Any economic policymaker is faced with two fundamental options when formulating fiscal policy. One is aimed at growing the economy in the short term, while the other is aimed at long-term economic growth. The former is aimed at boosting demand immediately while the latter is aimed at developing the potential of the economy and thereby generating more supply.
If an economy seeks to boost demand, it would increase consumption and such an increase would eventually transform itself into economic growth. This can happen in a fairly short period of time. The underlying idea is that government uses measures related to taxation and public expenditure to stimulate consumption to even out the economic cycle.
On the other hand, if an economy seeks to develop its potential for growth, the impact is first on increased supply which in turn generates employment and, as a consequence, economic growth.
It targets elements that enhance an economy’s ability to supply more goods and services. This process takes longer to have the desired effect of growth and, therefore, one needs to have a longer-term perspective.
The former policy has been dubbed as demand management, while the latter has been dubbed supply side. Demand management policy aims at controlling demand to avoid a recession or to provide a stimulus to an economy. It is seen as a way of tackling a short-term economic crisis such as the one caused by the coronavirus.
Supply-side economics aims at providing incentives and funding to improve an economy’s productive capacity.
There was a time when the divide between demand management policies and supply-side policies was drawn along ideological lines. Demand management policies were seen more as left-wing policies and supply-side policies were seen more as right-wing policies.
Supply-side policies on their own cannot work because it is useless producing more if there is not enough demand for that additional output
In effect, they do depend on each other for them to succeed. If one stimulates demand without stimulating supply, inflation is likely to creep into an economy. This is what some countries are experiencing at the moment.
Governments have pumped in billions into their economy but supply could not keep the pace because of disruption issues caused by the coronavirus. Supply-side policies on their own cannot work because it is useless producing more if there is not enough demand for that additional output.
There are also other considerations to make. We can take Malta as an example. As a country, we import most of what we consume. This means that if a government adopts demand management policies, it needs to appreciate that most of the increased demand for goods will go towards imported products. This would imply that demand management policies have a limited impact on our economic cycle, but are appropriate policies when government is seeking to provide support to certain sectors of society and to achieve more social justice.
Supply-side policies have a limited impact if one is seeking to generate a greater level of output in an economy which is facing labour market shortages, such as ours. However. they would be most appropriate if one is seeking to have a transformation and restructuring of the economy.
As we emerge from the coronavirus, Malta has an excellent opportunity to think deeply about which economic goals we should set for ourselves and what would be the most suitable mix of policies that help us achieve such goals. We should not seek to put the clock back; we need to evolve and that forces us to make some choice.