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Using the data and your economic knowledge, assess the policies that could be adopted to improve the underlying rate of economic growth of the UK economy (25)

The underlying rate of economic growth is the increase in the productive potential of the economy. It can be demonstrated by a shift outwards of the LRAS curve, as shown below where the increase from y1 to y2 demonstrates the underlying growth. In order to improve the underlying growth rate, supply side policies could be used reduce of spare capacity in the economy and increased capacity itself as this increases the productive potential of an economy.

The government could use supply side fiscal policy and reduce corporation tax in order to allow firms to retain more profit which can then be invested into research and development. This could lead to advances in information and communications technology which is “one of the main factors behind Europe’s poor productivity” (extract B, Line 25) resulting in more efficient production, thus leading to an increase in capacity and underlying growth.

However reduced corporation tax means a decrease in revenue for the government which could potentially lead to a budget deficit or result in higher taxes elsewhere in the economy, such as income tax which would negatively impact on consumers.

The government could also introduce subsidies to encourage new businesses to set up in the UK, thus increasing capacity. This would reduce a firms costs of production, and thus allow them to lower prices and become more competitive on the assumption that they pass on the reductions in their costs to consumers.

However this also leads to an opportunity cost for governments as the money may be better spent elsewhere. Alternatively the government could also attract more businesses to the UK to increase capacity through deregulation, at a much lower cost than subsidies. Deregulation would make it easier and more attractive to operate in the country, and could lead to more job creation and increased productivity.

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The government could also increase labour productivity by investing more into education and training. Training schemes could help to reduce regional inequalities in labour and help reduce structural immobility by for example giving people the skills needed to take up the more service based jobs available in the UK economy.

Also investing in schools will, in the long run, result in a more skilled workforce who can produce more in the same time, thus leading to an increase in capacity and underlying growth. However these policies are timely and would require continued investment leading to an opportunity cost for the government.

There are many different policies that the government could implement to improve underlying growth. However in the current economic climate, with deficit reduction a priority governments may not want to provide subsidies, due to the opportunity cost of the money, or reduce taxes as this would lead to an increase in the deficit.

Policies such as deregulation may be more favourable as they entail lower costs, however investment in schools and education may be an effective policy as it would lead to more significant improvements in the long term. Also in order for the supply side policies to lead to an improvement in underlying growth there would need to be simultaneous increases in demand to attract the firms and callow them to continue increasing output.



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