Evaluate the likely microeconomic and macroeconomic effects of the supply-side policies recently introduced

in Indonesia (25)

Supply-side policies are policies enacted by the government in the hope of increasing the overall output of the economy.
These involve interventionist supply side policies, in which the government intervenes in a market to affect the supply
side of the economy, often to increase potential output and achieve long term economic growth. On the other hand,
market-based supply side policies incentivise private decision makers to increase output and grow by allowing them to
resolve their own problems.

The likely microeconomic consequences of the supply side policies is an increase in profit for firms in indonesia. We are
told that one of the supply side policies imposed by the government is to reduce tax, with ‘most workers pay[ing] little
or no tax’. The result of this decrease in income tax is that consumers will have more disposable income (C+S=Y)
meaning that they can now spend more on certain goods.This means that the demand for certain goods such as luxury
goods may increase as people can now afford them more easily. For example, the car market in Indonesia would
experience an outward shift in demand, leading to increased profits for the firm seen by the area ABCD. These
increased profits could then be used to reinvest into the business, improving the products quality or and allowing for
organic growth, increasing the scale of the business and even allowing it to compete abroad. Furthermore, this decrease
in tax rates could also encourage large TNCs from other countries to operate in Indonesia which would encourage FDI
into the economy and lead to economic growth as investment is a component of Aggregate demand which would
increase. The lower tax rates could also incentivise new firms to open as they now have larger profit margins.

However, this reduction in tax does not necessarily cause increased profits for firms in Indonesia. Firstly, it depends on
the reduction in taxation as a 2% reduction per tax bracket may have little impact on the economy. Furthermore, we are
told that ‘large companies are often squeezed for taxation’. This means that it is unlikely for TNCs to situate
themselves in Indonesia as they may be targeted for tax revenue. If the economy is in a recession, a decrease in tax may
not actually increase spending as consumers may be suffering from the negative wealth effect or the markets which
benefit from the tax cuts may have income elastic demand and may offer normal or luxury goods so demand for these
firms will not increase despite tax reductions as consumers’ incomes decrease. Finally, a decrease in tax will result in a
worsening of the budget deficit and debt which already stands at 26% of GDP. The consequences of this worsening
debt is that the government will have to pay more money servicing this debt and this could lead to economic instability
and a large opportunity cost as this money could be spent elsewhere, e.g improving education.

One macroeconomic effect of the supply side policies introduced in Indonesia is economic growth driven by increased
spending on infrastructure spending. We are told that the government’s ‘infrastructure spending will encourage
exports’. This is because infrastructure spending, for example on education and healthcare, will increase the
productivity of workers in Indonesia and will make them more efficient as there will be less sick days and workers will
be more focused at work. The UK loses over £100 billion annually due to sick days so if the government was able to
improve the healthcare system it could improve the efficiency of firms. This would result in an outward shift in LRAS
as the quality of factors of production (labour) have increased meaning that firms can now produce more than they
could previously. The consequence of this is not only economic growth, with an increase from Y1 to Y2, but also an
improvement in the current account as the price level decreases from PL1 to PL2. At this lower price, firms will be able
to compete abroad with other countries leading to an increase in exports which causes a balance of payments surplus
and further economic growth as exports are an injection into the circular flow of income meaning that more money
will enter the economy and AD will increase as one person's consumption is another's' income. Finally, government
spending on infrastructure is said to also ‘increase jobs’ meaning that employment will increase and more people will
have more disposable income to spend on goods and services in the economy, shifting AD outwards and increasing
RGDP significantly. Furthermore, this increased employment will lead to increase tax revenue for the government
because currently only ‘27 million’ people are registered as tax payers but after the increase in employment due to
crowding in, more people will have to pay direct tax and the government can use this revenue to tackle market failure or
to improve other sectors of the economy also leading to economic growth.

However, these interventionist policies may not trigger economic growth because they carry a significant opportunity
cost. The opportunity cost is the value of the next best alternative forgone. In this case, government spending on
infrastructure carries the opportunity cost of subsidising exporting firms which may have been more successful.
Furthermore, government spending often incurs a large time lag meaning that the benefits of this spending may take
years to be seen. Furthermore, it is not guaranteed that Indonesia may experience export-led growth because the
inflation rate may be high meaning that their goods appear expensive on the international market and therefore their
low costs caused by increased productivity may not actually lead to more exports as their goods still appear expensive.
Alternatively, other countries may be in economic decline and not demand imports from Indonesia which is likely as
these policies were post brexit meaning that the consumer confidence of some Eu countries and the UK will have been
low and they may not have demanded these raw materials such as ‘coal’ as they have low confidence and expect poor
business projections. FInally, there is no guarantee that this spending will lead to economic growth as Indonesia is likely
to import hugely if they mainly produce raw materials. This consistent importing means that they are likely to have a
current account deficit and not see export-led growth.

In conclusion, the supply-side policies, both interventionist and market-based, will lead to an increase in profits for
firms in Indonesia and also economic growth. This is because consumers will be taxed less, resulting in more disposable
income and demand in certain markets, causing revenue and profit to increase. Moreover, the interventionist supply
side policies will trigger the positive multiplier effect and cause and increase in Aggregate demand leading to economic
growth.