Supply-side policy measures: infrastructure spending

Supply‑Side Policy (SSP) – 4.4

• Definition (Cambridge 4.4.1): Government actions designed to increase the productive capacity of an economy (shift the LRAS curve right) rather than to boost aggregate demand.
• Typical SSP measures (Cambridge 4.4.2):
  • Infrastructure spending – roads, rail, ports, energy, communications, public services.
  • Education and training – schools, colleges, vocational programmes.
  • Labour‑market reforms – flexible wages, reduced trade‑union power, active labour‑market policies.
  • Lower direct taxes on firms and individuals – corporation tax cuts, income‑tax reductions.
  • Deregulation – removing unnecessary licences, simplifying planning rules.
  • Privatisation of state‑owned enterprises.
  • Incentives for research & development and innovation.
  • Environmental‑friendly measures – “green” infrastructure, carbon taxes.

4.4.1 Infrastructure spending – a supply‑side measure

1. What is it?

Government expenditure on the physical and organisational structures that enable economic activity. Main components:

• Transport: roads, motorways, railways, ports, airports.
• Energy: power stations, electricity grids, renewable‑energy networks.
• Communications: broadband, telephone and satellite systems.
• Public services: schools, hospitals, water & sewage, waste‑management facilities.

2. How does it help achieve the macro‑economic aims? (4.5‑4.7)

Thus infrastructure spending contributes to all five macro‑economic aims set out in sections 4.5‑4.7 of the syllabus.

3. Key mechanisms – how the policy works

4. Advantages

• Long‑term growth: Expands productive capacity (rightward LRAS shift).
• Job creation: Construction and ancillary services generate employment in the short run.
• Multiplier effect: Initial public outlay induces further private spending. The fiscal multiplier is $$k=\frac{1}{1-\text{MPC}}$$ where MPC = marginal propensity to consume.
• Regional convergence: Projects in lagging areas reduce geographic income gaps.
• Environmental benefits (if “green”): Lower emissions and support for sustainable industries.

5. Disadvantages / Risks

• High fiscal cost: Large borrowing can raise public debt and future tax burdens.
• Implementation lag: Planning, land acquisition and construction may take several years before benefits appear.
• Misallocation: Politically motivated projects may have low economic returns.
• Crowding‑out: If financed by higher taxes, private consumption and investment may fall.
• Risk of over‑capacity: Excessive or poorly targeted infrastructure can lead to under‑used assets.

6. Evaluation criteria (AO3) – what examiners look for

Sample evaluation paragraph (Level 2/3 answer): “The new high‑speed rail link is likely to be effective because it cuts travel times and logistics costs, directly raising LRAS. However, its efficiency is questionable: the projected pay‑back period of 12 years exceeds the typical 5‑year horizon for public projects, suggesting a high fiscal cost. In terms of equity, the link connects a deprived northern region with the capital, improving regional income distribution, but the benefits accrue mainly to businesses that can afford higher freight rates. Environmentally, the shift from road to rail reduces carbon emissions, supporting sustainability goals. The project’s long implementation lag (≈ 6 years) means short‑run AD effects are modest, while financing through a new loan raises public debt, raising the risk of crowding‑out. Overall, the rail link offers clear long‑run gains but must be weighed against its fiscal burden and timing.”

7. Diagram – sketch prompt

Draw an AD‑AS diagram with the following features:

• Axes: Real GDP (output) on the horizontal, Price level on the vertical.
• Initial equilibrium at point A (AD₀, SRAS₀, LRAS₀).
• Show a rightward shift of LRAS to LRAS₁ (higher potential output).
• Show a possible short‑run rightward shift of AD to AD₁ (due to multiplier and job creation).
• Label the new long‑run equilibrium at point B with higher real GDP and, if cost reductions are significant, a lower price level.

8. Worked example – multiplier calculation

Suppose the government increases infrastructure spending by £200 million and the marginal propensity to consume (MPC) is 0.75.

1. Calculate the fiscal multiplier: $$k=\frac{1}{1-\text{MPC}}=\frac{1}{1-0.75}=4$$
2. Determine the total change in aggregate demand: $$\Delta AD = k \times \Delta G = 4 \times £200\text{m}= £800\text{m}$$
3. Interpretation: The £200 million injection is expected to raise total demand by £800 million, creating additional income and potentially shifting AD rightwards in the short run.

9. Glossary (syllabus terms)

• LRAS (Long‑Run Aggregate Supply): The vertical curve showing the economy’s potential output at full employment.
• SRAS (Short‑Run Aggregate Supply): The upward‑sloping curve showing the relationship between price level and output when some input prices are fixed.
• AD (Aggregate Demand): The total demand for goods and services at each price level.
• MPC (Marginal Propensity to Consume): The proportion of an additional pound of income that is spent on consumption.
• Fiscal multiplier: The ratio of the total change in output to the initial change in autonomous spending.
• Perfectly inelastic: Quantity demanded (or supplied) does not change when price changes (elasticity = 0).
• Unitary elastic: Percentage change in quantity equals the percentage change in price (elasticity = 1).
• Perfectly elastic: Any price increase eliminates demand (or supply) – quantity changes infinitely with a tiny price change (elasticity = ∞).

10. Summary

Infrastructure spending is a core supply‑side policy that raises an economy’s potential output by improving production efficiency, reducing costs, and enhancing human capital. It contributes to the five macro‑economic aims (growth, employment, price stability, balance of payments, and equitable distribution) and, when designed as “green” infrastructure, supports environmental sustainability. The main challenges are fiscal cost, long implementation lag, and the risk of politically driven misallocation. Effective evaluation must weigh effectiveness, efficiency, equity, sustainability, timing, and financing to determine whether the policy delivers sustainable economic growth.