Indian Economy

Course Instructor
Somenath Chakraborty
Department of Commerce (Morning Section)
St. Xavier’s University
Kolkata
Broad Classifications of Economics
Micro Economics:
• Study of economic agents (individuals, firms)
• Theory of demand and consumer behaviour
• Theory of supply and producer behaviour
• Market structures
• Theory of factor pricing (wages, profits, rent and interests)
Broad Classifications of Economics
Macro Economics:
• Theory of income and employment
• Theory of general price level and inflation
• Theory of economic growth and development
• Theory of foreign trade
• Government policies
• Central bank policies
Learning Objectives of the Course
• To make the student understand the difference between economic
growth and economic development
• To understand India’s position in terms of development in comparison
to countries across the globe
• To give the students an idea of India’s economic history particularly at
independence - the role of policy in India’s economic development –
stabilization and structural adjustment
• To make students understand the importance of different sectors of
the Indian economy in terms of their performance and contribution
to India’s national income and employment over the years; reforms
pertaining to the different sectors
Syllabus Outline
• There are five units in total
• Unit 1 - Basic Issues in Economic Development
• Unit 2 – Basic Features of the Indian Economy at Independence
• Unit 3 – Policy Regimes
• Unit 4 – Growth, Development and Structural Change
• Unit 5 – Sectoral Trends and Issues
 Unit 3
Policy Regimes
Historical Review of Planning
• National Planning Committee was set up towards the end of 1938
• The committee focused on economic development
• State control over key industries like railways, waterways, shipping
and other public utilities along with all large-scale industries
• Eight industrialists conceived a plan of economic development,
popularly known as the Bombay Plan
• Other paper plans like Gandhian Plan, People’s Plan
• Planning Commission was set up in 1950
• First Five-Year Plan started in 1950-51 followed by a series of Five-
Year Plans
Objectives of Economic Planning in India
• To achieve full employment level of output
• To increase production to maximum possible extent to achieve higher
national and per capita income
• To reduce income and wealth inequalities
• To set up a socialist society based on equality and justice with an
absence of exploitation
• To formulate a plan for the most effective and balanced utilisation of
country's resources
• To indicate the factors that tend to retard economic development
Objectives of Economic Planning in India
• To make necessary recommendations from time to time regarding
those things which are deemed necessary for facilitating the
execution of these functions. Such recommendations can be related
to the prevailing economic conditions, current policies, measures or
development programs. They can even be given out in response to
some specific problems referred to the commission by the central or
the state governments
• To determine the conditions which need to be established for the
successful execution of the plan within the incumbent socio-political
situation of the country
Planning and Removal of Poverty
• Rapid economic growth: economic growth through the development of
agriculture, industry, power, transport, communications and other sectors,
betterment of physical quality of life (life expectancy, infant mortality,
literacy)
• GNI growth should be higher than population growth
• Increase in national income was accompanied by increase in poverty –
poverty removal was given importance in Fourth Plan (1969 – 1974)
onwards
• An objective of economic planning in increase in employment – economic
growth, more investment, more employment generation
• Employment generation was never given proper priority
• Unemployment was first addressed in Sixth (Janata) Plan (1978 – 1983)
Planning and Removal of Poverty
• The practically implemented Sixth Plan (1980 – 1985) believed that
employment would increase with increase in investment
Economic Planning and Social Justice
• Reduction of inequality of incomes: removal of intermediaries, ceiling
on land holdings, reduction of wealth inequality in rural areas
• Increase in agricultural productivity, establishment of agro-based
industries, fair price to farmers
• Wealth redistribution was not given its due priority
• Establishment of a socialist society: equal opportunities in education,
occupation, healthcare etc., economic democracy
Long Term Objective of Planning: Evaluation
• Conflict of two objectives of planning: rapid economic growth
through industrialization and reduction in income inequalities
• Highest priority was given to economic growth – other factors were
neglected
Democratic Socialism in India
• Marx and Engels considered private ownership to be a social evil
• The idea of socialism is borrowed from Russia after the huge success
of the Soviet plans
• The idea was to evolve a new pattern of society where man can
realize his self (innate nature) in a fuller manner and in the process
we attain a higher standard of material comfort
Features of Democratic Socialism
• Removal of Poverty and the provision of national minimum
• Reduction of income and wealth inequalities
• Provisions of equal opportunities to all
• Faith in mixed economy
• Maintaining a balance of economic power
• Not private profit but social gain
• Faith in democratic values
Evolution of the Concept of Mixed Economy
• Laissez faire capitalism: Adam Smith, Absence of government in economic
activities, society is guided by self-interest, exists in U.K., USA, Australia or
in other European nations
• The idea of free market got developed in 18th century
• It was doing pretty well until the Great Depression (1929)
• The depression ended with contra-cyclical policies of John Maynard Keynes
• However, Keynes never lost faith in free market economies although he
admitted it had faults
• Communism: Karl Marx, collectivization, followed in USSR, China, Vietnam,
Cuba etc.
• The idea of communism came in 19th century
Mixed Economy: A Framework
• Side by side existence of private and public enterprises
• Strict regulation for private enterprises: limited or no access in some
sectors, licenses and permits needed to enter a sector
• Conflict between individual profit and social benefit
• Government investment is required in hydro-electric projects,
irrigation, road and railway transport
• Many bank-run incidents happened before the nationalization of
banks
• Mixed economy has features of both: socialism and capitalism
Mixed Economy: Planning Process
• Promotion of the industries that were neglected during the British
period
• Major chunk of the resources go into building infrastructure
• A dominant control over financial institutions (life insurance, banks)
for better financial integration for the population
• Restricting monopolies using MRTP commission
• Protect the weaker section of the population
• Special programmes to train and educate SC, ST, OBC and EWS
categories
• Transparent tax system for social welfare
Planning Process: Distortions
• Increase in income inequality
• Rising unemployment: population growth and emphasis on capital-
intensive technology (possible reasons)
• Concentration of economic power into the hands of a few
• Emergence of black money and parallel economy
• Food price inflation
• No increase in real wages for workers
• Poor growth rate
• High incidence of poverty
Mohalanobis Model of Growth
• The growth model was introduced by Prof. P. C. Mohalanobis
• The model is inspired from the Soviet experience of development –
rapid industrialization through large scale heavy industries
• The second Five-Year Plan (1956-1961) put a focus on coal, iron-steel,
heavy chemicals, electricity and heavy machinery industries
Reasons for Rapid Industrialization
• India, an agrarian economy during independence needed industries
to compete with other foreign countries
• Heavy population burden on agriculture: surplus population needed
to be shifted to industries
• Population growth and labor migration from rural to urban areas:
more requirement for food grains and agricultural raw materials
(cotton, jute, oil seeds etc.), agricultural output requires fertilizers,
pesticides, agricultural machineries
• Higher productivity in manufacturing
• Higher income elasticity of demand for industrial outputs and also
possibility of exports
Emphasis on Heavy Industries
• Investing in heavy industries helps up the country to build up capital
stock at a faster rate
• Heavy industries can work as a foundation stone for self-reliant
economy, less dependence on imports of machinery and equipments
• Development of heavy industries is required as a long term strategy:
consumer goods industries can be developed in future
• Small scale and cottage industries were encouraged for the
production of consumer goods to battle inflation
• Agriculture: rationing of food items is required to combat inflationary
pressure
Emphasis on Heavy Industries
• Public sector: plays the dominant role, heavy industries should be run
by public sectors due to long gestation periods, low profitability, to
prevent monopoly ownership and exploitation
• Private sector: large scale enterprises regulated, new small and
medium sized entrants were given permissions
• Foreign aid and foreign trade: Little importance was given to export
promotion
Models of Economic Development: Nehru vs.
Gandhi
Nehru-Mohalanobis Model:
• High rate of saving is required to boost up investment
• Heavy industry biased
• Protectionist paths safeguarding the infant industries
• Import substitution to achieve self-reliance
Achievements:
• Rate of saving increased from 7% (1950-51) to 22-24%
• Laid the foundation of industrial base of India
Models of Economic Development: Nehru vs.
Gandhi
Failures:
• Continuing losses or poor profits in government industries
• Political influence in appointment of the top officials of the public
enterprises
• Administrative bureaucrats employed as top bosses instead of
professional experts in government owned companies
• Heavy subsidies, tax cuts, huge wage-bills for public enterprises
• Increase in income inequality and almost 40% of the population lived
below poverty line
Models of Economic Development: Nehru vs.
Gandhi
Gandhian Model:
• Agriculture: Self-sufficiency in agriculture in each and every villages,
implementation of ceiling on land holdings, co-operative farming, ban
on money lending, dairy farming
• Cottage and Village Industries: Spinning and weaving, importance on
khadi, self sufficiency in clothes in every village, Gandhi was against
rapid urbanization and use of capital-intensive techniques
• In 1910, 40% of labour force was employed in village industries. This
decreased to 10% in 1946 and it declined to 2% after independence
Models of Economic Development: Nehru vs.
Gandhi
• Gandhi was not against heavy industries. He gave due importance to
defense, hydro-electric, thermal power generation, mining,
metallurgy, machinery, heavy engineering and chemical industries
• Basic industries should be managed by state – no difference with the
Nehruvian Model here
• He believed that use of extensive machinery leads to exploitation of
the labour force, machines are welcome if they lighten the burden of
labourers, no substitution of man with machines
Features of (Draft) Sixth Plan (1977-80)
• Employment oriented planning to replace production oriented
planning
• Agriculture and employment potential
• Large v/s small industries
• Equitable distribution
Liberalization, Privatization and Globalization
(LPG) Model of Development
• Adopted in 1991 by Indian Finance Minister Dr. Manmohan Singh under
the leadership of Prime Minister P. V. Narasimha Rao
• Exclusive public sectors were opened for private investment: disinvestment
of profit-making PSUs
• End of the license-permit-quota raj
• MRTP act diluted, upper ceiling on assets removed
• Foreign investment of upto 51% in high priority areas, no permission for
foreign technicians or testing of indigenous industries
• Sick industries were referred to Board for Industrial and Financial
Reconstruction
• Greater autonomy to PSUs and professional handling of PSU
Liberalization, Privatization and Globalization
(LPG) Model of Development
• Removal of import duties and other barriers, encouragement for exports,
import of foreign machinery and technology
Criticisms:
• The model benefits the corporate sector mostly
• Agriculture and agro-industries ignored, no concrete policy for
infrastructural development, financial support for agro based industries
• Bad for small and medium consumer goods industries if MNCs are allowed
freely to operate
• Possibility of trade imbalance if import quotas are removed given the
opportunities for limited exports
• Focus on capital-intensive production technology: bad for an economy with
growing labour force
PURA Model
• This neo-Gandhian model came along with the Vision 2020 plan of Dr.
A.P.J. Abdul Kalam when he became the President
• Providing Urban Amenities in Rural Areas (PURA)
• He proposed integrated action in areas like agriculture and food
processing, electrification of villages, education and healthcare for all,
expansion of ICT to rural areas, growth in nuclear, space and defense
technology
• Four connectivities: connectivity of villages through roads and
highways (physical connectivity), digital connectivity through ICTs and
cyber cafes, knowledge connectivity through schools and colleges,
economic connectivity by linking the village markets
PURA Model
• Depending on the present development status villages are
categorized in three clusters: Type A (minimal physical connectivity,
limited infrastructure, minimum support – school and primary health
centers), Type B (small infrastructure and no connectivity), Type C (no
connectivity, no infrastructure, no support)
• The model focuses on providing basic amenities in villages without
population transfer from villages to town
PURA Model: Evaluation
• The model focuses on village community similar to Gandhian Model
• Very limited resources were allocated in PURA
• The third cluster needs larger investment compared to the other two
clusters, the allocation can not be same for the three
• The allocation in the Eleventh Plan (2007-2012) was only 248 crore -
insufficient
Industrial Policy Resolution (1948)
• First Category (exclusive monopoly of central government): arms and
ammunition, atomic energy, railways
• Second Category (state industries): coal, iron and steel, aircraft
manufacture, ship-building, manufacture of telephone and
telegraphs, mineral oils
• Third Category (centrally regulated if necessary): salt, automobiles,
tractors, prime movers, electric engineering, heavy machinery,
fertilizers, electro-chemical, rubber, power and industrial alcohol,
cotton or woolen textiles, cement, sugar, paper and newsprint etc.
• Fourth Category (open to private or, cooperative enterprises):
industries not mentioned in the first 3 categories
Industrial Policy Resolution (1956)
• New classification of industries: three schedules created
• Schedule A: exclusive state responsibility
• Schedule B: progressively new enterprises will be set up by the state,
private players can supplement
• Schedule C: remaining industries left for private enterprises
• Fair and non-discriminatory treatment for private sector
• Encouragement to village and small-scale industries
• Removing regional disparities
• Foreign capital
Industrial Policy Resolution (1977)
• The Janata Government introduced the policy statement in
Parliament
• Development of small scale industries – primary focus
• Large scale industries: basic industries (steel, non-ferrous metal,
cement, oil refineries), capital goods, high technology industries
• Expanding public sector: encouragement of ancillary industries,
growth of decentralized production
• Foreign collaboration: ownership and effective control in Indian
hands, export oriented industries might have foreign collaboration
• Sick PSUs: capital infusion in loss making PSUs not sustainable in LR
Industrial Policy Resolution (1980)
• Effective operational management of public sectors
• Integrating industrial development in private sector by promotion of
economic federalism
• New definition of small units
• Regularization of unauthorized excess capacity in private sectors
• Automatic expansion of capacities in large scale industries
• Industrial sickness: merger of sick PSUs with healthy units
Industrial Licensing Policy (1951)
• Industries (Development and Regulations) Act was passed in 1951 for
implementation of Industrial Policy Resolution (1948)
• Compulsory licenses are required for new industrial units and for
increasing capacity, Govt. has power to dictate locations and min. size
of plants
• Government has the power to take over a company if the company
fails to implement its recommendations
• Government has the power to prescribe prices, method and volume
of production along with channels of distribution
• Industrial units with less than 100 workers and with fixed assets
below 10 lakhs are not required to take licenses
Hazari Report on Licensing Policy of 1951
• Dr. R. K. Hazari was appointed to review the implementation of
Industries (Development and Regulations) Act (1951) in 1966
• Multiple applications for a same product by leading business houses
(especially Birlas)
• Licenses given on first come first serve basis: beneficial for the large
business houses with offices in Delhi
• Unbalanced regional development: more licenses issued to states
with already established industrial base
• Poor monitoring after the issuance of licenses: Birlas did not utilize
even 50% of the licenses issued to them
Subimal Dutt Committee Report (1969)
• The committee was formed as a follow-up to the Hazari Committee report in
1967, report submitted in 1969
• 56% of total proposed investment in machinery licenses were owned by 73 large
business houses, 60% of their total import value was capital goods
• Those same 73 companies received 44% of total financial assistance by public
sector term lending institutions, 17% went to other 17 large business houses
• Complete ignorance of the licensing policy objectives
• Exclusive areas for PSUs were practically made open for private players
(examples: aluminum, machine tools (HMT), fertilizers, drugs and
pharmaceuticals)
• Unbalanced regional development: more licenses issued to states with already
established industrial base
• Foreign collaboration in non-essential consumer products (refrigerator, radio
receivers, cameras, transmitters, thermometers, toilet soap, ball point pen, loud
speakers etc.)
Industrial Licensing Policy (1980)
• This policy was in favor of large business houses, automatic increase
in capacities allowed, 23 industries were made out of the purview of
FERA and MRTP act
• Broad-banding introduced: licenses were issued for broader
categories, machine tools, motorized two wheelers, four wheelers,
paper and paper pulp industry, chemical, pharmaceutical, petro-
chemical, fertilizers industries benefitted
• Raising the asset limits of MRTP companies
• Relaxation in industrial licensing
Industrial Policy (1991)
• The policy was made to remove the red-tapism and bureaucratic
control on industries
• Integration of Indian economy with world economy
• Removal of restrictions on FDI and domestic business houses by
dilution of MRTP Act
• Disinvestment of loss making PSUs
• Abolition of industrial licensing in all sectors except security or
defence, hazardous chemicals, coal, petroleum, sugar, animal fats and
oil, cigarettes and tobacco, asbestos, plywood, paper, newsprint,
motor cars, industrial explosives, drugs and pharmaceuticals,
entertainment electronics (VCR, colour TV, CD players, tape recorders)
etc.
Industrial Policy (1991)
• List of industries reserved for public sectors: arms and ammunition,
defense (aircrafts, warships), coal, mineral oil, mining iron ore,
copper, lead, zinc, atomic energy minerals, railways
• No need for industrial approvals from Union Government in locations
other than cities with 1 million population for industries that are not
on the list of compulsory licensing
• Foreign Investment: easy approval for FDI in high priority areas upto
51%, export promotion
• Foreign Technology: automatic approval of technology agreements in
high priority areas, no permission necessary for foreign technicians,
foreign testing of indigenously developed technologies
Industrial Policy (1991)
• Public Sector Policy: top priority areas (essential infrastructure goods
and services, oils and mineral resources, technology development
and building manufacturing capabilities, defense equipment), greater
management autonomy for profit making PSUs and priority sectors
• Selective opening up of some of the exclusive public sectors, public
sector will also be allowed to enter sectors that are not open for it
• Sicks units to be referred to Board for Industrial and Financial
Reconstruction (BIFR) for formulation of revival policy from its
position or rehabilitation packages for its workers
• Professionals hired in Boards of PSUs
• The policy puts an official end to the long running license-permit-
quota raj
Shift from MRTP Act to Competition Act
• MRTP provisions on mergers and acquisition were made inoperative
• MRTP was supposed to keep a check on monopolies, concentration of
assets, unfair trade practices
• MRTP Act repealed and replaced by Competition Act (2002) in 2009
• Competition Act is focused on promotion of competition, freedom of
trade, protecting the consumers interests
• MRTP Commission has an advisory role unlike the Competition
Commission established under the new act can impose punishments,
can take suo moto action
Industrial Policy (1991): Criticisms
• Policy regarding foreign capital: upto 51% foreign equity in high
priority sectors (upto 100% in case the entire output is exported),
excessive growth of MNCs bad for home grown small and medium
scale sectors, possibility of later opening up of least priority sectors to
FDI
• Public sector policy: PSUs giving negative returns mostly in consumer
goods, textiles, construction services, technical consultancies has 3%
share in total investment in Central public sectors, PSUs with return
ranging within 0-8% per annum has got 12% of total investment in
Central public sectors, 85% of total investment went to PSUs giving
good returns on investments
Industrial Policy (1991): Criticisms
• Social security policy: job losses due to closure of sick units, no clear
rehabilitation packages for workers in PSUs that were referred to
BIFR, selling of sick industries to big business at throw away prices
(passing up the ownership of UP State Cement Corporation to Dalmia
Industries for a petty sum – possible politician-bureaucrat-
businessman nexus, instead of selling of PSUs workers co-operative
could have been formed like Kamani Tubes, Central Jute and Mewar
Textiles – by linking workers incentives with company profits by
entitling them in shares in ownership dividends
• Dilution of the MRTP Act: MRTP Commission failed to stop formation
of monopolies, industrial policy was changed to increase competition
but still most of the sectors are controlled by a few, privatization led
to increase in prices of cement and paper
Expanding role of the public sector (1956-
1990)
• “The adoption o f the socialist pattern of society as the national
objective, as well as the need for planned and rapid development,
require that all industries of basic or strategic importance or in the
nature of public utility services should be in the public sector”
• “The public sector has to expand rapidly. It has to play the dominant
role in shaping the entire pattern of investment in the economy,
whether it makes the investment directly or whether these are made
by the private sector”
• “In a growing economy which gets increasingly diversified there is
scope for both the public and the private sectors to expand
simultaneously”
• The consensus on the eve of the Second Plan was that all industries of
basic and strategic importance should be in the public sector
• The public sector was to act as a senior partner in the process of
development and undertake investments in such areas in which the
private sector was unwilling or unable to undertake such investments
• In the exploration of minerals and basic and capital goods industries
and infrastructure, public sector has to undertake direct responsibility
• While accepting the framework of the mixed economy, public sector
was expected to contribute effectively to the social ends in view and
grow at a fast rate so that the share of public sector grows both
absolutely and relatively to the private sector
Expansion of Public Sector
• Government nationalised the Imperial Bank of India and named it as State
Bank of India in 1955
• Nationalisation of Life Insurance and creation of the Life Insurance
Corporation of India in 1956 by merging 245 insurance companies
• Nationalisation of 14 major commercial banks of the country in 1969
• Takeover coal mines and creation of Coal India Ltd. in 1975
• Takeover of 113 sick mills of private textile sector
• Total investments in public sectors (CPSE investments along with
investment in railways, postal and telegraph services and other state level
enterprises) went up to Rs. 2.5 lakh crore by 1992-93. It was providing 71%
of total employment in the entire organized sector. Contributed 25% of
NDP
Shortcomings of Public Sector
• Overmanning and low work ethics leading to low capacity utilization
• Over-capitalisation due to substantial time and cost overruns
• Political and bureaucratic interference stifling the ability to innovate
• Burden of taken-over private sector sick units
• Excessive social welfare expenditure
• Absence of a rational pricing policy based on economic calculus
• Low rate of return
• Despite the domestic availability of some capital goods and technology,
sometimes they were unnecessariliy imported
• Foreign companies appointed as contractors chose international suppliers
of plants, equipment and technology ignoring domestic sources
• Top managements officials were bribed by foreign contractors to
secure orders
• Examples: Shipping Corporation of India imported shipping vessels
instead of buying it at a cheaper rate from Cochin Shipyard. Power
equipment materials were imported instead of buying it from BHEL.
Non-price factors (like delivery time, quality, reliability) were
advanced as arguments to justify the unnecessary imports
• The public sectors has spread to too many areas even in sectors
where it should not be
Market Failure and State Intervention
• In case of imperfect competition, markets generate situations in which
state intervention becomes necessary to ensure competition
• In case of monopoly, market failure is obvious and the state must intervene
to break monopoly by anti-monopoly legislation or other measures
• Market failure has also been noticed in public goods like education and
health. In these areas, unless the state establishes schools, colleges,
universities, primary health centres and hospitals, it would not be possible
to take care of the weaker sections of the society
• Market failure has also been noticed in areas of economic infrastructure
like irrigation, roads, railways etc. Private sector would not like to invest in
infrastructure, more especially in remote areas, where the rate of return
maybe very small
• In the year 2004-05 about 27.5% of our population was under
poverty line. Market mechanism failed to provide basic amenities to
them. Effective government intervention is required to uplift the
marginalized section
• Land reforms act (ceiling on land holding) has arrested the
concentration of land holdings. It successfully provided secured
tenancy rights but it failed to provide land to the landless due to the
high landless population
• The government has a role to play in providing rural infrastructure
and subsidized credit so that the poor can create assets – helps in
poverty removal
• Economic infrastructure (railways, hydro-electric works, irrigation
dams, drinking water etc.) should be provided the Government as
private sector is not keen to invest in infrastructure
• State has a important role to provide education especially higher
education in field like medicine, engineering, technology, electronics
etc. as the cost of private education is high
• Private healthcare facilities are costly and are in not within the reach
of the population. So the state must provide these facilities also
• State should promote labour-absorbing industries by various means.
Keeping deposit rates low and maintaining ceilings on borrowing rates
to increase profits and retained earnings, protecting domestic import
substitutes, subsidising declining industries, establishing and
financially supporting government banks, making public investments
in applied research, establishing firm and industry-specific export
targets, developing export marketing institutions, and sharing
information widely between public and private sector
• Some of the unimportant commercial enterprises can be privatized,
but privatisation in the nature of selling five, ten or twenty percent of
the shares to cover the deficit of the Central Government will be of
no use. They can be privatized with the condition that labour
employed in them will not be retrenched
• Wages can be linked with productivity so that loss making public
sectors can be made profitable – improves efficacy of the
management
• The state should play effective role and not an active role. Striking a
balance between the two is difficult. The market mechanism or the
invisible hand theory believes in the system of ‘survival of the fittest’.
Overall economic growth will benefit the marginalized section as well.
But that is not always the case
• Removal of barriers to using markets can significantly enhance
opportunities, the practical usability of the opportunities requires the
sharing of certain basic capabilities — including those associated with
literacy and education (and also those connected with basic health,
social security, gender inequality, land rights, local democracy)