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In the long run the productive potential of an economy (measured by LRAS) is driven by improvements in productivity and by an expansion of the available factor inputs (more firms, a bigger capital stock, an expanding active labour force ).
Improvements in labour productivity and efficiency cause the long run aggregate supply curve to shift out over the years.
The government can facilitate this process in a number of ways.
These include:
• Reduced direct taxation.
This increases the incentive to work and to earn profits. It is also likely to increase the level of Foreign Direct Investment. However it is likely to be regressive and to increase inequality.
• Increased expenditure on education and training.
This should in theory lead to a more skilled and productive workforce. However, significant increases in education spending have had only a marginal impact on educational attainment and have made it very difficult for the government to control its deficit.
• Allowing inwards migration of skilled workers.
This should increase the skills base of the workforce but is likely to be socially divisive and be politically unpopular.
• Reduced levels of welfare benefits.
This should increase work incentives but again is likely to be socially divisive.
• A programme of de-regulation.
This would reduce the administrative burden on firms and make it easier for them to expand. It would obviously be welcomed by employers but not by workers who would see employment protection and health and safety legislation as central to their interests.
• Expansionary demand side policies such as fiscal and monetary.
These are only relevant in so far as they increase the productive potential of the economy. Low interest rates may be beneficial as they make it cheaper for firms to invest in new plant and equipment.
lydiajane74 answered the question on July 4, 2018 at 20:20
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