SUBJECT: BUSINESS ECONOMICS III

Topic: why india needs supply side economics?

Name: yashvi sheth
Roll no.: HSBC0108
Content
1. Introduction
2. The message
3. Features of Supply Side Economics
4. Importance of SSE in India
Introduction:
Supply side economics (SSE) as a body of theoretical ideas, has far less substance or
elegance than either the standard Keynesian income-expenditure model or the new classical
economics.

Actually, supply side economics does not constitute a coherent set of relationships like the
Keynesian model, relationships which explain how the macro economy works.

Supply side economics is based on two propositions—first, full faith in the validity of Say’s
Law of Markets and secondly, a belief that tax rates are the prime determinant of incentives,
which in turn, are the prime determinant of production. Basically, supply side economics is as
much, if not more, ideological than it is economic.

Supply side economists insist on the validity of Say’s Law because it is in part an article of
faith, a belief in the efficient working of the market system. It is also a logical necessity to
explain for their basic argument, namely, that it is possible to explain how the economy
works by approaching it from the viewpoint of aggregate supply rather than aggregate
demand. Contemporary supply side economics deals with what Keynes called a real
exchange economy—an economy which uses money, but only as a natural link between the
transactions in things. It (SSE) does not allow money to enter into motives or decisions-—as
it does in Keynesian theory.

Supply Side Economics—the Message:

When we talk of supply side economics, it only means manipulating the aggregate supply
curve by modernisation, rationalization, skill formation, liberal depreciation, reorganization,
cost manipulation (while these are treated as constant parameters during demand
management). For an economy clearly in need of major revitalization the provisions of
bringing depreciation charges more in line with the current cost of capital gains and high
taxes as at present will shift the scarce capital resources both in the developed and developing
economies from the higher to the lower productivity levels adversely affecting the supplies.

SSE shifts the emphasis from aggregate demand management of the economy to micro-
motivations for productivity. The stress is transferred for distribution of income, monetary
and fiscal policy and ‘fine-turning’ of the economy to incentives for the supply of labour,
improvements in productivity and removal of restraints on optimizing activities.

The most common theme of SSE is the responsiveness of work, productivity, saving,
investment and enterprise to after-tax rewards. High tax rates are opposed because they
discourage economic activity; divert resources to tax-shelter industries and tax exempt goods;
waste fine talents of lawyers, accountants and consultants in search of loopholes in tax laws;
drives economic activity underground; induces tax evasion and encourages smuggling and
fraud; and worst of all, causes the disintegration of the moral values of the nation.

The proper characterization of supply side economics is a mystery to many. There are those
that believe that the Supply-side theory is the one that holds that tax cuts pay for themselves.
Others believe that this theory dictates that fiscal policy be only concerned with the supply-
side of the economy. A third belief is that supply-side economics is whole-hog for
government intervention to promote saving and investment through subsidizing these
activities.

All of the above are false characterizations. In simple terms, supply-side economics is the
application of price-theory to aggregate entities in the economy—nothing more, nothing less.
It has as its underlying philosophy the belief that the market is stable and, if left to itself, will
lead to an efficient allocation of resources.

The essential argument of SSE is that adding to supply unlike adding to demand, is not a
zero- sum game. In order to make something a producer need not be given any money—
instead he needs incentive—an intangible. Consumption, on the other hand, is really zero sum
—in order to stimulate demand a policy-maker gives someone $50, then he must either take
the money away from someone else, or suffer the central bank of the country to print it, thus
marginally devaluing everyone else’s money.

Supply and demand are far from being symmetrical though text-books suggest that these are
exactly so. They differ in this crucial respect; things are consumed with cash—but made with
effort. Supply-siders think of high tax rates as potential barriers to commerce—not as revenue
collecting devices— tax rates are one thing; tax revenues are another. They argue that high
tax rates collect tiny revenues; Laffer’s Curve graphically makes the point that a 100 per cent
tax rate will collect no revenue as is illustrated in the Fig.36.1

According to economist Arthur Laffer, there is a close relationship between tax rates,
revenues and productivity. When the tax rate is 100 per cent, all revenue ceases; people will
not work for nothing. On the other hand, if the tax is zero, there is no government.
Somewhere there is an optimum point on the curve where tax rates will produce the desired
revenues—and the desired national product.

That point is variable, but basically in a democratic system, it is, to quote Dr. Laffer, “where
the electorate desires to be taxed”. Too much of a tax burden can lower incentives to work.
Revenues—and production—will fall. Lower taxes can increase both. There is nothing
controversial about the curve itself, which diagrams one of the most basic propositions in
economics. At the left hand side of the scale, the government imposes no taxes on income
and so gets no revenues.

Moving right along the scale, as the tax rate increases, so do the revenues. But when the rates
get high enough to discourage work and encourage tax avoidance, ever higher rates produce
less revenues (the downside of the hill). If the tax rate reaches 100 per cent, it yields zero
revenues—no one would bother to earn taxable income if the government confiscated all of it
through high tax rates.

Keynesian analysis holds that the first effect of a tax change is to change the level of
disposable income in the economy. The supply side view is that aggregate income, in real
terms, cannot change at the outset but can only change when output increases. According to
supply-side economists, the only effect, at the first level of a tax change is a change in the
relative costs confronting economic factors in the economy. Acceptance of this fact leads to
quite different approach to tax policy from that pursued in a Keynesian framework.

Supply-side economists hold that market is inherently stable and left to itself is the best and
most efficient allocator of resources—the government may intervene in those rare
circumstances in which market fails to properly represent value through the pricing
mechanism. The neo-classical or supply-side analysis, in contrast with Keynesian approach
treats changes in income as a second level consequence of a tax or tax change.

The first effect, they assert, is the change in one or more of the relative costs which private
sector entities confront. They believe that every tax has the attribute of altering relative costs.
As such, supply siders believe tax changes should–always be expressed in rates and the
thresholds at which they apply; to do otherwise is to posit a static universe in which there is
no post-tax-change shift in incentives.

Thus, Laffer Curve is a graphical representation of the disincentives created by high tax rates,
is an essential element of a brand new theory called Supply-Side Economics. Its recent
emergence signaling the beginnings of a return to micro or Classical from macro or
Keynesian economics is, no doubt, the most important development in economic theory in
the cast 25 years—especially during the last decade of glaring phenomenon of stagflation.

Features of Supply Side Economics:

An important feature of SSE is the issue of incentives and tax cuts. It constitutes the basis of
radically different perspectives on economic activity of supply side and neo-Keynesian
theory—supply side economics treats incentives as the main engine of growth—incentives
energies the economic system— unlike Keynesians they do not take it for granted—these
incentives are blunted and thwarted by a heavy tax burden.

All that the Laffer Curve says is that, after a certain point a tax—or the tax level as a whole
can become counterproductive by adversely affecting the incentives. The central theme of
economic growth is that people should work less hard—but more productively—and this is
what the supply side theory tries to achieve. The supply side economists seek the removal of
disincentives to saving and investment.

Supply siders believe that a permanent cut in tax rates (as opposed to low income credits and
piecemeal concessions) powerfully stimulates supply of all goods and services produced by
the economy thereby stimulating the incentives to produce, save and invest. Tax cuts must be
so shaped as to encourage production than to boost demand—especially when the problem is
to fight ‘stagflation’.

Their main contention is people don’t work to pay taxes. People save to make an after tax rate
of return on their savings—so these are the personal and productive incentives that matter in
the disposition of income, of production and of savings—when you change incentives—you
change human behaviour conducive to growth, production and saving.

It must be realized that the crucial source of creativity and initiative in any economic system
is the individual investor. Economies do not grow of their own accord or by dint of
government influence. They grow in response to the enterprise, initiative and dynamism of
people, entrepreneurs who are willing to take risks encouraged by incentives. That is why,
Schumpeter, in his model of growth gave a key role to skill formation, entrepreneurial
behaviour, dynamism and innovation—these constitute the essential ingredients of growth in
any society—believe the supply-side economists.

Supply-side economists believe that the problem of stagflation couldn’t be tackled because
we have been taxing work, output and employment and subsidizing non-work, leisure and
unemployment during the past decade or so. The real theoretical core of supply side
economics rests in the belief that the major reason holding back production, causing
unemployment creating inflation and leaving the government with insufficient revenues and
larger deficits is taxation.

More specifically, supply-side economy maintains that marginal tax rates and the real source
of economy’s problems. The marginal tax rate is the progressive increase in the tax rate
applied to each increment of income as the tax-payer moves into a higher tax bracket every
time his nominal money income increases.

Jude Wanniski, a great advocate of SSE says, “that the concept of marginality is crucial to
understanding of economic behaviour very few people think of the margin, but everyone acts
on the margin “Production comes about because people are willing to work, and people work
for only one reason—to maximise their welfare. It is at this point that, taxes enter the picture,
particularly the marginal tax rate. Taxes are a disincentive to production.

Taxes on capital discourage investment and taxes on people discourage work. This is the
essential message of supply-side economics. It is in this connection that Professor Laffer
developed the concept of ‘wedge’, especially a ‘tax wedge’. This is the gap that government
through its power to tax and to regulate introduces between what an individual gets for
working and what the individual is allowed to keep. “Marginal tax rates of all sorts stand as a
wedge between what an employer pays his factors of production and what they ultimately
receive in after-tax income–therefore, to increase total output taxes of all sorts must be
reduced. These reductions will be most effective where they lower the marginal tax rates the
most.”

The supply-side economics emphasizes the tax rate changes because tax rate changes affect
relative prices, output and growth. Higher tax rates create preferences for leisure to work,
consumption to saving and allocation of resource, to non-market activity to market activity.

Disincentives for work and saving affect supply of labour and capital, and all marketable
goods and services and hence economic growth and price stability. Much to the charging of
the proponents, its basic idea remains extremely simple… “If the rate of taxation is raised, the
incentive to work, and consequently the national income, may fall.” According to this view,
beyond a point, this decline is so sharp that the total tax collection (which depends on the
national income) falls as well. The American “Supply-siders” argue that in the US and many
other countries during the 1980s the existing tax rates have gone past this critical point.
Hence, if the tax rates were cut, national income would rise and, more paradoxically, so
would the total tax takings.

Role of Government:
The SSE economists view the government as essentially non-productive, if not positively
wasteful. They think that the ultimate test of the legitimacy of production, so to speak, is the
market. Productive activity is basically market determined activity. From the ‘wedge’
analysis it is easy to understand the hostility to SSE to government activity. Therefore, the
SSE insists that government should do those minimum necessary acts which are essential to
maintain a lawful and orderly society including protecting it from external aggression—all
else is waste; The SSE is emphatic about the inefficiency of government regulations.

They do not deny the necessity of government but hold that its virtues are minimal. They
consider government regulations as a necessary evil to be tolerated. Beyond that limit, SSE
wants to roll back government, to get it off the backs of the people to prevent its wasteful use
of productive resources.

Emphasis on Growth:
Back of Adam Smith can be described as its chief motto, though not in the sense of returning
to some purist version of laissez-faire. It may sound incredible, but supply side economists
really do believe and preach that if you want economic education—The ‘Wealth of
Nations’—is still the best book to read. They realize Smith’s ideas have still great relevance
to the economic problems of developing and developed countries in the matter of industry
and trade. As such, supply-side economics naturally gives emphasis on growth, not
redistribution.

It aims at improving everyone’s economic conditions over time, but not necessarily in the
same degree or in the same period of time. The aggregate demand created by economic
activity, as seen from supply side is indifferent to the issue of equality. Its bias is
consequently in favour of a free market for economic activity, because this provides the most
powerful economic incentives for investment, innovation and growth. However, those for
whom economic equality is at least as important as growth will always want to see the
government, to restructure this aggregate demand and will be indifferent to the issue of
economic incentives.

Importance of sse in india

The Indian government’s push to ensure a supply-side recovery rather than a demand-focused
reinflation of the market is a result of a longer-term strategic outlook. As proof of the
pudding, Principal Economic Advisor to the Ministry of Finance Sanjeev Sanyal cites the
massive debt incurred by western economies who have fallen into the trap of shorter-term
demand-side boosts through stimulus package rollouts. Not only has it not eased the
economic slowdown, but hyperinflation is a present problem rather than a future nightmare.
With US President Joe Biden further raising the debt ceiling, debt repayment in the recent
future seems highly unlikely, whereas any accompanying economic recovery through
increased liquidity in the market is invisible enough to be considered negligible.

The economy of India is in bad shape for the past few years. In 2016, demonetization
followed by a raw planned implementation of GST were the starters for the bad phase of the
Indian economy. On top of this, there had been an uncountable number of banking and
NBFCs crisis. The ongoing Pandemic has further deepened the dip in the economy.
Businesses have been shut down; the unemployment rate is at an all-time high; companies
have laid off millions of workers because the revenue of the companies has gone down like a
rocket. From agriculture to big corporates to micro, small and medium enterprises, a slump is
everywhere. Many economists have termed it as the fourth recession in Indian history since
independence. Some sustainable measured needed to be taken before things get more
complicated than before.
So, what are the key areas that should be targeted?
Demand and supply are always vital factors that define a company, a market and the
economy of a country. For a country of India’s size and population where there are millions
of firms to supply for the demands of over a billion people, this concept of demand and
supply becomes even more crucial. The role of the government to fluctuate the demand and
supply in a country is something that knits it together.
 
The Supply Side 
Agriculture, manufacturing and services are the three pillars of any economy. In India’s
context, despite the majority of people live in rural areas, agriculture contributes well below
20% to the GDP. Same is the case with manufacturing, that has not much to offer to the
economy. The growth of these two sectors has been the lowest lately. The slump in recent
times has hit these two sectors even harder. Despite an excellent harvesting season and a lot
of harvested crops, farmers in the country do not have access to markets to sell their crops.
COVID-19 has further hit the automobiles sector, which was in decline. In India, motor
vehicles attract taxes as high as 28% and additional levies up to 22%. These figures are some
significant factors for the decline in automobiles sales.
 
Short term and long term reforms to increase the supply- Farmers must be provided loans at
low-interest rates or the rates subsidized by the central and the state governments. Proper
infrastructure for them to supply their harvests to give farmers an instant relief. Along with
these, better MSPs for the farmers will help them sustain this battle in a more significant
manner. Manufacturing sectors needs a substantial boost, for the automobiles sector, in order
to encourage the producers, relaxes on high taxes will act as a catalyst for an improved
supply of motor vehicles. The increase in production will also positively affect the services
sector, where a considerable number of layoffs are done recently. Adding to this, the
government should make a clear stand on the future of electric vehicles, as the ambiguity is a
hurdle in front of the manufacturing companies to reduce the supply.