Economic Policy under Planning, Aspects of

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ECONOMIC POLICY UNDER PLANNING, ASPECTS OF Economic development in India was initiated in 1952 through the formulation of Five-Year Plans, which set the direction of growth for the Indian economy. The government's economic policy under planning was predicated on four basic premises. First, the economy would not achieve rapid growth and egalitarian income distribution under free markets; therefore, the state must intervene in multiple ways. As a consequence, a comprehensive regulatory apparatus whose wings spread to all sectors of the economy emerged. Second, the economy should pull itself up by its own bootstraps, which meant in practice that it should operate almost as a closed economy, producing as many products as possible domestically and assigning a marginal role to foreign trade. Third, the public sector should occupy a commanding height in the economy, producing basic goods like steel and machinery, with consumer goods playing a complementary role. Fourth, the growth should benefit the most disadvantaged classes of society, affording them more employment opportunities and more equal income distribution.

Instruments of Economic Policy

The instruments devised to ensure the outcome of the economic policy according to the plan priorities were—apart from the fiscal, foreign exchange, trade and monetary policies (which are discussed separately in related entries): domestic industrial licensing, foreign investment licensing, price controls, and regulation of monopolies. All these instruments except the last one originated with the Industrial Development and Regulation Act of 1951, although their nature and coverage changed over time.

Industrial licensing

Industrial licensing was directed toward creating capacity in existing lines of manufacturing and in intended new areas. As a priority, small-scale industries with fixed capital below 50 million rupees were exempted from licensing and labor legislation in order to increase employment through less capital-intensive methods of production. In addition, production of certain goods was reserved for this sector, which was also given a credit subsidy. The issue of a letter of intent, which was only the first step in a series under the licensing procedure, often went through a bureaucratic tangle involving various ministries of the government of India and other concerned agencies. By the time a license was translated into concrete action, a considerable amount of time was spent, and in many cases, the investor either lost interest and withdrew or held the license without actually using it to start production. This dilatory procedure often ended in the hoarding of licenses for approved projects by influential producers, solely with a view to preventing their competitors from entering the field. Since 1985 there has been considerable relaxation of the regulations. Some categories of manufactures were completely delicensed, and industrial licensing was made more flexible by allowing additional capacity under different provisions of the act, like "automatic growth," "unlimited growth," and so on. However, the liberalization of industrial licensing remained half-hearted, with uncertainty hanging over its possible future reversal.

Foreign investment control and licensing of foreign technology

Being concerned about the free entry of foreign capital into the country, many restrictions were imposed on foreign investment on the grounds of foreign exchange scarcity and the need to promote domestic enterprise and indigenous technology suited to India's resource endowment. India opted for the purchase of foreign technology and minority foreign participation in equity during the 1960s. Royalty rates and fees were prescribed, and the conditions for Indianization of management and proportion of equity participation were set forth. The most restrictive policy was introduced through enactment of the Foreign Exchange Regulation Act in 1973, under which maximum equity participation by foreign investors was limited to 40 percent, except in export-oriented and high-technology industries, and the royalty rates were lowered. In terms of the impact on industrial growth, however, these restrictions were less onerous because foreign investment, both in stock and flow terms, had been modest and the domestic industrial policy's bias against competition and high profits hardly excited foreign firms.

Price controls

The government maintained comprehensive price controls on commodities, varying from essential consumption goods like sugar and gram to intermediate goods and even capital goods, accounting for about sixty-five individual goods or groups of commodities. Prices were usually set on a cost-plus basis, derived from technical relationship and the norms for reasonable rate of return on capital employed. The coverage of commodities was altered from time to time, depending on which prices needed to be raised or lowered. This mode of determining prices was not uniform and varied from industry to industry. As a result, there were anomalous situations, such as uniform pricing for all plants for a given product like steel, regardless of the cost conditions in each, or different prices for different plants for the same product, depending on the obsolescence of the plant, or different prices for the same product from a given plant. On many occasions, the prices of products manufactured by public enterprises were raised only to wipe out their losses or to increase their profits. It was overlooked that the policy of jacking up prices of intermediate goods helped raise resources for financing public sector investment only in the short term, while creating a resource crunch in the medium and long run with higher intermediate goods prices. The chaotic and counterproductive price control regime was continued, despite a severe indictment of this regime by various official committees. The government did, however, eventually recognize the complexity and irrationality of price controls, though it persisted with the core of the administered price control system to accommodate populist opinion and the vested interests.

Regulation of monopolies

Whenever the industrial licensing mechanism failed to accomplish what it was designed to do, other regulatory measures, often draconian, emerged from its womb. One such was the Monopoly and Restrictive Trade Practice Act (MRTP) to control the size of firms. One of the committees of the government of India, set up in 1969 to evaluate the effectiveness of the licensing policy, concluded that the prevailing licensing framework did not succeed in regulating the growth of industrial output in the right direction and in fact facilitated concentration of economic power and monopolistic practices. The MRTP Act was passed to prevent this outcome by restricting the expansion of large industrial firms with gross assets exceeding 200 million rupees in interlinked undertakings, or of "dominant" undertakings with assets over 10 million rupees. Since 1985, however, the asset limit to be exempt from the application of MRTP was raised to 1 billion rupees. As a result, the large firms had to overcome more obstacles than other industrial firms to raise the production capacities or to introduce new products. Paradoxically enough, the MRTP-induced restrictions on large firm entry or expansion accentuated the prevailing market concentration and led to excessive profits, as the threat to the existing dominant firms from new competitors was substantially reduced.

Implications of Economic Policy

The implications of economic policy, vaguely perceived initially by the government and the intelligentsia, became clear with the passage of time. If the public sector was to be the promoter of heavy industry, the private sector must be denied entry into that field. If employment-generating and quick-yielding small-scale industries were to be encouraged, large industries in the private sector must be prevented from encroaching on the areas reserved for small industries. If egalitarian goals were to be attained, luxury goods must not be allowed to be produced domestically or imported from abroad. These "don'ts" rather than "dos" received prominence in fashioning industrial policy as well as trade policy design. Initially, the government's objectives were confined to steering investment allocation where it would yield maximum benefits, but once the regulatory machinery was set in motion, it developed a life of its own, with constricting impact on growth in industrial production, efficiency, and trade promotion, thereby creating opportunities for corruption.

Indian economic policy under planning, often buffeted over the years for ideological reasons, can best be characterized as "unlearning by learning." Right from the beginning, the basis of economic policy and the instruments of its implementation were influenced by a strong perception that there was a pervasive market failure and that salvation lay in frequent and decisive government intervention. The effectiveness of this interventionist approach was judged in terms of its "first impact effects." If industrial licensing was used to determine the output pattern, import quantity, and composition of imports, it was believed that the final outcome would conform to the original intention. If foreign exchange was allocated according to a scale of priorities, it was assumed that it would go to the sectors that were designated as high priority. If bank credit was selectively channeled to what were designated as essential sectors, like agriculture, small-scale industries, and so on, it was concluded that the earmarked sectors would be the real beneficiaries.

As it turned out, the actual effects of the remedies directed toward eliminating market failure were vastly different from the intended ones. Although impressive progress was achieved by the late 1960s in diversification of output and development of infrastructure, and in industrial and agricultural technology, there was widespread inefficiency in the use of labor and capital. Industrial production was of low quality and high cost; small-scale industry used more capital than labor; and the public enterprises, which were heralded as the instruments of resource mobilization and income distribution, drained away, instead, the resources mobilized by the government through massive tax efforts. The only beneficial consequences were discerned in several infrastructure activities and public distribution of essential supplies to the low-income population—the areas that were well suited to government intervention. However, such was the mesmerizing appeal of state intervention that it took several decades before the targeted groups could realize its pernicious effects and utter futility. In the meantime, parasitic middlemen mushroomed to appropriate the gains flowing from the interventionist policies.

The importance of competition and efficiency was recognized at times, as reflected in marginal changes in the economic policy frame in 1964 and 1965, 1981 to 1985, and 1989, but there were quick retreats from action to promote them at the slightest sign of protest from not only the left but the center and the right political parties as well. Despite the superficial diversity in political ideology, India's political parties were usually in agreement with regard to the core of economic policy. Both those who advocated liberalization and those who urged interventionist policies held that the state should not abdicate its responsibility in economic management. If there was any difference among the various ideological camps, it was only about the degree of intervention. Though the parties rationalized their advocacy of state intervention by invoking the poor and downtrodden, the real reason lay in the enormous power that they wielded and the patronage they dispensed when the state remained strong and centralized.

Political Economy Perspective of Economic Policy

The inability of a democratic polity and its highly modernized political leadership to pursue a growth-promoting and welfare-enhancing policy has to be seen from a political economy perspective. Policy instruments under planning, though designed as promotional measures, bred proliferating rent-seeking activities. The initial controls were the product of ideas and ideology, but they later created the interests that stalled a shift in strategy, even when ideas and ideology changed. As Jagdish Bhagwati (1988) argued, the regime of controls yielded a society with entrepreneurs enjoying squatters' rights, "which created a business class that wanted liberalization in the sense of less hassle, not genuine competition. The bureaucrats, however idealistic at the outset, could not have noticed that this regime gave them the enormous power that the ability to confer rents generate. The politics of corruption also followed as politicians became addicted to the use of licensing to generate illegal funds for election. The iron triangle of businessmen, bureaucrats and politicians was born around the regime that economists and like-minded ideologues had unwittingly espoused."

The condition for such an "iron triangle" was made possible by the existence of a proprietary coalition of the industrial-capitalist class, white-collar bureaucrats, and rich farmers, all of whom belonged to the top percentile of the population, as propounded by Pranab Bardhan (1984). There have been continuing conflicts among these proprietary classes—conflict between urban industrial and professional classes and rural classes of rich farmers, between the professional class in the public sector and the other proprietary classes in industry and trade, and so on. The consequences of these conflicts were seen in the deceleration of public investment and the decline in the productivity of capital, which largely accounted for the slowdown of economic growth. The resources raised were frittered away through the competing demands of these various classes, entailing uncontrollable expansion of the government's nonproductive current expenditure.

In the name of social welfare, the proprietary groups created a regime that protected the administrative power of a literati bureaucratic power group, the business class, which easily manipulated its way through the maze of regulatory controls, being insulated from foreign and domestic competition, and the rich farmers who benefited from massive subsidies. This configuration of power derived legitimacy from the populist rhetoric of national self-reliance, the role of the benign state in providing distributive justice, and the need for protection from the greed of the unbridled private sector. In such a conjuncture, the economy that evolved only culminated in waste of resources, not to speak of lack of economic growth and poverty alleviation. The answer to the intriguing question of why the proprietary classes could exploit the state machinery with impunity for their parochial interests could be sought in the role of the prevailing political system in economic decision making. The weaknesses of the ineffective economic policy had its genesis in the inner workings of the political system, which operated in such a manner that, at one extreme, economic policy had punishment as its basis, but without any sanctions for enforcing it, and at the other, incentive as its basis but without any built-in mechanism to reward success. The omnipresent physical and price controls and licensing procedures, though motivated by the desire to punish the defaulters, left enough loopholes to render them ineffective. The announcement of penalties was more often than not in a nature of a quietus to hold in check the restiveness of the electorate. The reason for this opportunistic nature of economic policy lay in the concentration of political power at the center and the dominant role of the state in decision making.

The economic reforms unleashed in 1991 transformed the Indian political landscape and consequently the framework of economic policy making. Through liberalization, the iron grip of the state on the economy was loosened, and this process was strengthened by changes in center-state relations induced partly by the economic reforms but more importantly by the eclipse of the dominant one-party rule at the center and its substitution by a coalition of different political parties. The economic policy making therefore tended to become less dependant on the arbitrary decisions of the bureaucracy and vested interests of all hues and was governed more by the impersonal judgments of the market.

Deena Khatkhate

See alsoFiscal System and Policy since 1952 ; Industrial Growth and Diversification ; Monetary Policy from 1952 to 1991 ; Private Industrial Sector, Role of


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Economic Policy under Planning, Aspects of

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