Money and the Smooth Working of the Economy

Read this article to learn about the three key benefits of money to ensure smooth working of the economy.

1. Money in a Capitalist Economy:

Money has been of great help to consumers as it has given them ready command over goods and services with additional facility of its being divisible into smaller units.

It enables them to distribute their limited income on different goods and services in a manner that they can get maximum satisfaction.

Further, it has made possible the best use of scarce resources. Money has brought expansion in consumer demand thereby laying the foundation for a broad extent of the market.

According to Prof. Robertson, “The existence of a monetary economy helps society to discover what people want and how much they want…and so to decide what shall be produced and in what quantities and to make the best use of its limited productive power. And it helps each member of society to ensure that the means of enjoyment to which he has access, yield him the greatest amount of actual enjoyment which is within his reach.”

In a system of free enterprise, the decisions as to how much and what kind of goods shall be produced are guided by the price-mechanism, which operates through money only. Price-mechanism brings about not only a redistribution of factors of production as between the industries, but also directs the use of resources into most desired channels.

Money has great importance to producers specially in a capitalist economy characterized by large-scale specialisation and division of labour. It has enabled the producer to organize his production in a most economical manner and spared him the botherations of barter system, under which good deal of time and energy had to be wasted in bartering the goods and services produced.

A large-scale producer is able to pay labourers wages in the farm of money, which they accept in the confident expectation of being able to obtain with these wages the things which they need. Producers and businessmen are concerned, while planning their future production, with the cost of production, and selling prices along with profits—all calculated in terms of money. According to H.G. Moulton, “Money is an indispensable pre-requisite to the assembling of the concrete instruments of production.

The businessman uses money…… to purchase materials for the construction of his factory. He uses money…in buying the supplies…and he employs money as a means of attracting to his organization the requisite labour force and administrative officials.

Further, it facilitates advance payments of various types. The producer has to pay to the labour force much before he gets the final product and sells it. Labour is, thus, supported by means of advance payments made in the form of money wages. Similar is the case of loans made by one businessman to another businessman, which is rendered easier by the presence of money. Mobilization of saving from the general public would have been impossible but for money.

It is altogether an indispensable tool for development of the credit market. Lending and saving in the last resort means lending and saving of real goods and services which money commands, when one man lends, it means that he shows his willingness to transfer command over goods and services to another and expects to be repaid at a future date—all this having been made possible by the use of money. Again, a modern state no more receives taxes in the form of goods and services but in the form of money. Money has made capital more mobile.

Money is a vehicle of social reform and a cure of economic maladies. It is held by some that life will not be worth living without money. The importance of money in the smooth functioning of society can be realized when we recall to our minds the bad effects of disorganized monetary system as in an underdeveloped economy, where everything gets confused the moment money ceases to work smoothly.

According to Dr. Marshall, the growth of money economy made possible the growth of present day liberal and free enterprise system. Even housewife willingly takes the help of money in arranging her budget so as to derive the maximum benefit from the expenditure of money. Even in the non-financial sphere, money has assumed importance as it measures both things and persons.

According to H. Davenport, “All economic comparisons are made in money terms, not in terms of beauty, or of artistic merit or of moral deserving.” Is one a great artist or leading advocate or a famous singer or a learned teacher or a celebrated author will depend upon what his earnings in terms of money are! It would not be out of place to say that money valuations pervade all our thinking in a capitalist economy.

2. Money in a Socialist Economy:

Some writers have expressed the opinion that money in a socialist economy has no role to play. They feel that it is ‘carry over’ from capitalism and a true socialist economy should bring about an abolition of money and credit, thereby sparing the economy of the evils of money. They further believe that in a socialist economy the means of production are owned and operated by the state for the common good, sources are employed in an optimum manner and goods are distributed amongst the consumers under the direction of the state.

Hence, pricing process and therefore, money has no role to play in such an economy. Money is regarded as a superficial element in such an economy— where economic activities are planned, controlled and executed by the state the use of money can be given up altogether. Marx and Lenin express themselves against money.

According to Marx money helped the exploitation of labour. In his opinion, an ideal economy is a natural economy where there is no medium of exchange like money and goods are exchanged freely against goods and this is quite possible in a socialist economy.

However, the attempts made to abolish money through extensive direct controls and free distribution of goods failed after the October Revolution of 1917 and Lenin admitted in 1921 that communism without a process of money circulation will not be possible. Trotsky also asserted the inevitability of money in socialist planning. As such the use of money was retained despite the intensive totalitarian planning of the USSR.

Such a contention, however, cannot be upheld. The modern socialist economies like USSR, Yugoslavia, Poland and even China have all made use of the pricing process and hence money both in theory and practice. History of Russian economic development tells us that Lenin had to introduce free market in retail trade through price mechanism to restore order in an otherwise dislocated economy. He confessed that a socialist economy could not do away with the use of money in the socialist calculation and control.

Trotsky also expressed the view that no commercial accounting was possible without the use of a monetary unit. Even in the present day Soviet Russia, workers receive wages in exchange for their services in terms of money which they spend on consumer’s goods. The experience in Soviet Russia proved that the abolition of money payments would seriously affect incentives and reduce efficiency of labour. Prof. A.P. Lerner is of the opinion that a socialist economy cannot function smoothly without money. He says, “Without money, it is impossible for an economic system of any complexity to function with any reasonable degree of efficiency.”

According to Prof. N. Halm, “Even if the aims of production should be determined by a dictator, the allocation of resources according to these aims would have to be the result of the working of pricing process by means of which it is possible to compare the usefulness of the available resources in different fields of employment.” Thus, a socialist economy is also a monetary economy, as it has the impact of money in one form or the other, though its role may be minor at times.

While money is a master in a capitalist economy, it only acts as a servant in the socialist economy. Money has been found necessary in such an economy because of its technical functions, such as, means of payment, standard of value, unit of account, etc. The question of right priorities and equal distribution of goods produced are rendered possible through price-mechanism, which in turn, acts through money.

3. Money in a Mixed and Developing Economy:

Money plays no less significant role in a mixed and a developing economy. A mixed economy is characterized by the prevalence of public sector and an equally important private sector which plays varying degrees of role. In England, the public sector serves to stabilize and regularize the imperfections in the economy and aims at providing services, which the private sector cannot provide without incurring huge social costs (like the public utility service).

In other words, in mixed economy of the type found in England, public sector plays the regulatory role of compensatory spending and pump priming. But in India, public sector plays a more dynamic and important role in the planned economic growth. The public sector in India has been given an important place in different Five-Year Plans of development.

Prices and money, therefore, play an important part in a mixed and developing economy in determining the volume of output and employment in the private sector, as it is solely guided by the profit expectations calculated in terms of money. Further, in a developing and expanding economy, which has adopted ‘Mixed Economy’ as the pattern of development, more and more money is needed for the rapid monetisation of the non-monetised sector of the economy.

Moreover, money will influence not only the relative shifts in the distribution of income in an expanding economy, but will also determine the allocation of limited resources to different sectors of the economy. The role of money in a developing and mixed economy assumes greater importance as money becomes an important factor of development and capital formation.

A developing economy is characterized by an increase in national and per capita income. It is an economy in motion in which stagnation lags behind and dynamic forces of growth are constantly at work to break through the old values and institutions. In the unorganized sector of such an economy, subsistence farming holds sway over the commercial farming and not much margin is left for exchange. The use of money is, therefore, at best limited. But as the economy expands, agriculture gets commercialized and urban influence penetrate into the rural sector, money is increasingly used in the day-to-day transactions, thereby lubricating the wheels of production.

In the rural areas, where it was used primarily as a store of value to fulfill the desire for high liquidity of the people and was kept in the form of gold till now, it assumes a more active and dynamic role by serving as a standard of deferred payments, a unit of account, a measure of value and a medium of payment.

Thus, the unorganized rural sector of the developing economy, which had hitherto remained unaffected by monetary influences, now comes under the purview of money and through it the rate of interest, thereby affecting income, output and employment.

In a developing mixed economy (like India), the public sector is affected by the use of money partly because goods and materials have to be purchased from the private sector at rising prices, thereby raising the cost of production of various productive units in the public sector.

Again, if the rate of interest shows a tendency to rise on account of inadequate supply of money (funds), the public sector may have to pay more on loans borrowed from the public and the burden of the public debt may be increased. Thus, the role of money in a developing and mixed economy is more complex, for its true and real nature is not revealed during transition and, therefore, lot of control is needed so as to avoid its evil effects without effecting the tempo of development.