IGCSE Economics – Supply‑side Policy: Labour Market Reforms
Government and the Macro‑economy – Supply‑side Policy
Labour Market Reforms
Labour market reforms are supply‑side measures aimed at improving the efficiency, flexibility and productivity of the workforce. By removing barriers to employment and enhancing skills, governments seek to shift the long‑run aggregate supply (LRAS) curve to the right, increasing potential output (\$Y^{*}\$) without generating inflationary pressure.
Key Objectives
Increase the quantity and quality of labour available to firms.
Reduce structural unemployment.
Enhance labour productivity and potential output (\$Y^{*}=A\cdot f(K,L)\$).
Make the economy more adaptable to technological change.
Lower the natural rate of unemployment.
Typical Labour‑Market Reform Measures
Education and Training
Investment in secondary and tertiary education.
Vocational training programmes and apprenticeships.
Adult retraining schemes for workers displaced by technology.
Incentives for Work
Reduction of marginal tax rates on labour income.
Introduction of earned‑income tax credits.
Child‑care subsidies to enable greater labour‑force participation, especially among women.
Flexibility of Labour Markets
Reforming employment protection legislation (EPL) to make hiring and firing easier.
Encouraging part‑time, temporary and freelance contracts.
Introducing flexible working hours and remote‑work options.
Improving Labour Mobility
Reducing geographic mobility barriers (e.g., housing subsidies, transport improvements).
Recognition of professional qualifications across regions.
Active Labour‑Market Policies (ALMPs)
Job‑search assistance and counselling.
Public employment programmes for short‑term work.
Subsidised wages for employers hiring long‑term unemployed.
Expected Economic Impacts
The table below summarises the short‑run and long‑run effects of each reform type on key macro‑economic variables.
Reform Measure
Short‑run Effect on AD
Long‑run Effect on LRAS
Typical Impact on Unemployment
Potential Side‑effects
Education & Training
Neutral (no immediate change in demand)
Rightward shift (higher productivity)
Structural unemployment falls
Time lag before benefits materialise
Incentives for Work (tax cuts, credits)
Rightward shift (higher disposable income → higher consumption)
Rightward shift (greater labour supply)
Frictional unemployment may fall
Reduced fiscal revenue; possible budget deficit
Labour‑Market Flexibility
Potential rightward shift (lower hiring costs → more investment)
Rightward shift (easier reallocation of labour)
Both frictional and structural unemployment decline
Job security concerns; possible increase in income inequality
Mobility Improvements
Neutral
Rightward shift (better matching of jobs and workers)
Frictional unemployment falls; short‑term reduction in structural unemployment
Fiscal cost; risk of creating dependency if not time‑limited
Diagrammatic Illustration
Suggested diagram: LRAS shifting rightward from \$LRAS{0}\$ to \$LRAS{1}\$ as a result of labour‑market reforms, with AD unchanged in the short run.
Evaluation – Advantages and Disadvantages
Advantages
Increases potential output without triggering demand‑pull inflation.
Reduces long‑run unemployment, freeing resources for other sectors.
Improves competitiveness of the economy in a global market.
Disadvantages
Many reforms have long implementation lags; benefits may not be felt within an election cycle.
Costs of training, subsidies and public programmes can strain the fiscal budget.
Greater labour‑market flexibility can increase job insecurity and income inequality.
Key Formula
The relationship between potential output and factor inputs can be expressed as:
\$\$
Y^{*}=A\cdot f(K,L)
\$\$
where \$A\$ represents total factor productivity, \$K\$ capital stock, and \$L\$ the effective labour input (quantity of labour adjusted for skill and effort).