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Lesson M08.L05: Policies to Promote Long-Run Growth in Australia

Module: The Economy in the Long Run: Introduction to Economic Growth Level: intro Duration: 30 minutes Learning Objective: Evaluate supply-side policies to promote long-run growth in Australia. Data as of: 2023 Provenance: pc.gov.au | ABS | RBA | OpenStax Macro 3e

Explanation

Policies to promote long-run growth target the supply side of the economy — they aim to increase potential output (Y*) by shifting the LRAS curve to the right. Unlike demand-side stimulus, which has temporary effects on output, supply-side policies raise the economy's productive capacity permanently (or sustainably) by improving TFP, expanding the labour force, or increasing the capital stock.

Key supply-side policy categories (with Australian examples):

1. Investing in education and skills:
Higher-quality education and vocational training raise human capital — the skills and knowledge embedded in workers. More skilled workers are more productive, raising TFP. Australia's TAFE system and university sector play a key role. The Productivity Commission (2023) recommends targeted investment in digital and STEM skills.

2. Promoting research and development (R&D):
Government-funded R&D (through the CSIRO, universities, and the R&D Tax Incentive scheme) generates new technologies that raise TFP. Spillovers from R&D mean private investment underproduces it — justifying public subsidy.

3. Improving infrastructure:
Investment in transport (roads, rail, ports), digital infrastructure (NBN, 5G), and energy grids reduces production and distribution costs for firms, raising productivity across the economy.

4. Reducing regulatory barriers:
Excessive licensing, planning restrictions, and compliance costs increase the cost of doing business and slow the reallocation of resources to higher-productivity uses. The Productivity Commission regularly identifies regulatory reform opportunities (e.g., in housing, childcare, and professional services).

5. Increasing labour force participation:
Policies such as subsidised childcare, flexible working arrangements, and accessible aged care enable more Australians (particularly women) to participate in the workforce. A larger, more skilled labour force directly increases Y*.

6. Immigration and skilled migration:
Australia's skilled migration programme supplements domestic skills shortages and increases the size of the labour force, directly raising L in the production function.

Trade-offs and limits: Supply-side policies typically have long implementation lags and uncertain returns. Education investments may take 15–20 years to affect the workforce. Not all policies succeed (e.g., the NBN rollout faced cost overruns). Policymakers must weigh costs, equity implications, and political feasibility.

Worked Example

Scenario: The effect of childcare subsidies on labour force participation and GDP

Suppose a federal government childcare subsidy reduces the effective cost of childcare, enabling an additional 200,000 parents (predominantly women) to enter the workforce.

Step 1: Estimate additional labour hours.
Assume each new worker works 30 hours per week for 48 weeks per year.
New labour hours = 200,000 × 30 × 48 = 288,000,000 hours per year

Step 2: Estimate GDP impact using labour productivity.
Australian labour productivity ≈ $65 per hour worked (ABS, approximate 2022–23 figure).
Additional GDP = 288,000,000 × \(65 = **\)18.72 billion**

Step 3: Consider the government cost.
Suppose the childcare subsidy costs $4 billion per year in additional government expenditure.

Step 4: Net GDP gain.
Direct GDP gain = \(18.72b Less fiscal cost (which has opportunity cost) = −\)4.0b
Net GDP benefit ≈ $14.72 billion per year

Step 5: Long-run LRAS effect.
The labour force has permanently expanded → LRAS shifts right → Y* rises.
This is a supply-side growth effect, not just a demand stimulus.

Step 6: Tax revenue effect.
200,000 new workers paying an average tax rate of 25% on $70,000 income:
Additional tax revenue = 200,000 × \(70,000 × 0.25 = **\)3.5 billion/year
This partially offsets the \(4b cost, making the net fiscal cost approximately **\)0.5 billion/year.

Common Misconception

Misconception: The best way to promote long-run economic growth is to increase government spending (fiscal stimulus).

Correction: Fiscal stimulus (increasing G or cutting taxes to boost AD) is a demand-side tool that raises output in the short run but does not permanently expand the economy's productive capacity. Long-run growth requires supply-side policies that raise TFP, increase the labour force, or grow the capital stock. This is why the Productivity Commission focuses on education, R&D, infrastructure, and regulatory reform rather than budget deficits as the drivers of Australia's long-run prosperity. Demand stimulus can help close a recessionary gap, but it cannot shift the LRAS curve to the right.

Practice Prompts

  1. The Productivity Commission recommended reducing occupational licensing restrictions in trades and professions. How does this policy promote long-run economic growth? → Answer: Excessive licensing restricts labour supply in regulated occupations, reducing the number of qualified workers and keeping wages artificially high. Reducing these barriers allows more workers to enter high-productivity occupations, increases labour market efficiency, and raises TFP by reallocating workers to their highest-value use. This shifts LRAS to the right.

  2. Australia's federal government increases the R&D Tax Incentive from a 43.5% offset to 48.5% for eligible SMEs. Through which growth variable (K, L, or A) does this primarily operate? → Answer: R&D subsidies primarily raise A (TFP) — they incentivise firms to invest in innovation, developing new technologies and processes that make capital and labour more productive. Over time, successful R&D also may increase the effective K (intangible capital), but the primary channel is productivity (A).

  3. Why do supply-side growth policies typically have longer lags than demand-side policies? Give one Australian example. → Answer: Supply-side policies work by changing the economy's productive capacity, which requires building physical or human capital — processes that take years. For example, investing in university STEM education takes 3–5 years for students to graduate, then more years for graduates to accumulate workplace experience and impact productivity. By contrast, the RBA cutting interest rates transmits to mortgage rates within weeks. The Productivity Commission acknowledges these lags in its policy evaluations, recommending early, sustained investment rather than short-term fixes.

Further Resources