Supply-side vs demand-side economics

The challenge of creating an enabling environment so as to spur growth of the private sector in line with Rwanda’s Vision 2020 begs the question; what is the best way to nurture entrepreneurs and grow them from small to medium to large businesses? This straight forward question has no straight forward answer. Two schools of macroeconomic though dominate:  Supply-side economics (made famous by former American president Ronald Reagan) and demand-side economics.
Sam Kebongo
Sam Kebongo

The challenge of creating an enabling environment so as to spur growth of the private sector in line with Rwanda’s Vision 2020 begs the question; what is the best way to nurture entrepreneurs and grow them from small to medium to large businesses? This straight forward question has no straight forward answer.

Two schools of macroeconomic though dominate:  Supply-side economics (made famous by former American president Ronald Reagan) and demand-side economics.

In supply-side economics, economic growth can be most effectively created by lowering barriers for people to produce (supply) goods and services, such as lowering tax rates, and by allowing greater flexibility by reducing regulation |(what Rwanda Development Board is doing) . Consumers will then benefit from a greater supply of goods and services at lower prices.

Typical policy recommendations of supply-side economics are lower marginal tax rates and less regulation. The tenet of supply-side economics is embodied in the Laffer curve: that government tax revenues are the same at 100% tax rates as at 0% tax rates.

The tax rate that achieves highest government revenues is somewhere in between. Increased taxation steadily reduces economic trade between economic participants.

It discourages investment since taxes act as a type of trade barrier that causes economic participants to revert to less efficient means of satisfying their needs.

Crucial to the operation of supply-side theory is the expansion of free trade and free movement of capital.

It is argued that free capital movement, in addition to the classical reasoning of comparative advantage, frequently allows an economic expansion. Lowering tax barriers to trade provides to the domestic economy all the advantages that the international and regional economy gets from lower tariff barriers.

In our case, supply side would advocate for reduction of taxes and expansion of the tax base.

Transactions that seem to be ‘revenue sapping’ such as say the case or foreign cars (talk of town) can be looked at this way; any car in Rwanda will fuel in Rwanda gas stations and is repaired in Rwandan garages (increasing revenues, taxes, both direct and indirect, and employment in these sectors. Any car dealer will tell you that this is where the money is, with regards to cars. Supply side economics would advise two things; one, quickly look into ways of reducing taxes(the reason given for purchasing cars out of Rwanda) on car purchases  and two; let the foreign cars stay (presuming they are properly documented)

 Supply-side economics is viewed by critics as a form of “trickle-down economics” (pejoratively; the idea that tax breaks or other money are all appropriated for the top in hopes that it would trickle down to the needy.)

Conversely, in demand-side economics, economic stimulation comes best from increasing the demand for goods and services.

Also called Keynesian economics, this concept is usually placed in direct opposition with supply-side economics. Demand-side economics is first and foremost a means of ridding an economy of a recession and stimulating economic growth while preventing inflation.

 It is meant as a control on both expansion and retraction, to keep an economy in a stable zone.

The idea is that to stimulate growth, a government should lower taxes on the middle and working class, and increase government spending. To combat rising inflation in an expanding economy, a government should raise taxes and reduce spending.

Back to our challenge of nurturing and growing entrepreneurs; one, more policy instruments (both monetary and fiscal) have to be put in place to make the economic environment even more friendly and conducive for small and medium enterprises.

Two; with regard to fiscal environment, RRA’s tough job is reducing the tax rates and spreading the tax base thereby increasing revenues (the objective). Three; all EAC countries to desist from non-tariff barriers to regional trade, it is neither good nor sustainable.

It should be noted that no theory of economics has ever been proved to work at all times, in all situations.


Sam Kebongo teaches entrepreneurship at Rwanda Tourism University College. He also is a Director at Serian Ltd that provides skills and business advisory services consultancy.

sam.kebongo@gmail.com

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