Types of Economy · Types of Economy: It is said that every economy in the world is unique in some...
Transcript of Types of Economy · Types of Economy: It is said that every economy in the world is unique in some...
Types of Economy
Types of Economy: It is said that every economy in the world is
unique in some way or another. No two economies are identical.
However, these economies do share many of the same features and
characteristics. So economists have been able to identify four different
types of economy – traditional economy, command economy, market
economy and mixed economy. Let us learn about these in some detail.
Types of Economy
I. Traditional Economy
A traditional economy, as the name suggests, is based on a traditional
approach. These economies are based on ancient rules and are the
most basic type of economy. The focus in a traditional economy is
only on the goods and services that match their customs, beliefs, and
history.
Such traditional economies tend to focus primarily on agriculture,
cattle herding, fishing etc. A traditional economy will use the barter
system and has no concept of currency or money. Their economies
center around their tribes or families. Such economies believe in only
producing what and how much they require. They find no need to
produce any market surplus. There is no concept of trading.
If such traditional economy does not adapt it becomes very vulnerable
to change in their environment. Once such economies evolve they
begin to adopt farming. They even trade their surplus crop and start
evolving from this traditional economy. And when a traditional
economy interacts with a market or a command economy it becomes a
traditional mixed economy.
Then money (currency) starts to take importance in their lives as well.
This type of traditional economy is suited to underdevelop and
developing economies. Even today such economies can be found in
some pockets of Africa and the Middle East.
II. Command Economy
A command economy is the opposite of a free market economy. In a
command economy system, there is one centralized power, which in
most cases is the government. So the government makes all decisions
regarding the economy. It will decide which goods and services will
be produced, in what quantities. The price will also be determined by
such centralized power and not by market forces.
A command economy is a characteristic trait of a communist country.
Countries like Cuba, China, and the previous USSR are practical
examples of this command economy system. Such economies are also
known as Planned Economies because the government plans all the
forces of the economy, nothing is decided by the free market.
In such a planned economy there cannot be any competition. The
government has a monopoly in almost all the businesses and sectors.
All businesses follow the regulations and instructions of the
government and are not influenced by the forces of the economy.
One of the biggest disadvantages of such a command economy is that
the government cannot plan or provide for all its citizen’s individual
needs. And so this often leads to rationing. In an ideal world under
such a command economy the government should be able to provide a
living to all its citizens. However, the reality is different.
III. Market Economy
This is the complete opposite of a command economy. A free market
economy relies entirely on the free market and free market trends.
There is no involvement or interference from the government or any
such controlling power. This means there are no rules or regulations
imposed on either buyers or sellers. The entire economy is determined
by the participants of the economy and the laws of demand and
supply.
Theoretically, a free market economy can show very high levels of
growth. It makes private organizations (only these exist) very
powerful and influential in the country. So it may create an imbalance
of wealth and a scenario where the rich get richer and poor get poorer.
Realistically there are no perfect free market economies in the world.
Every economy has some level of government regulation as it is
necessary. Like for example laws that prevent monopolies, or restrict
production of harmful substances. Even anti-pollution laws that affect
production are a hindrance for a market economy. So in the modern
world free market is a subjective definition.
Currently, the United States is considered the epitome of capitalism.
Hong Kong is also a good example of a free market economy.
IV. Mixed Economy
A mixed economy is a perfect marriage between a command economy
and a free market economy. So, by and large, the economy is free of
government intervention. But the government will regulate and
oversee specific sensitive areas of the economy like transportation,
public services, defence etc. Such an economy is known as a dual
economy. The best examples of such a mixed economy are India and
France.
Such a mixed economy allows private businesses the freedom to
operate in the economy with minimum oversight. At the same time,
the government can regulate the economy so it does not adversely
affect the public interests. Both public sector and private sector can
co-exist peacefully in one economy. It is the perfect blend of socialism
and capitalism. In fact, most economies of the world are currently
considered as mixed economies.
Solved Example for You on Types of Economy
Q: One of the biggest limitations of a free market economy is which of
the following?
a. High taxes
b. Government Interference
c. Economic restrictions
d. Uneven distribution of resources
Ans: The correct answer is option D. In a market economy the
government cannot interfere to stop monopoly or concentration of
wealth in the hand of a few. So this often leads to uneven distribution
of resources as people with money hold all the cards.
This concludes our discussion on the topic of the types of economy.
Five Year Plan
After India gained independence in 1947 it basically had to rebuild its
economy from scratch. The leaders of those times had to pick the type
of economy India would be and also outline the economic planning as
well. This is where the five year plan was born. Let us study a bit
more about them.
Indian Economy after Independence
In the post-independence era, the leaders of the country had some
precarious decisions to take. One of them was which type of economic
model would India follow? In those times there were two models
followed by most countries in the world – capitalist economy and
socialist economy.
Our first Prime Minister Jawaharlal Nehru preferred the socialist
model. But in a democracy like India, a pure socialist economy can
not flourish. Capitalism was also not suited since the government had
to build up an economy and look after the common man and his needs.
So as a solution our economy combined aspects of both socialism and
capitalism.
It was decided India would develop a strong socialist society, where
the public sector would take care of its citizens. But the government
would also promote and encourage a strong private sector for the
future. There would be no prohibition on private property or wealth
keeping our democracy in mind.
Five Year Plan
An economic plan allocates the resources of a nation to fulfil the
general and specific goals as planned by the government for a
specified period. In India, these plans are made for five years and
hence are known as five year plans. These five year plans are
ultimately a short-term plan for a perspective plan. A perspective plan
outlines the long-term goals of a nation, spanning twenty years.
In India, after the independence, the government set up a Planning
Commision in 1950. This commission would be responsible for
framing and implementing the five year plans of the country. They
began their efforts with the first five year plan in 1950.
The Goals of the Five Year Plans
Every five year plan is developed with a specific goal in mind. But
there is never one solitary objective of the plan. The plan is supposed
to work towards the perspective plan and must cover a few important
objectives. However, it is not possible or practical to give equal
importance to all aspects of a plan.
There are basically five generalized goals of a five year plan, wherein
a particular plan one or two are given the most importance. In fact,
some of the goals are actually conflicting. So let us now look at these
five types of goals we cover in the five year plans.
Growth
This is the first and the most basic goal of an economic plan. Growth
in terms of an economy focuses on the increase of the Gross Domestic
Product (GDP) of the country. GDP is a way to measure the growth of
an economy. Higher the GDP more the common public can benefit
from the economic policies of the country.
This economic growth actually happens due to an increase in the
production capacity of a nation for either its goods or its services. This
can be due to an influx of capital into the economy as well. The sector
in which the growth is happening is also important. There are three
basic sectors – agricultural, industrial and service. Their respective
contributions make up the structural composition of the GDP.
For very many years India’s primary focus was the agricultural sector.
It was the main contributor to our GDP. And it also saw the highest
growth rate in the few initial five year plans.
Modernisation
Modernisation refers to the integration of technology in the economy.
Innovation, inventions, and advancement in technology play a huge
part in upgrading our economy and increasing its output. One example
would be the introduction of modern agricultural techniques which
increased output. Over the years, the Indian economy also saw a major
boom in the IT industry due to modernization.
Another aspect of modernization would be our advancement as a
society. Leaving behind discriminatory practices and pushing towards
an equal, fair and modern society.
Self Reliance
A new economy like India’s post-independence can become too
reliant on imports. So for seven editions of the five year plan, the
government promoted self-reliance. This basically meant that anything
we were capable of producing domestically we did not import.
Especially food and agricultural products were never imported as long
as possible. This was to ensure we not only became self-reliant but
also to protect our sovereignty. Because importing basic essentials
from other nations would make us dependent on them. Then after
1991, the government finally opened up our economy to the global
markets once we had already established a domestic base.
Equity
Now the previous three goals mainly relate to the economy. But the
development of the economy only is not sufficient. The five year plans
must also focus on the development of our society. It is essential to
ensure that these benefits from the economy are enjoyed by all
members of the society. This is where equity comes in.
Equity focuses on ensuring that all citizens of our country have their
basic needs for food, housing, clothing etc fulfilled. It also looks to
reduce the wealth gap and the inequality in our society.
Solved Question for You
Q: In which year was the first five year plan passed?
a. 1947
b. 1948
c. 1950
d. 1951
Ans: The correct option is D. India became independent in 1947 but
our first economic plan came out in 1951 under the guidance of the
PM and chairman of the Planning Commision Jawarhalal Nehru.
Land Reforms
After the British left, India had to undo a lot of damage they had done
to our economy and society. One such system of the British Raj that
independent India had to correct was the zamindari system. To
promote equity the government introduced land reforms. Let us see
how this was implemented.
Land Reforms
During the British times, the tillers of the lands were not its owners.
So a farmer did not have actual ownership of the land. The ownership
was with the intermediaries, i.e. the zamindars, jagidars etc. The
farmer would farm the land and pay rent to these zamindars.
This did not motivate the zamindars to invest in the farm or invest in
the agricultural practices. They were only focussed on collecting their
rent. And as you can imagine the farm and the farmer both suffered.
But after independence, the government realized that the agricultural
output was not sufficient for the whole country. One way to boost the
produce was to make the tillers of the land its owner. And so efforts
were made to abolish the intermediaries and this was known as the
land reforms.
Objectives of the Land Reforms
The government of a newly independent India had a few objectives in
mind to implement these land reforms. Let us take a look at the few
important ones
● The main objective was to bring systematic and complete
changes to the agrarian structure of the country.
● Its other main aim was to abolish the intermediaries of the
semi-feudal landlordism system of India, i.e. get rid of the
zamindars
● Bring about equity in the economy and society and ensure
social justice for past atrocities towards farmers
● The land reforms would also prevent any exploitation of the
tenant farmers by the hands of the landlords
● And finally to motivate these farmers and implement practices
to increase agricultural output.
Steps Implemented under the Land Reforms
Immediately after independence, many states in India passed the
Zamindari Abolition Act. In the states of Uttar Pradesh, Andhra
Pradesh, Bihar etc the surplus land of the landlords were seized by the
states. Although the Supreme Court found the act unconstitutional, the
legislature amended the article and corrected their actions.
By the abolition of intermediaries of all types, nearly 2 crore tenants
became owners of their own lands. The tenure laws were updated and
the land reforms were finally showing some positive results.
The other important step taken was the imposition of the land ceiling.
This law fixes the total amount of land an individual or family can
hold. Not only does the law implement the fixation of the ceiling, it
also allows the government to take over the surplus land. Such land
was then distributed among landless farmers or small farmers. The
imposition of such a ceiling was to deter the concentration of land in
the hands of a few.
The reforms also promoted consolidation of holdings. If a farmer had
a few plots of land in the village, under this scheme these lands would
be consolidated into one big piece of land. This can be done by the
purchase or exchange of land. Actually, one problem of agriculture in
India is that the land parcels are too small for commercial farming.
This method can solve the problem of land fragmentation.
To solve the problems of land subdivision and lack of financing the
government also began promoting co-operative farming. Here farmers
can pool their lands and resources and gain the advantages of
economies of scale and capital investment. But co-operative farming
in India has only seen limited success.
Importance of Land Reforms
The main incentive of these land reforms is to act as an incentive for
the farmers and the cultivators of the land. If the government can
assure their protection (from exploitation) and provide them financial
help, these farmers are willing to do the hard work. Once he is actually
granted ownership he can raise credit and cultivate his land to the full
potential.
Another major advantage of such land reforms is that they can
increase the agricultural output of the country. This is done without
any major influx of capital by the state. India was anyways struggling
with food self-sufficiency. These land reforms were a cost-free
method to increase grain and agricultural output from farms. And once
the farmer is self-sufficient he will sell the market surplus and help the
economy.
These land reforms also helped in establishing a relationship between
the farmers and the government. During the British rule these farmers
were heavily exploited and hence they became disenfranchised. These
reforms opened a dialogue between the government and the farmers.
They both cooperated to boost the agricultural sector of our economy.
And land reforms fulfilled one of the major goals of the five-year plan
– Equity. It provided social justice to the crores of farmers across the
country. It made sure the farmers benefitted from their own labour and
promoted equality of wealth.
Solved Question for You
Q: Bhoodan movement was started in India by _______.
a. Vinoba Bhave
b. Sardar Patel
c. M K Swami
d. None of the above
Ans: The correct option is A. Vinoba Bhave initiated this movement
in 1951. It was also known as the Land Gift Movement. This was a
voluntary form of land reform where they collected surrendered land
from landowners and gifted them to the poor landless farmers.
Green Revolution
At the time of its independence, India was an agricultural dependent
economy. And yet the state of Indian agricultural sector was dismal.
From the lack of investment, a dearth of technology, low yield per
acre and many such problems plagued the industry. And so the Indian
government took steps to bring about the Green Revolution using
HYV seeds. Let us see how.
Green Revolution
The Green Revolution started in 1965 with the first introduction of
High Yielding Variety (HYV) seeds in Indian agriculture. This was
coupled with better and efficient irrigation and the correct use of
fertilizers to boost the crop. The end result of the Green Revolution
was to make India self-sufficient when it came to food grains.
After 1947 India had to rebuild its economy. Over three-quarters of
the population depended on agriculture in some way. But agriculture
in India was faced with several problems. Firstly, the productivity of
grains was very low. And India was still monsoon dependent because
of lack of irrigation and other infrastructure.
There was also an absence of modern technology. And India had
previously faced severe famines during the British Raj, who had only
promoted cash crops instead of food crops. The idea was to never
depend on any other country for food sufficiency.
So in 1965, the government with the help of Indian geneticists M.S.
Swaminathan, known as the father of Green Revolution, launched the
Green Revolution. The movement lasted from 1967 to 1978 and was a
great success.
Features of the Green Revolution
● The introduction of the HYV seeds for the first time in Indian
agriculture. These seeds had more success with the wheat crop
and were highly effective in regions that had proper irrigation.
So the first stage of the Green Revolution was focused on states
with better infra – like Punjab and Tamil Nadu.
● During the second phase, the HYV seeds were given to several
other states. And other crops than wheat were also included
into the plan
● One basic requirement for the HYV seeds is proper irrigation.
Crops from HYV seeds need alternating amounts of water
supply during its growth. So the farms cannot depend on
monsoons. The Green Revolution vastly improved the inland
irrigation systems around farms in India.
● The emphasis of the plan was mostly on food grains such as
wheat and rice. Cash crops and commercial crops like cotton,
jute, oilseeds etc were not a part of the plan
● Increased availability and use of fertilizers to enhance the
productivity of the farms
● Use of pesticides and weedicides to reduce any loss or damage
to the crops
● And finally the introduction of technology and machinery like
tractors, harvesters, drills etc. This helped immensely to
promote commercial farming in the country.
Market Surplus
The Green Revolution by and far was a success. But now there was
another aspect to it. The government had to ensure that the benefit of
the higher productivity was passed on to the general public. If the
farmers kept the grains for themselves then the benefit of the higher
productivity would be lost.
But thankfully this did not happen. Due to the high yield and
productivity of the farms, the farmers started selling their produce in
the markets. The portion of the produce which is sold by them is
known as market surplus.
And so the higher output caused due to the Green Revolution started
benefiting the economy. There was a decline in the prices of grains
and such food products. The common man was able to easily afford to
buy them. The government was even able to stock grains and build a
food bank in case of future food shortages.
Impact of the Green Revolution
● Increase in Agricultural Production: Foodgrains in India saw a
great rise in output. It was a remarkable increase. The biggest
beneficiary of the plan was the Wheat Grain. The production of
wheat increased to 55 million tonnes in 1990 from just 11
million tonnes in 1960.
● Increase in per Acre Yield: Not only did the Green Revolution
increase the total agricultural output, it also increased the per
hectare yield. In case of wheat, the per hectare yield increased
from 850 kg/hectare to an incredible 2281 kg/hectare by 1990.
● Less Dependence on Imports: After the green revolution, India
was finally on its way to self-sufficiency. There was now
enough production for the population and to build a stock in
case of emergencies. We did not need to import grains or
depend on other countries for our food supply. In fact, India
was able to start exporting its agricultural produce.
● Employment: It was feared that commercial farming would
leave a lot of the labour force jobless. But on the other hand,
we saw a rise in rural employment. This is because the
supporting industries created employment opportunities.
Irrigation, transportation, food processing, marketing all
created new jobs for the workforce.
● A Benefit to the Farmers: The Green Revolution majorly
benefited the farmers. Their income saw a significant raise. Not
only were they surviving, they were prospering. It enabled
them to shift to commercial farming from only sustenance
farming.
Solved Question for You
Q: Which of the following grains were produced the most during the
Indian green revolution?
a. Wheat and Jute
b. Rice and Oilseeds
c. Wheat and Rice
d. Jute and Cotton
Ans: The correct option is C. The two grains that benefitted the most
in the Green Revolution were Wheat and Rice. In fact many believe
rather than Green Revolution, Grain Revolution is the more suited
name.
Industrial Policy
During many decades after independence, India was largely an
agrarian economy. But for any economy to be globally successful it
must have a robust industrial sector. And so for the first seven
five-year plans India actively focussed on industrial development
through industrial policy formation. Let us take a look.
Industrial Policy
Industrial development is a very important aspect of any economy. It
creates employment, promotes research and development, leads to
modernization and ultimately makes the economy self-sufficient. In
fact, industrial development even boosts other sectors of the economy
like the agricultural sector (new farming technology) and the service
sector. It is also closely related to the development of trade.
But just after independence India’s industrial sector was in very poor
condition. It only contributed about 11.8% to the national GDP. The
output and productivity were very low. We were also technologically
backward. There were only two established industries – cotton and
jute. So it became clear that there needed to be an emphasis on
industrial development and increasing the variety of industries in our
industrial sector. And so the government formed our industrial
policies accordingly.
Control of the State
One of the biggest hurdles in industrial development was the lack of
capital. Private industrialists did not have enough capital to build a
new industry. And even if they did, the risk involved was too high. So
in 1948, it was decided that state would play the primary role in
promoting the industrial sector. So the state would have absolute and
complete control over all industries that were vital to the economy and
the needs of the public.
Coal, petroleum, aviation, steel etc were all reserved exclusively for
the state. The private sector could provide services complementary to
those by the state. The public enterprises thus had a monopoly over
the markets for many years to come.
Industrial Policy Resolution 1956
During the second five-year plan the industrial policy resolution came
into action. The aim was to introduce more private capital int the
industry but in a systematic manner. So this resolution classified
industries into three categories as seen below,
i. First Category: Industries exclusively owned only by the State
ii. Second Category: Industries for which private sectors could
provide supplementary services. These industries would still be
mainly the responsibility of the State. And also only the State
could start new industries.
iii.Third Category: The remaining industries which fell to the
Private Sector.
While any private company or individual could start an industry
falling in the third category it was not that simple. The state still
maintained control over these industries via licenses and permits.
Every new industry needed a license and many permits from the
appropriate ministry. They even needed permissions and permits to
expand the present industry.
The aim behind such an industrial policy was to keep a check on the
quality of the products. It was also an important tool to promote
regional equality, i.e. make sure industries were developed in
economically backward areas.
Small Scale Industries
In 1955 a special committee known as the Karve Committee advised
the promotion of small-scale industries for the purpose of rural
development. It was believed that since small-scale industries are
more labour intensive they would create more employment. Also, the
manpower requirement of small-scale industries is semi-skilled or
unskilled which was suitable for those times.
However, these small-scale industries cannot match up to large scale
industries. So there were special goods and products reserved by the
government. These could only be manufactured by small and medium
scale industries. Such industries also got financial aid in form of loans
and tax and duty breaks.
Strengthening of Infrastructure for Industrial Development
One of the first requirements for the development of the economy is to
improve the infrastructure of the country. The various other sectors of
the economy cannot develop without the support of infrastructure
facilities like transport, rail, banking communication etc.
So to develop these industries the government formed appropriate
industrial policies. The development of most of these industries fell to
the public sector. Like for example, the rail industry to this day
remains firmly in the public sector.
Promotion of Capital Goods Industry
Capital goods are goods used in the production of other goods. Capital
goods are not for direct sale to the consumer. But they are a hallmark
of a good industrials sector. So the government decided to focus on
the capital goods industry for the development of our industrial sector.
So the Mahalanobis model came into effect in the second five-year
plan. The focus here was on heavy industries, especially those that
produce capital goods. This was to create a robust capital base for the
economy. So industries of heavy metals, chemicals, machine building,
tools, electrical etc all saw growth in this period.
Such industries have massive capital requirements. But the
government ensured they had enough capital to function smoothly.
Soon there was a development of high-tech goods in the market as
well.
Solved Questions for You
Q: What was the contribution of the industrial sector in 1950?
a. 11.8%
b. 12.3%
c. 24.6%
d. None of the above
Ans: The correct option is A. During the post-independence era the
contribution of the industrial sector was only 11.8% of the GDP. We
saw some development of this in the coming years and by 1991 it had
become around 25%.
Subsidies
A subsidy, often viewed as the discussion of a tax, is an instrument of
fiscal policy. Derived from the Latin word ‘subsidium’, a subsidy
factually implies coming to support from behind. Subsidies are useful
for both economy and citizens as well. These have a long-term impact
on a financial system like green revolution etc. These are only for the
reason that farmers receive good quality of grain on subsidized prices.
Subsidies
Subsidies, by means of creating a block between consumer prices and
producer costs, lead to changes in demand or supply decisions. These
are often aimed at:
1. Suggesting higher consumption/ production
2. Balancing market deficiency including internalization of
externalities;
3. The success of social policy objectives including redistribution
of income, population control, etc.
Transfers and Subsidy
Transfers which are directly income supplements need to be
distinguished from a subsidy. An unconditional transfer to an
individual will add to his income and will distribute it over the entire
range of his expenditures.
A subsidy, however, refers to a particular good, the relative price of
which has been lesser because of the subsidy with a view to changing
the consumption/ distribution decisions in favor of the subsidized
goods. Even when the subsidy is hundred percent, i.e. the good is
supplied free of cost, it should be distinguished from an
income-transfer (of an equivalent amount) which need not be spent
completely on the subsidized good.
Mode of Administering a Subsidy
The range of alternative means of administering a subsidy are:
1. Subsidy to producers
2. Subsidy to consumers
3. Providing Incentives Instead of Subsidizing
4. Production/sales through public enterprises
5. Cross-subsidization
Subsidy Targeting
A subsidy can be spread among individuals according to a set of
selected criteria, e.g. merit, income-level, social group etc. Two types
of errors arise if we do not do the proper targeting, i.e. exclusion
errors and inclusion errors. In the previous case, some of those who
deserve to receive a subsidy are disqualified. While, in the second
case, some of those who do not deserve to receive subsidy get
integrated with the subsidy programme.
Source: stock.adobe
Effects of a Subsidy
We can generally group the economic effects of a subsidy into:
1. Allocative effects: these relate to the sectoral distribution of
resources.
2. Redistributive effects: these generally depend upon the
flexibility of demands of the relevant groups for the subsidized
good as well as the flexibility of supply of the same good and
the mode of administering the subsidy.
3. Fiscal effects: subsidies have obvious fiscal effects since a
large part of subsidies originate from the budget. They in a
straight line increase fiscal deficits.
4. Trade effects: a regulated price, which is to a large extent lower
than the market clearing price, may reduce domestic supply and
lead to an increase in imports.
5. The subsidies may also lead to unmanageable or unplanned
economic effects. They would result in inefficient resource
allocation if forced on a competitive market or where market
imperfections do not give a good reason for a subsidy, by
diverting economic resources missing from areas where their
marginal productivity would be superior. For instance, a price
control may lead to lower production and shortages and thus
generate black markets resulting in profits to operators in such
markets and economic rents to private people who have right to
use to the distribution of the good concerned at the controlled
price.
Subsidy Issues in India
Subsidies have greater issues than before in India for several reasons.
In particular, we can trace this rise to the following:
i. The vastness of governmental activities
ii. Somewhat weak determination of governments to recover costs
from the respective users of the subsidies, even when this may
be desirable on economic grounds, and
iii.Usually low-efficiency levels of governmental activities.
Methodology for Estimation of Subsidies in India
Different approaches and conventions have changed regarding
measurement of the magnitude of subsidies. Two major conventions
relate to measurement through (i) budgets and (ii) National Accounts.
The comparative distribution of the benefits of a subsidy may be
studied with respect to different classes or groups of beneficiaries such
as consumers and producers. Thus, the various examples of subsidies
are:
● food subsidy
● electricity
● public irrigation
● Subsidies to elementary
● Subsidies for health
Solved Example for Tou
The government gives subsidies in various sectors. Which of the
following are the special effects of subsidies?
1. increases inflation
2. increases fiscal deficit
3. decreases export competitiveness
Pick the correct answer using the codes given below.
1. a) 1 and 2 only
2. b) 2 only
3. c) 2 and 3 only
4. d) 1, 2 and 3
Ans. b) 2 only. There is no straight relation between subsidies given
and inflation. It may increase inflation (eg. subsidies on LPG helping
people save more, as a result, increasing their capacity which can
cause demand-pull inflation.) or decrease inflation by making easy to
get to low cost subsidized goods. Subsidies certainly increase the
fiscal deficit. Subsidies increases do not decrease the export
competitiveness of goods, as a result, it decreases their cost of
production.
Trade Policy
Industry and Trade are both closely related in an economy. After
independence, the leaders had to focus on the industrial growth of our
country. So they framed the trade policy to achieve this objective. Let
us take a look at some of the important features of the trade policy of
India after independence.
Trade Policy
India’s trade policy has been through many stages over the last few
decades. There were transitory phases and some short-term policies to
deal with the changing economy. But overall the trade policy followed
some basic themes spread over three specific periods.
From independence until the 1980’s there was the general policy of
planned regulation and import substitution. After the 1980’s the
government started to focus on some partial form of liberalization.
And then came the phase after 1991 which focused on liberalization,
privatization, and globalization.
We will be focusing on the trade policy formation of a few years just
after independence and how they shaped our economy and promoted
industrial growth as well.
Inward Looking Strategy
Just after independence, the government was looking to boost trade
and industry in the country. We were an economy heavily dependent
on the agricultural sector, and to change that the development of trade
and industry was of the essence.
So for many years, the first seven Five-year plans precisely, India
adopted the trade policy of inward-looking, or better known as Import
Substitution. The policy was simple, we were going to substitute the
imports of our economy with domestic production. This trade policy
was applied to almost all sectors of the economy.
The aim of this policy was to boost domestic production and also
protect domestic goods from international competition. In a way, this
policy closed off our economy from the world. But during the initial
stages of development, this was secondary to our main aim of
boosting domestic production.
Such a protection of imports was done through two steps.
● Tariffs: Firstly tariffs were imposed on imports. Such tariffs
make imports costlier. This, in turn, will help the production as
well as the sale of domestic products.
● Quotas: Another measure was to impose quotas on imports.
This means only a specific quantity of goods can be imported.
And hence the domestic market will have to make up to meet
the demand.
Trade Policies and Industrial Development
We already saw that one of the aims of any trade policy is to influence
industrial development in the country. The trade policies of the first
seven plans had a profound effect on the GDP of the country and the
industrial growth as well.
The contribution of the industrial sector was only 11.8% in 1950. By
1991 it had more than doubled and was now at 24.6% of the GDP.
And it was not just growth, but the industrial sector also saw great
diversification. Initially, the main contributors of the sector were the
cotton and the jute industries. But the trade policy of the plans
promoted many other small-scale industries.
Protecting the domestic market from foreign imports really helped the
small and medium scale industries boom in the economy. It even
assisted indigenous industries, especially in the automobile and
electronics sector.
Public Sector Enterprises
We saw earlier, that India adopted a mixed economic system. It had
ideologies of both socialism and capitalism. One feature of the earlier
five year plans was the massive development of the public sector.
Most of the major industries like telecom, air travel, railways, defence
etc were entrusted to the public sector. And for many years they were
successful in ensuring that all members of the public got access to
these products.
However, some economists and academics have been critical of this
over-dependence on the public sector. Some were even critical of the
performance of such public companies. During the initial few years
after independence, these companies were essential. But some
economists were of the opinion that after a few years they were
actually blocking the entry of private players into the market.
We have now come to the realization that state and national
enterprises may have overstayed their welcome. They continued with
the production and the monopolization of certain goods and services
even though their services were no longer of any requirement. The
best example here is the telecom industry. The government had a
monopoly over this industry until the 1990’s. The private sector was
capable of providing this service, but the government never granted
any licenses. This lead to slow and poor service by the public
company.
There are many such examples where public companies continued to
function despite being loss-making operations. Closing a public
company is a huge task and usually leaves a hole in the market. And
so the government just allowed these companies to run inefficiently,
sometimes for decades. There were no checks to ensure the quality of
products or services and the public companies became insensitive to
the consumer demands.
Solved Question for You
Q: What was the Permit License Raj? How did it affect our economy?
Ans: During 1960-1980, to open any company or business in India the
industrialist had to obtain many permits from the associated
authorities. So industrialist spends more time lobbying the ministry
and trying to obtain the licenses and permits that they spend on
developing their products. This system was also misused by certain
industrialists to keep away the competition. It even leads to an
increase in corruption. And so the government needed to change their
trade policy to promote ease of doing business in the country.