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 a policy to influence long-run aggregate supply.
Government structural policy objectives
Structural policies affect the long-term economy. Because resources are scarce and wants are unlimited, this policy tries to influence resource allocation by the household and business sectors.
Structural policies attempt to address deeper economic problems. It is not like monetary and fiscal policy, which are short-term oriented.
The main target of structural policies is supply-side issues of the economy. Through it, the government tries to direct the efficient production of goods and services. However, the economic problem is not only the demand side but also the supply side.
Difference between stabilization policy and structural policy
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
Price control consists of two types, price ceiling, and price floor. Both reduce economic welfare by raising deadweight losses.
The elimination of price controls allows the market mechanism to operate freely. That ultimately leads to the best results for both consumers and producers.
Often, taxation systems are complicated. Besides, the administration is inefficient. Through tax reform, the government is trying to fix it all.
Also, tax reform attempts to find the optimal rate (see Laffer’s curve), which results in maximum tax revenue without sacrificing the economy. However, when taxes are less optimal, the government accumulates debt. It limits its ability to finance development expenditures such as infrastructure.
Improving the competitiveness of state-owned companies
State-owned companies are often in a more advantageous position because they often receive preferential treatment from the government. 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 generate quality human capital. Workers are more productive and more mobile. They are more flexible in moving from one job to another.
Improved human quality should contribute positively to people’s participation in the labor market. They are also more open to acquiring new skills. That, in turn, lowers the structural unemployment rate and results in a more reliable labor supply.
Building large scale infrastructure
Large-scale investment to build infrastructures such as roads, railroads, airports, and bridges is a solution to reduce the cost of doing business. Inadequate infrastructure hinders the flow of goods and people. That increases costs in the economy. Firms have to bear higher logistics costs, increasing operating costs. Likewise, it is more difficult for people to switch jobs between regions, increasing geographic mobility barriers.
Competition promotes efficiency and introduces more innovation in the economy. Pro competition regulations (such as antitrust laws) introduce more competition to the market. It forces businesses to become more competitive. 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. It should lead to efficiency and reduce monopoly power. Apart from that, 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 is one solution 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 the 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 potential output of the economy.
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. Eliminating the minimum wage 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 production capacity of the economy. Households can benefit from cheaper (and better) products. Also, increased economic activity will lead to more jobs and income for households.