Need for Planning in Developing Countries (9 Ways) | Economics

Most of the developing countries were under colonial rule prior to 1950. They were greatly exploited by the colonial powers. For instance, India, which was once quite prosperous, became underdeveloped and poor during the British rule. Its handicrafts could not compete with the cheap imported industrial products, and as a result the artisans and workers employed in them were rendered unemployed. To make their meagre living they also sought employment in agriculture. With this too many people came to be employed in agriculture than required resulting in disguised unemployment on a large scale.

On attaining freedom from colonial rule, they adopted economic planning as a means of developing their economies.

That is, instead of relying on market mechanism to bring about optimum allocation of resources and bring about economic growth and development, the State through proper economic planning has to play an important role in the following ways:

1. Correct Market Imperfections:

The markets in developing countries are characterised by widespread imperfections. The product markets are characterised by widespread imperfections. The product markets are characterised by monopolies, oligopoly and other forms of imperfect markets. Under these market forms, firms have a lot of market power to influence price by restricting their output. The exercise of this markets power is more common when the firms enjoy increasing returns to scale.

Prices in these markets do not reflect their social values and are set above the marginal cost of production and therefore lead to less than socially optimum output. There is need for government to regulate the prices of goods, especially those of essential products such as drugs, milk, soaps, washing powder, cement, steel, petroleum products such as petrol, diesel, LPG etc. Besides, the Competition Commission should ensure that mergers do not lead to the emergence of monopolies or formation of cartels.

Further, imperfect factor markets prevail in developing countries due to which factor prices determined do not reflect the social opportunity cost. Under the pressure of trade unions, labour is overvalued and paid higher wages than its productivity. On the other hand, to provide incentives to investors, capital is undervalued compared to its scarcity value by providing various tax breaks, lower interest rate policy of the Central Bank of the developing countries. The overvaluation of labour and undervaluation of capital lead to the use of capital-intensive techniques of production which cause increase in unemployment of labour. Likewise, foreign exchange rate of the national currency of a developing country may be overvalued which discourages exports and encourages imports and causes difficulties of balance of payments of a country.

It is evident from above that imperfection in product, factor and foreign exchange markets of developing countries would lead to economic inefficiency or Pareto non-optimality and would therefore be unable to achieve maximum social value. There is therefore a case for the role of State and planning by it to remove these factors of price distortions if the goal of economic efficiency is to be achieved.

2. Ensure Benefits of Positive Externalities on Resource Allocation and Economic Growth:

Even when perfect competition prevails in the markets, there is no guarantee that social optimum levels of certain important goods which generate substantial positive externalities would be produced. The most important examples of such goods are education and healthcare facilities which have substantial positive externalities and should be provided below their cost of production or even free. It is the State which can provide them in adequate quantities through proper planning.

The private sector, guided as it is by profit motive, would not produce them free or below their cost of production. It is quite well known that so called public schools in India not only charge high tuition fees from the students but also huge capitation fees from them for admission. The engineering and medical institutes run by private sector trusts demand several lakhs of rupees as capitation fee for admission in them. Obviously, the general public or common men cannot get their children admitted in these private institutions for education.

Likewise, in private hospitals such as Apollo, Fortis, and Max charges are so high that only the rich can get treatment in them while common man is deprived of proper treatment to maintain his health. Because of generating positive externalities education and health services have a high social value which is not reflected in market prices. In modern economic thinking education and health services are called human capital because of their crucial importance for economic growth but the private sector guided by market forces does not make adequate investment in these sectors.

Therefore, to accelerate economic growth and provide social justice, it is of paramount importance that the State through planning should make adequate investment in them. The planning by state in these manpower resources (i.e., education and health) will not only quicken the process of economic growth but will also help in eradicating poverty. Todaro and Smith write, “Because such goods, as education and health services, must be valued at a price below their cost or even free, the private sector has no incentive to produce them. Thus the government often be responsible for providing these goods in order to ensure a minimum of welfare. In view of the population growth and poverty that characterise many developing countries it is likely that public sector activity in this area will continue to expand.”

Besides social capital represented by education and health services, the physical infrastructure such as power generation, coal and gas, transport facilities (including roads and highways), posts and telegraphs also create positive externalities and their short supplies are a major bottleneck to accelerate economic growth. The private sector driven by market forces has no incentive to make adequate investment in them as much of their benefits accrue to others. Therefore, it is now well recognised that planning in developing countries should make adequate investment in them to achieve higher rate of economic growth.

3. To Correct Market Failure due to Imperfect Information:

Another important market imperfection in developing countries is lack of information and the presence of uncertainty that are faced by both producers and consumers. Joseph E. Stieglitz rightly emphasises that even if markets are competitive, they are almost never efficient when information is imperfect or asymmetric. By asymmetric information it is meant that of the two parties in the market while one party has complete information about the good, service or financial security which is being sold, the other party lacks the necessary information about this.

Writing about the financial crisis arising out of bursting of housing bubble in 2008, he says that investors in the tainted securities did not have the same information about the quality of the securities as the banks or investment institutions issuing them. According to Stieglitz, this asymmetric information played a crucial role in bringing about financial crisis in the U.S. in 2008 when the sub-priming housing bubble burst.

Stieglitz also brings out flaws in so called rational expectations model of Lucas according to which investors are rational and their behaviour will ensure stability in the market. Referring to the financial crisis of 2008 in the U.S. he writes, “A long line of research has shown that even using the models of the so called ‘rational expectations’ school of economics, markets might not behave stably and that there can be price bubbles. The crisis of 2008 has indeed provided ample evidence that expectations are far from rational, but the flaws in the rational expectations line of reasoning, namely, hidden assumption such as that all investors have the same information had been exposed well before the crisis.”

He further adds, “Just as the crisis has reinvigorated thinking about the need for regulations, so it has given new impetus to the exploration of alternative strands of thought that would provide better insights into how our complex economic system functions”.

Similarly, speaking about the situations prevailing in developing countries Todaro and Smith write, “In many developing countries producers are often unsure about the size of local market, the presence of other producers, and the availability of inputs (both domestic and imported). Consumers may be unsure about the quality and availability of products and their substitutes. Moreover, in contrast to their counterparts in developed countries, producers and consumers usually lack the tools to ferret out this information because little is done by way of marketing. Under such circumstances profit and utility maximising behaviour may be based on wrong information and hence does not lead to an efficient allocation of resources. Planning by the government may attempt to provide this information or may decide to intervene in the market by guiding producers and consumers.”

4. Accelerating Capital Formation and Economic Growth:

Further, market not only fails to attain efficiency in allocating current resources at a given point of time. It may not however operate efficiently in allocating resources over time, that is, it may not ensure adequate rate of investment which is required to bring about rapid capital accumulation so as to raise the productive capacity and consumption in the future. This also shows the importance of planning for allocating resources over time. Capital formation is a prerequisite for economic growth.

Though there are large inequalities in income distribution in developing countries that should ensure higher rate of private saving, but due to the conspicuous consumption by the rich and the working of its demonstration effect on the upper middle class and middle class people, the private saving rate determined by market mechanism is not large enough to meet the needs of higher rate of investment or capital formation. Therefore, it is through appropriate fiscal and monetary policy measures that can raise the total saving and capital accumulation to accelerate economic growth. In this connection, investment in infrastructure, both physical and social, is of crucial importance. Private sector, driven by profit motive, may have neither any incentive nor sufficient funds to make adequate investment in them.

Further, it is important to note that economic development is a process of structural change. The market may ‘perform well in allocating resources at the margin by developing some industries further and allow others to decline but is generally ineffective in structural transformation of the developing economy that requires a broad and long-term view of the growth process. Therefore, active role in making a desired structural change of the economy is essential. Todaro and Smith rightly write, “The market may be ineffective in producing large discontinuous change in the economic structure, changes that may be crucial to the country’s long-term development. The government may therefore have to intervene in sectors crucial to the country’s development to ensure that they change over time and flourish.”

It is evident from above that due to widespread imperfections and the special requirements for eradicating absolute poverty and chronic unemployment and bringing about structural changes the market mechanism fails to deliver and therefore active government intervention is needed to achieve the desired results. Besides, the free working of market mechanism without regulation by the government may produce income distribution that is highly unequal that can pose dangers to the social and economic stability.

However, this should not mean that government should do everything and put stringent controls on the private sector and on the working of market mechanism. In fact as there are market failures, there are government failures too. What is needed is the judicious mix of roles of private sector and government to bring about not only rapid economic growth but also to ensure equitable distribution of income and eradication of poverty and unemployment.

To conclude in the words of Professors Todaro and Smith, “No Central Planning agency is capable of regulating the vast array of different-goods and services, nor would this be desirable. Rather it means greater and more effective cooperation between the public and private sectors. It also means that governments must seek to determine in which areas the market can most efficiently operate and in which areas the governments itself can achieve the best results given its own limited human resources. This public sector-private sector partnership through a proactive government industrial policy is a key lesson of the success stories of South Korea, Taiwan and Singapore.”

5. Accelerating Industrial Development:

There were two main features of economic policy of the developing countries, especially India, that emphasised the role of planning and intervention by the State in the development process of the economy until 1980. First, to accelerate economic and industrial growth economists and planners recognised that raising the rate of saving and investment was essential to accelerate the rate of economic growth. It was thought that the private sector on its own would not be able to achieve a higher rate of saving and investment required to break the vicious circle of poverty. Therefore, the State had to intervene to raise resources through its fiscal and monetary policy and thus increase the rate of saving and investment. This made the planning and the expansion of the public sector essential to accelerate economic growth.

Secondly, the strategy of development adopted in India’s Second and Third Five Year Plans laid stress on the industrialisation with an emphasis on the development of basic heavy industries and capital goods industries. This implied allocating a higher proportion of invisible resources to capital goods industries than to consumer goods industries. Private sector which is driven by profit motive could not be expected to allocate sufficient resources to the growth of capital goods industries. Therefore, the role of planning and the public sector was considered essential for rapid growth of basic heavy industries.

Latin American countries such as Brazil and Mexico after gaining freedom from colonial rule also adopted import-substituting industrialisation to bring about rapid economic growth. They gave higher priority to the development of consumer goods industries instead of capital-goods industries. But to bring about industrial development they did not rely on market and the private sector but the State and planning played a crucial role in their economic growth.

Similarly, South Korea, Taiwan, Hong-Kong and Singapore instead of import-substituting industrialisation adopted export-led industrial growth strategy. Contrary to popular perception the State played an important role in facilitating and promoting exports by the private sector.

6. Promoting Agricultural Growth:

Though priority was given to rapid industrialisation to bring about structural transformation of their economies, developing countries (including India) did not entirely neglect agriculture. Unlike in the communist countries in the 1950s, the agriculture was left to the private sector for developing it. However, in India land reforms were undertaken to protect tenants from eviction and fixed fair rents to be charged by the landlords from them. Attempts were also made in India to redistribute land after fixing ceilings on land holdings.

But rapid growth of agriculture itself requires a good deal of State intervention and planning. The land reforms in agriculture, supply of adequate credit to farmers, development of infrastructure such as irrigation, power, and roads were necessary where planning and the State could play an important role.

7. Regulation of Market and Private Sector by the State:

There is another important aspect of the role of State and planning in the development of the Indian economy which dominated economic thinking in the pre-reform period. Though the private sector was given an important role to play in the framework of mixed economy, to achieve optimal allocation of resources among different industries according to plan priorities, economic activities in the private sector were required to be regulated by the State.

Further, to achieve other objectives of planning such as restraining the concentration of economic power in a few big business houses, the private sector was subjected to industrial licensing controls. To quote C. Rangarajan, the former Governor of the Reserve Bank of India, “While the private sector was given space to operate in keeping with the concept of a mixed economy, in the field of industry particularly the decisions of the private sector were circumscribed by the licensing mechanism. Hence, while foreign trade was subject to controls because of the strategy of import substitution, industrial production and investment were subject to control because of the need to direct resources according to plan priorities.”

8. Role of Planning and State in the Post-Reforms Period of Liberalisation and Privatisation:

The crisis of 1991 which was the result of fiscal imbalances and balance of payments difficulties proved to be a turning point in Indian planning and economic policy pursued for accelerating economic growth. On the recommendations of IMF and World Bank a drastic change in India (and also in other developing countries) was made in economic policy. Under this the policy of liberalisation and privatisation was adopted to quicken the pace of economic growth and achieve economic stability.

A permanent question has been raised whether in this regime of liberalisation and privatisation, there was any useful role for planning and State to play in the development of the Indian economy. In the review of earlier economic policy, public sector was found to be inefficient. Far from generating resources for investment, it became burden on the national exchequer. Private sector was crippled by various direct bureaucratic controls which prevented its growth. In response to these, policy of economic liberalisation and privatisation was adopted.

Licensing was abolished except in case of few industries. In the new economic policy, the exclusive role of public sector was confined to a few strategic industries. All other industries were thrown open for production and investment by the private sectors. However, even in this regime of liberalisation and privatisation planning by the State has an important role, though somewhat different one from that envisaged earlier. We explain below the role of planning and the State in the post-reform period.

Tackling the Problems of Poverty and Unemployment:

Despite higher GDP growth in the 1980s, India faced the acute problem of poverty and unemployment. The planning and State intervention is needed to tackle the problems of poverty and unemployment. Since the beginning of the seventies the Indian planners realised, especially in the Fifth, Sixth and Seventh Five Year Plans, that even if growth rate of GDP was raised to 5 to 6 per cent per annum, it was not possible to make a significant dent on the problems of mass poverty and unemployment prevailing in the Indian economy.

It was realised that benefits of economic growth did not trickle down to the poor. Others are of the view that even if the poor get benefits from growth by way of more employment opportunities generated by it, mere economic growth is not enough to eradicate poverty and unemployment. Therefore, role of planning and State is necessary to start and implement special employment schemes such as Food for Work Programme and Employment Guarantee Schemes to help the poor and weaker sections of the society.

Planning has to play an important role in poverty alleviation and employment generation. Poverty exists because the poor people and downtrodden have little asset endowments with which to engage themselves in productive activities to earn sufficient incomes. Lack of adequate number of jobs on wage basis is another important cause of poverty and unemployment. It is through planning that the assets for the poor can be built. For example, adequate credit supply to the poor farmers is necessary if they have to make improvements in their land, build irrigation facilities and other assets to increase their productivity. Private sector and market mechanism cannot be expected to build and provide assets to the poor.

Besides, due to various factor price distortions such as relatively low price of capital due to various fiscal concessions, overvalued exchange rate of rupee, private sector has a tendency to use more capital-intensive techniques and therefore will not create sufficient employment opportunities. It is due to increasing capital-intensity of the production processes that employment elasticity of output in the industrial and agricultural sectors of the Indian economy has greatly fallen in the last two decades. This has significantly reduced the employment potential of the Indian economy. Planning and State intervention is needed to provide disincentives to the use of capital-intensive techniques and to give incentives to use labour-intensive techniques of production.

Further, plans can provide for special anti-poverty schemes and special employment programmes for the poor and unemployed. Anti-poverty programmes such as Food for Work Programme, Employment Guarantee Programme to provide one person of a household living below the poverty line employment for 100 days in a year will be of great help for the poor and unemployed. If the poor and unemployed are used to build durable assets, it will enhance the productivity of the economy. It is through planned actions by State that such anti-poverty programmes can be effectively implemented.

Building Physical Infrastructure:

It is now well known that private sector is least interested in building physical infrastructure such as power, communication, roads, ports, highways as private benefits are less than social benefits in their case. This is because building of infrastructure generates external economies. It is now well recognised that economic growth is impeded by the lack of these infrastructural facilities. Past experience also shows that except in the field of telecommunication, private sector in India does not feel attracted to make adequate investment in the infrastructure projects. Therefore, to achieve 8 per cent annual growth rate in GDP on a sustained basis, which is the new goal set for the Indian economy, public investment in economic infrastructure in the framework of a well-designed plan is of paramount importance.

Investment in Agriculture:

Whereas economic reforms initiated since 1991 had a focus on accelerating industrial growth through liberalisation and privatisation, investment in agriculture was neglected. Much of the resources of the government were spent on providing subsidies to farmers. As a result, capital formation in agriculture has substantially slowed down since the early nineties. The average rate of agricultural growth has been extremely low in the last one decade and a half.

This has worsened the employment opportunities in agriculture and in some States, especially Andhra Pradesh, Karnataka and Odisha, several farmers have committed suicide. Agriculture needs adequate investment for which access to credit for farmers at low interest rates are needed. Besides, to enhance the productivity in agriculture investment in irrigation is essential. Only the State in a planned framework can make adequate investment in expanding irrigation facilities and in undertaking flood control projects.

Creating Social Infrastructure and Promoting Human Development:

The first and foremost, planning is needed even after the policy of liberalisation and privatisation for creating the social infrastructure and for human development which are of crucial importance for promoting economic development We need to build schools, colleges, hospitals, institutions of technical education and scientific research. We have to impart skills to the youth so that they can be employed in productive activities. These can be built better through planning by the State. Private sector participation in creation of social structure and human development is not capable of taking care of the entire needs of the society particularly of the poor and weaker sections of the society. Market mechanism which is driven by private profit motive will not be able to bring equilibrium between the ‘need’ and ‘supply’ in this regard. Therefore, planning in this area will remain important.

Regional Balanced Development:

Planning in developing countries is also necessary to remove large disparities in development between regions. The removal of the regional disparities in economic development requires flow of investible resources across regions. With greater freedom and choice of location that is now available to the private sector, it is more likely that some States would be able to attract more private investment than others. As a matter of fact, the past experience has shown that market forces do not work in a way to achieve regional balance in economic development. Therefore planning is needed to manage the flow of resources across regions for rapid removal of regional disparities.

For this plan formulation has to ensure that public investment in infrastructure must be reoriented in favour of the less well-off States. At present plans do provide for special area programmes such as the Hill Area Development Plan, Tribal Area Plan, and Plans for Development of North East area and Jammu and Kashmir. While these programmes help in development of basic infrastructure in these areas, the backlog of development is large. Therefore, considerable planned efforts and resources are needed for integration of such backward regions into the mainstream of development process in the country.

It may be further noted that the focus regarding the issue of backwardness and regional balance has traditionally been on industrialisation. The evidence, however, suggests that reduction in regional disparities, particularly in average standards of living, may be better achieved through greater focus on agriculture and other rural activities. For this plan formulation should be such that provides for increasing the productivity of agriculture in backward areas. Besides, planned efforts are needed to improve connectivity of these areas in terms of transport and communication with the rest of the country.

Protecting Environment and Ecology:

Finally, there are areas such as protection of environment, forests and ecology in which markets cannot play an efficient allocative role. The intervention of the State is essential to regulate private sector operations and working of market mechanism in respect of activities which adversely affect environment, forests and ecology of the economy. Similarly, working of market mechanism works in a way that leads to the excessive depletion of scarce natural resources like rare minerals, land and water.

This harms the prospects of sustainable growth. Proper planning for their optimal use is therefore necessary. In this regard, the observations of India’s Eighth Five Year Plan are worth quoting – “Market mechanism is never adequate for protecting environment, forests and ecology. Nor is it adequate in giving guidance about the use of scarce resources like rare minerals, land and water. A long-term perspective, and hence planning, is needed in these areas.”

Allocation of Resources among States:

India is a federal State. Both the Centre and States have distinct areas of operation. Investment for development requires resources. Resources from certain taxes levied by the Centre are distributed among the States by the Finance Commission which is appointed every five years to review the situation. Non-tax resources are allocated among the States by the Planning Commission according to their developmental needs and projects submitted by them in this regard.

9. Market-Friendly New Economic Reforms in Developing Countries Since 1980:

Since 1980s there has been a neoclassical counter-revolution in economic policy in both the developed countries such as United States, Britain, Canada, West Germany and developing countries of Latin America and Asian countries such as India, Pakistan, and Bangladesh. Under this there has been a change from public ownership of enterprises in various sectors of the economy to dismantling of public ownership, and also to the dilution of the role of government and public sector in the economy. As a result, market economy has been allowed to work freely without much controls by government over it. Besides, under this new policy framework, supply-side macroeconomic policies have been given dominant role in promoting economic growth in place of demand-management policies adopted under the influence of J.M. Keynes.

Many developing countries (including India) after independence did not completely do away with market system of production, exchange and distribution by private sector on the basis of profit motive. In fact, India and also some other developing countries adopted ‘mixed economy model’ where both the public and private sectors were allowed to work and grow in their respective fields. In India Industrial Policy Resolution of 1956 demarcated the respective fields in which the public and private sectors were conceived to work and grow with crucial sectors such as basic heavy industries, power generation, making arms and ammunition, atomic energy having been reserved for the public sector.

Almost all consumer goods industries were left to the private sector for production, exchange and distribution on the basis of free play of market forces. However, the centralised planning and public sector was given a dominant role in providing or producing goods, especially in which private sector was not attracted to invest. In India for almost four decades from 1950 to 1990 this mixed economy system of coexistence of public and private sectors with public sector occupying commanding heights of the economy prevailed.

However, the actual experience with the mixed economy model though seemed to work well for some time, it had its shortcomings too. Economic growth rate in India in the first four Five Year Plans (1951-1974) was on an average 3.5 per cent per annum which was hardly sufficient to make dent into the problems of poverty and unemployment in view of rapid population growth of around 2 per cent per annum and requirement of 1 per cent of GDP for increase in investment per year in the economy.

As a result, the magnitudes of poverty and unemployment remained very high. Given a very modest poverty line (Rs 49.1 per capita per month for rural India and Rs 56.6 per capita per month at 1973-74 prices), 54.9 per cent of population was found to be living below the poverty line in 1973 which fell to 51.36 per cent of population in 1977-78 and to around 40 per cent in 1983 for All India (both rural and urban areas put together). Likewise, in India in 1983 a high 9 per cent of labour force was found to be unemployed on daily status basis.

However, as a result of relaxation of certain industrial controls over the private sector and adoption of some measures to promote exports during the eighties and pickup in public sector investment in the later part of the eighties, the growth rate of GDP rose to 5.6 per cent per annum during the eighties. However, the period of eighties in India was characterised by large-scale borrowing from abroad which led to the large increase in India’s foreign debt and its annual service charges. This ultimately resulted in balance of payments crisis in 1990-91 and sharp rise in inflation rate in India.

Thus in the overall period of four decades (1951-91) reliance on centralised planning and important role given to the public sector for accelerating economic growth seemed to be not successful. It was realised that as there are market failures, there are government failures too. Thus due to apparent failures of economic planning and the macroeconomic imbalances as reflected in balance of payments crisis on the one hand and high inflation on the other in India and other developing countries, the role of government and planning in economic growth began to be called into question. This called for revision of the role of government and planning in economic development.

Why Market-Friendly New Economic Reforms were adopted?

Due to failures of Government in the late eighties it was felt that importance given to the public sector in the strategy of industrial development and stiff controls over the working and expansion of the private sector were obstructing economic growth and promoting inefficiency. Further, in 1991, India experienced serious problems of a high rate of inflation on the one hand and huge deficit in the balance of payments on the other. To overcome these problems some economists such as I.M.D. Little, Jagdish Bhagwati, Bela Balassa who had been advisors of World Bank and IMF argued for the adoption of the policy of economic liberalisation by India and other developing countries to promote growth, check inflation and solve the problem of balance of payments. They advocated that free markets and greater role of private sector (including foreign investors) would ensure efficiency by encouraging competition.

The experiment of a mixed economy as described in the Industrial Policy Resolution of 1956 and later amendments made in it wherein public sector was given a prominent role in industrial development of the Indian economy seemed to be a success in the beginning. It was through public sector investment that a lot of infrastructure such as irrigation, transport, power was developed. Many basic and basic heavy industries such as steel, fertilizers, and machine-making industries were built by the public sector. But during the eighties several shortcomings of the working of public sector were observed.

First, the public sector which was expected to generate adequate resources for the growth of the economy not only failed to do so but in fact was incurring huge losses which raised the expenditure of the government. The losses of the public sector were said to be due to the inefficiency of the public sector enterprises. Secondly, the problem of macroeconomic imbalances, both in the internal and external sectors, emerged and assumed serious proportions in 1990-91. The huge budget deficits of the government and expansion in money supply led to the serious problem of inflation.

On the external front, higher commercial borrowing from abroad at higher rates of interest resulted in the serious problem of persistent deficit in the balance of payments. This caused a sharp decline in the foreign exchange reserves. The foreign exchange reserves fell to such a meagre amount that it could meet the payments for imports only for 15 days. This compelled the Government to approach IMF and World Bank for necessary help to tide over the foreign exchange crisis. IMF and World Bank agreed to help only if policy of economic liberalisation was adopted and accordingly greater role be assigned to the private sector in boosting industrial investment and production in a competitive environment.

It was believed that market competition would ensure efficiency and stimulate economic growth. The objective of new industrial policy based on liberalisation, privatisation and globalisation was to improve the efficiency of the economic system by eliminating the regulatory mechanism that involved various licenses and permits which reduced competition in the market and planning in the late eighties switched back to the market system which led to the policy of liberalisation and privatization in many developing countries under the guidance and direction of World Bank and IMF. Dr. C. Rangarajan, Chairman of the Advisory Council to the Prime Minister of India, writes, “The thrust of the new economic policy was towards creating competitive environment in the economy as a means to improving the productivity and efficiency of the system. This is to be achieved by removing the barriers to entry and restrictions on growth of the firm. While the industrial policy seeks to bring about a greater competitive environment domestically; the trade policy seeks to improve international competitiveness subject to the protection offered by tariffs which are coming down.”

We explain below these structural adjustment reforms, with special reference to India. After independence, India avoided the extremes of both capitalism and socialism and opted for a mixed economy where planning and the public sector played an important role in the economic development of the country. The experiment of a mixed economy as evolved in India seemed to be a success in the beginning but during the seventies and eighties several shortcomings of its working had been noticed.

Inefficient Working of Public Enterprises:

First, the public sector which was expected to generate adequate resources for the growth of the economy not only failed to do so but in fact was incurring huge losses which raised the expenditure of the government. The losses of the public sector were said to be due to the inefficiency in the working of public enterprises. Secondly, the problem of macroeconomic imbalances, both in the internal and external sectors, emerged and assumed serious proportions in 1990-91.

The huge deficits in the successive budgets of the government due to internal imbalance of Government expenditure and revenue led to the creation of more money supply which created the serious problem of rising prices, so much so that rate of inflation went up to about 17 per cent per annum during August 1991. This compelled the newly elected Congress government to reduce government expenditure and fiscal deficit for stabilising prices.

Balance of Payments Crisis:

In the external sector, the huge deficits in the balance of payments due to the rising imports and sluggish exports persisted for a long time and, to meet this deficit, the government resorted to commercial borrowing from abroad at higher market rates of interest. As a result of persistent deficits on the current account, the foreign exchange reserves declined to a very small sum in June 1991 which could last for payments for necessary imports only for about few weeks. This compelled the government to approach IMF (International Monetary Fund) for loans to make necessary payments and enhance the foreign exchange reserves.

Thirdly, though the annual growth of national income during the eighties went up to over 5 per cent and of the industrial sector to 8 per cent, which was considered to be a good performance, but due to macroeconomic imbalances which emerged in the economy they could no longer be sustained any more. In the external sector, the situation became so worse in 1991 that India came to the brink of default. To avoid the default and to win over the confidence of international business community, the government had to sell a part of its gold reserves and a certain amount of gold was even pledged with Bank of England to obtain the foreign exchange reserves to meet its obligations. Further, it had to approach the IMF for loans to tide over the foreign exchange crisis.

Excessive Government Controls over Private Sector:

Besides, excessive government regulation and control over the private sector proved to be counter-productive. The following drawbacks of excessive regulation of the private sector were emphasised and case for liberalisation of private sector was built up, especially by Jagdish Bhagwati and T.N. Srinivasan, the two economists associated with World Bank and International Monetary Fund.

The following arguments were given in favour of deregulation of the private sector and assigning to it a greater role in economic growth of the Indian economy:

1. The industrial licensing and controls had degenerated into arbitrary bureaucratic controls on the allocation of resources in competing industries. The licences were issued to make investment in those industries which bureaucrats chose in tune with the policies they administered. This licensing system replaced the efficient market system of resource allocation by personal system of resource allocation. Thus excessive regulation of the private sector, according to the advocates of economic reforms, had resulted in the suboptimal resource allocation in industries. Hence, there was a need for liberalisation.

2. The industrial licensing system had stifled private initiative and enterprise because this system had left no scope for private initiatives in investment planning and investment decisions. In fact, the industrial licensing system did not allow the competitive economic environment to operate. As a result of this, the entrepreneurs had become attuned to secure monopoly rent, rather than to earn profits through enterprise and skills. Jagdish Bhagwati and T.N. Srinivasan identified licensing and control regime as the causative factor responsible for low productivity and high capital-output ratio.

Hence, industrial liberalisation became an imperative condition for the growth of forces of competi­tion to ensure high efficiency and productivity in Indian industries.

3. Under the regime of licensing, the industrial units which tried to increase output by making full utilisation of installed capacity were penalised on the ground that their production exceeded the licensed capacity even if goods produced were much needed and were in short supply. Hence, industrial liberalisation became essential from the point of view of promoting industrial growth by the creation of additional productive capacity and its optimal utilisation.

4. The industrial licensing policy had failed to achieve its objectives of balanced regional industrial development and prevention of concentration of economic power. In fact, during licensing regime, the regional industrial imbalances and concentration of economic power had got intensified. Hence, there was a strong case for scrapping licensing system and switching over to market system.

Washington Consensus and Reforms:

Before explaining the economic reforms initiated in 1991 under the pressure of IMF and World Bank, it may be mentioned that these reforms mainly constituted what is now labelled as Washington Consensus. This consensus was formulated by John Williamson, with the other officials of World Bank, IMF and key US government agencies. This consensus contains 10 elements of development policy which were suggested to promote economic growth in the developing countries and also help them solve their problems of indebtedness, balance of payments difficulties and high rate of inflation.

It is noteworthy that this Washington Consensus followed a free market approach to development and, contrary to the views of many development economists, it did not emphasise elimination of poverty and reducing inequalities to achieve real development, as it is now widely understood. The Washington Consensus and fiscal and structural reforms it envisages views that poverty will be automatically removed if rapid economic growth is achieved. Its message is ‘take care of growth, poverty will take care of itself’.

Emergence of Market Failures:

Now, from 2008 onwards as a result of financial crisis which shattered the U.S. and European countries and through the greater integration of the world economy through trade and international capital flows, the developing countries (including India) could not remain unaffected. Financial crisis in the US occurred because banks and other financial institutions in their financial market operations clubbed sub-prime housing loans securities into the new deriva­tives in a non-transparent manner and sold them in the market.

This whole financial market system collapsed when people started defaulting in paying their housing loans. In India as in other developing countries, which adopted the free market system under directions of World Bank and IMF which insisted on the adoption of policy of liberalisation, privatisation, globalisation as a precondition to bail them out of the balance of payments crisis and tough fiscal situation have witnessed again in recent years the failures of market system to ensure growth with stability.

The most important reason is that in developing countries markets are characterised by widespread imperfections due to which they failed to work with efficiency and rationality. Joseph E. Stieglitz argues that “markets are not necessarily either efficient or stable or that our economy is not well described by the standard model of competitive equilibrium used by a majority of economists”.