick boost during economic downturns, structural policies take a more long-term approach. They aim to create a fertile ground for sustainable economic growth by tackling the root causes of sluggish productivity or inefficient resource allocation. This can lead to a stronger foundation for long-term prosperity.
In a nutshell, structural policies are like building blocks for a healthy economy. They address underlying issues that hinder long-term growth, paving the way for a more productive and efficient system of producing goods and services.
Structural policy and short-term stabilization policies
The stabilization policy aims to solve short-term economic problems. The government launched it to minimize the business cycle’s negative impacts, such as hyperinflation and recessions.
Stabilization policy runs through its effect on aggregate demand, which in turn has an impact on aggregate output in the economy. The two main stabilization policies are monetary policy and fiscal policy.
Some of the stabilization policy tools are:
- Tax. The government changes the tax for households or businesses. To stimulate economic growth and inflation, the government lowers taxes. On the other hand, to moderate inflation and economic growth, the government raises taxes.
- Government spending. Increasing government spending stimulates aggregate demand and economic growth. Conversely, when the economy is overheating, the government reduces its spending.
- Policy rate. The central bank raises interest rates to reduce the rate of growth in the money supply. It causes interest rates in the economy to rise, weakening aggregate demand, and economic growth. The opposite effect applies when the central bank lowers the policy rate.
- Open market operations. In this case, the central bank influences the money supply by trading government securities. To increase the money supply, they buy government securities. On the other hand, to reduce it, the central bank sells securities.
- Reserve requirement ratio. This instrument works through an obligation for commercial banks to reserve a portion of deposits. If the central bank lowers its ratio, the commercial bank will reserve fewer deposits, increasing its money to make a new loan. Through the money creation process, a decrease in the ratio increases the money supply in the economy.
Meanwhile, structural policies attempt to overcome supply-side problems in the economy. The government seeks to increase productive capacity and encourage more efficient production. The policy can take a variety of forms, for example, regulatory reform and taxation.
Examples of structural policies
Increasing aggregate supply requires structural changes to the economy. Some examples of structural policies are:
- Eliminating price controls
- Reforming the tax system
- Improving the competitiveness of state-owned companies
- Improving the education system
- Building infrastructure
- Promoting competition
- Reducing labor costs
- Reducing barriers to trade and investment
- Improving bureaucracy and regulations
- Strengthening the financial system
Eliminating price controls
Eliminating price controls, which come in two forms (price ceilings and price floors), can be a powerful structural policy tool. Price controls often distort market forces, leading to inefficiencies and deadweight losses. These losses occur when government intervention prevents mutually beneficial transactions from happening.
For instance, a price ceiling set below the equilibrium price creates a shortage. Consumers might face scarcity and producers are discouraged from supplying enough goods, leading to a net loss for society. Conversely, a price floor set above the equilibrium price creates a surplus. Producers might be stuck with unsold goods, while consumers have less incentive to search for better deals.
By eliminating price controls, the government allows the market mechanism to operate more freely. This means that prices are determined by supply and demand, which can lead to a more efficient allocation of resources. Producers are incentivized to supply goods at a level that meets consumer demand, ultimately benefiting both sides of the market.
Reforming taxation
Taxation systems can often be a tangled web of rules and regulations, making them complex and cumbersome for businesses and individuals alike. Tax reform is a structural policy that aims to streamline this system, making it more efficient and easier to navigate. This can involve simplifying tax codes, reducing unnecessary deductions and loopholes, and improving the overall administration of tax collection.
Beyond simplification, a key objective of tax reform is to find the optimal tax rate. This sweet spot, as depicted by the Laffer Curve, aims to maximize government revenue without discouraging economic activity. If tax rates are too high, it can disincentivize businesses from investing and individuals from working hard. This can ultimately lead to lower tax revenue for the government.
However, when tax rates are too low, or the system is riddled with loopholes, the government might struggle to collect enough revenue to fund essential services and infrastructure development. This, in turn, can hinder long-term economic growth. Striking the right balance through tax reform is crucial for ensuring a sustainable and healthy economy.
Improving the competitiveness of state-owned companies
State-owned companies are often in a more advantageous position because they receive preferential treatment from the government. However, that leaves them with less incentive to be more competitive and efficient.
To carry out structural policies, the government privatizes several of these companies. Privatization promotes competition for these firms, forcing them to be more competitive.
Structural reforms may also not proceed through privatization. Governments may still retain their holdings, especially in strategic industries such as electricity and telecommunications. However, they are taking steps such as closing inefficient companies and changing their management. Of course, the aim is to make them more competitive, not only in the local market but also in the international market.
Improving the education and training system
An adequate education system and training program, implemented as part of a well-designed structural policy, generates quality human capital. Workers equipped with valuable skills are not only more productive but also more mobile within the labor market. This flexibility allows them to adapt to changing economic conditions and move between jobs more easily.
Improved human capital quality, fostered by effective structural policies, should contribute positively to people’s participation in the labor market. Workers become more open to acquiring new skills, continuously enhancing their employability. This, in turn, can lead to a lower structural unemployment rate and a more reliable, adaptable labor supply for the economy.
Building large-scale infrastructure
Large-scale investment in infrastructure – roads, railroads, airports, and bridges – is a prime example of a structural policy. This strategy aims to reduce the cost of doing business and boost long-term economic growth.
Here’s how:
- Improved flow: Inadequate infrastructure creates bottlenecks, hindering the movement of goods and people. This can significantly increase logistics costs for businesses, ultimately raising operating expenses. Structural policies that prioritize infrastructure development help streamline these flows, making it cheaper and faster to move goods and services around the economy.
- Geographic mobility: Poor infrastructure can also hinder geographic mobility. If the transportation network is inadequate, it can be difficult for workers to switch jobs or relocate for better opportunities. By investing in infrastructure, structural policies can help remove these barriers, allowing for a more efficient allocation of labor resources across different regions.
Overall, structural policies aim to create a more connected and efficient economic environment by improving infrastructure. This not only benefits businesses but also fosters a more dynamic labor market, ultimately contributing to long-term economic growth.
Promoting competition
Competition promotes efficiency and introduces more innovation in the economy. Pro-competition regulations (such as antitrust laws) introduce more competition to the market. They force businesses to become more competitive, and they try to be more productive to survive and make a profit.
Competition ultimately leads to innovation. Investment in knowledge-based capital is an essential factor for improving living standards.
Reducing labor costs
High labor costs relative to productivity erode the competitiveness of the economy. Some of the possible solutions to lower labor costs are:
- Eliminating minimum wages
- Reducing the power of the labor union
- Reducing social security contributions
- Improving the quality of workers
Reducing barriers to trade and investment
The openness of investment and trade creates new opportunities for workers, consumers, and companies. The openness of trade gives companies access to a broader market.
Likewise, the government can encourage foreign direct investment to introduce more competition in the local market. This should lead to efficiency and reduce monopoly power. Direct investment is also beneficial for technology and knowledge transfer and the provision of sophisticated inputs.
Improving bureaucracy and regulations
Poor governance and regulations deter investment and increase business costs. In the end, it hurts economic growth. Bureaucratic reform can take various forms, such as:
- Improve the justice system to make it easier for businesses to resolve disputes
- Simplify business regulations and licensing
- Streamline the tax administration system
- Eradicate corrupt practices among government officials and staff
Strengthening the financial system
The financial system plays a vital role in allocating capital efficiently. Sound financial markets ensure that capital flows where it is most productive. Improving institutions, introducing good governance, and investor protection are some solutions to strengthen financial markets.
Financial market deepening is another significant undertaking. Financial literacy increases people’s access to financial services, which leads to higher rates of private savings. That has an impact on increasing liquidity and providing more investment and growth opportunities.
Impacts of structural policies
Structural policies work on the supply side and affect the economy in the long run. By overcoming barriers to producing goods and services, it helps increase productivity, investment, and employment. This can be done in many ways.
Improving bureaucracy and handling overlapping regulations can improve the investment climate. The more investment in the real sector, the more capital accumulates in the economy. An increase in capital accumulation ultimately increases the economy’s potential output.
Likewise, the government encourages a more flexible labor market. The workforce is increasingly mobile, both horizontally, vertically, and geographically. Increasing the mobility of the labor force reduces the natural rate of unemployment in the economy.
The government also reduced (eliminated) the minimum wage. Minimum wages create deadweight losses and reduce economic well-being while eliminating them increases economic well-being.
On its budget, the government makes a more straightforward tax system. It makes it easier for companies to do business and plan company targets in the long term.
These structural changes will ultimately increase the economy’s production capacity. Households can benefit from cheaper (and better) products. Increased economic activity will also lead to more jobs and income for households.
