Managerial Economics by Srinivas R. Rao - HTML preview

CHAPTER V

Lesson XIV Economic Environment And Transition In Indian Economy

• Economic growth and development
• Sources of economic growth and development
• Pre and post transition
• Liberalization
• Privatization
• Globalization
• Review questions

Introduction

Economic growth is the foremost objective of macroeconomic policies. Higher the economic growth higher the national income which will help solve problems of poverty, unemployment, inflation, and international trade of a country.

Growth rate =

Y = real income (NNP at factor cost)

P = population

Economic growth implies more output and economic development implies both increase in output and changes in the technology and institutional arrangement by which it is produced. Input efficiency leads to growth, allocation of input by sector leads to development. Economic development is the outcome of conscious and deliberate efforts involved in planning. Economic growth signifies the progress of an economy under the stimulus of certain favorable circumstances.

Sources Of Economic Growth And Development: Economic Factors:

1. Natural resources: Without natural resources it is difficult to achieve economic development. It highly depends on factor endowment.
2. Human Resource and population growth: Labour is the most active factor of production. Therefore sufficient number of quality labour force is essential.
3. Capital formation and accumulation: Economic growth is a function of capital formation of a country. Without capital mobilization it is impossible to develop the economy.
4. Technological progress: Advancement of technology is a key factor for development and it helps to utilize resources in an effective manner.
5. Entrepreneurship: Without strong risk taking entrepreneurs an industry cannot innovate and introduce new products to the society.
6. Investment criteria: The investment policy and regulation of a country improves the investment and in turn helps the economy to grow at a faster rate.
7. Removal of market imperfection: To develop a countries economy removal of imperfect market and reducing monopoly market are essential.
8. Capital output ratio: High capital output ratio indicates the increase in productivity of capital invested.

Non Economic Factors:

1. Desire for development: Desire to grow in the right direction is important for the economic development of a country.
2. Widespread education: The growth in the educational sector will help the society to grow at a faster rate.
3. Social and industrial reforms: Liberal social system, and reduced disparity helps the economy to grow.
4. Good government: Establishment of consistent law and order is essential to grow internationally.

Pre Requisites Of Economic Growth:

1. Population growth
2. Removal of monopoly
3. Optimum utilization of resources
4. Development planning and
5. Financial stability

Meier and Baldwin have listed the following areas as important for government action

1. Government may establish markets
2. Government may establish enterprises at high risk and low profit .
3. Government direction is needed to promote external economies for balanced growth.

The Government of India set up the Central Statistical Organization (CSO) to monitor the economic growth and expenditure of various goods and services. The available data from CSO provides the valuable information on the ongoing economic transition in India.

Table – Government Outlay (1950 – 2011)

Pre Transition:

The economic scenario provided before the adoption of the New Economic Policy were,

1. Highly autarkic economy: India was experiencing autarky and closed economic system.
2. Centralized planning: All economic plans were centralized and controlled at the centre.
3. Protectionist trade policies: Trade policy was closed and not opened to the world. I.e. it was following a protectionist trade policy.
4. High tariffs and non tariff barriers: India had high level of tariff and non tariff trade barriers
5. Capital controls: The capital market was controlled by the government of India.
6. Import substitution: Our country had been adopting import restrictions with large import substitutions.
7. State owned public sector industries: Most of the industries were owned by the central or state government before economic reforms.
8. State controlled financial sector: The financial sector was controlled and monitored by the government.
9. Import Restrictions: Reservation policies like quota system were followed for imports.
10. Regulated markets: Market for all commodities was regulated by the government.
11. Administrative prices: Market price was regulated with the help of price ceiling and by adopting dual pricing policy.

Post Transition:

The economic scenario prevailing as on date i.e. after the adoption of the New Economic Policy in India after 1991 are:

1. Deregulation and liberalization of the Industries
2. Lowering of the tariffs and easing of import licensing requirements.
3. Export incentives were provided to the exporters to promote exports.
4. Special Economic Zones were established to promote exports and encourage exports.
5. Single window licensing policy.
6. Declining incidence of poverty.
7. Divestment of public sector units.
8. Liberalization of the banking and financial sectors.
9. Promotion of Foreign Direct Investments.
10. Tax incentives for capital investment in domestic and foreign markets
11. Managed exchange rate in the place of controlled exchange rate.
12. Portfolio investment strengthened.

Barriers To The Faster Economic Growth:

1. Low productivity levels: The economy was opened up but the productivity level was low to compete in the market.
2. Infrastructure deficiencies: Infrastructure facilities of our country have not fully improved to meet the targeted economic growth.
3. Rising public sector debts: The government borrowings and accumulated debt were high.
4. High subsidies fostering inefficiency: Government provided more subsidies which in turn increased the inefficiency of the organizations.
5. Low literacy levels: The literacy rates have not increased at a faster rate to compete in the open economy.
6. Demographic deficiencies: The demographic deficiencies, did not support the transitional policies of our country.
7. Rigid labour laws: The labour laws were not favorable to bring in more Human Resource 8. Functioning of judicial system: Our legal environment also has not been supportive towards the liberalization of the country.
8. Campaigns against cultural consumerism: Due to transition the consumer behaviour of the society has changed and hence we are able to see the cultural commonality, and also campaigns against the cultural consumerism.
9. Corruption: Along with economic changes corruption has been pervasive at all levels and has increased.

Growth Potentials Of The Indian Economy Especially After Transition:

1. Large potential markets: Both urban and rural markets of India are growing at a faster rate.

2. Booming IT and Biotech sectors: India occupies a leading position in the world in these sectors.

3. Highly professional and scientific manpower: India is having the third largest technically qualified man Power.

4. Trend towards political decentralization: Now the trend has started towards decentralization.

5. Dominant player in south Asian region in certain areas of economic activity.

6. Competitive Environment has already set in almost all spheres of life.

Inspite of all the above stated barriers India has great potential to grow in the future. The major reasons for the growth of the economy are liberalization of our economy followed by privatization and globalization.

Liberalisation, Privatisation And Globalisation (LPG)

Need For Liberalization:

India has vast natural resources and abundant manpower but our contribution in the world trade is less than 1%. India has low Per capita income and Net National product. To improve the same, liberalization has been recommended. Under the direction of the former Prime Minister P.V. Narashima Rao the economic reform process was resorted to improve the position of the Indian economy in the world and to solve the problems of trade deficit.

Path To Liberalization:

The Government has to release the economy from the restrictive rules and regulations followed earlier. It was appropriate on the part of the government of India to implement globalization strategy to pave the way for economic liberalization.

The Liberalization, Privatization and Globalization (LPG) model was developed in 1991 by the then finance minister Dr. Manmohan singh under the direction of the Prime Minister Shri.P.V.Naraimha Rao . Structural changes in the Indian economy were :

1. End of the private sector: The government decided to transfer the loss making public sector units to the private, but there were no takers, therefore the government went for disinvestment of the public enterprises including profit making units.
2. Government permitted private sector to set up individual units without license.
3. The investment ceiling was lifted and hence the private investment could go up to any level.
4. The Government approved up to 51% FDI. No permission was required for hiring foreign technicians and technology.
5. Rehabilitation schemes to reconstruct the sick public sector enterprises. (board for industrial and financial reconstruction) BIFR was established.
6. Greater autonomy was given to manage Public sector units.
7. Economy was opened to other countries to encourage exports.

Therefore it encouraged private participation and expected the rise in exports from India.

Reasons For Implementing The Policy Of Liberalization, Privatization And Globalization:

1. Excess consumption and expenditure over revenue have been experienced resulting in heavy government borrowings.
2. Growing inefficiency in the use of resources.
3. Mismanagement of firms and the economy.
4. Losses of public sector enterprises.
5. Various distortions like poor technological development, shortage of foreign exchange, borrowing, mismanagement of foreign exchange reserves etc., have distorted the Economic growth.
6. Low foreign exchange reserves.
7. Burden of national debt and
8. Inflationary pressure on the economy.

Weakness Of LPG Model:

The major weaknesses of India’s LPG model were:

1. Narrow focus
2. Free entry of MNCs
3. Agricultural sector was bypassed
4. Facilitated more imports
5. Capital intensive development

Liberalization:

Relaxation of government restriction in social and economic policies was called as liberalization. Trade liberalization means removing the tariff restriction on the flow of goods and services between countries. Liberalization is a pre requisite for privatization. Capital market should be developed to absorb the changes. In India the people were allowed to start their business without getting license except in limited fields. Due to this, a number of firms have been started domestically which increased the production and expanded the market.

Privatization:

Privatization means transfer of assets or service functions from public to private ownership through franchising, leasing, contracting and divesture. Disinvestment means disposal of public sector units, equity to the private sectors. Privatization helps the public sector to modernize, diversify and make their business more competitive. It increases managerial efficiency of the organization and revives sick units. But it may result in income inequality, causing difficulty in maintaining social justice and public welfare.

Privatization means sale of nationalized industrial units to the private sector and transferring the revenue available from the public sector to the private sector by adopting any one of the following methods.

1. Sale of part of nationalized industries to the private
2. Sale of individual assets of Government bodies to the private
3.  Creation of competitive spirit of the private sector to the state enterprises.

Arguments In Favor Of Privatization:

1. Cost: Private sector has productive efficiency therefore their cost of production have been less than the cost of the goods produced in the public enterprises.
2. Choice and quality: Private sector spends more on R&D and they can produce more variety with better quality and offer more  choice to the customers, due to their allocative efficiency.
3. Innovation: Private sectors have efficiency in innovating new models.
4. The Invisible hand of the market: Free market forces will ensure the optimal allocation of resources.
5. Wider share of ownership: The ownership of the business is well spread throughout the country and not held in one or in a few hands.
6. Reduction in public borrowing and state spending: Privatization reduces the government borrowings and spending.

Problems Of Privatization

Privatization created more monopoly in the market and inequality in pricing which had led to negative externalities. Only through creation of competition and with regulatory measures we can control and minimize the problems of privatization in the economy.

Why should government own and run firms?

Lower cost: Public sector organizations were productively efficient and have economies of scale.

Better management: Government organizations have better management system than private.

Control of monopolies: Public sector enterprises will reduce and control the monopoly market.

Maximum benefit: Government provides maximum of net social benefits and not profit.

Greater control of the economy: Public sector can control the economy to a greater extent.

Fair distribution of resources: The available resources are allocated in an effective manner.

Apart from the above mentioned reasons Public sector is more efficient than private organizations. Private enterprises exploit workers and consumers more than the public sector enterprises. Profit is not the sole motive for public sector enterprises.

Globalization

Globalization means integrating the domestic economy with the world economy, moving towards a new world economic order which leads to integrated financial markets and trade. Globalization improves the effective allocation of resources and expenditure of a country along with economic growth. Globalization has helped developed countries more than the developing countries. Globalization has completely transformed the way Indian business used to operate.

Globalization is a process of integration of the world into one market by removal of all the political, geographical trade and business barriers among nations. Indian businesses should formulate the following strategies to overcome the challenges posed by globalization.

1. Behavioral strategy: continuous up gradation of skills, knowledge and technology of Human Resource is important for empowerment. Efforts should be made to develop a comprehensive version of managerial strategy which helps to improve the decision making skills and problem solving skills of the managers.
2. Operational strategy: producing quality products and maintaining the international quality is essential in the globalised market. Organizations must use various methods like TQM, JIT, Kaizen and others to improve the operational efficiency. Therefore organizations should plan a gradual transition in technological up gradation.
3. Marketing strategy: to maximize customer satisfaction, to render better services, and to introduce e-marketing, net marketing etc., Various marketing strategies should be followed to improve retail environment.
4. Investment for growing FDI: Due consideration should be given to the exchange rate, other risks like political risk and economic risk.
5. Governance: the business situation changed dramatically over the last few years. Quality is important for sustainable development in this competitive environment. Business opportunities are more with tough competition. Therefore good governance will maximize the value of shareholders wealth.
6. Risk management strategy: international business is complex in nature and it leads to various types of risks. Which can be managed by insurance, letter of credit, joint ventures, but the top management should consider broader business strategies to define and overcome these risks.

Effects Of Globalization On Indian Economy

1. India’s share in the world export have increased from .53% (1950) to 1 % (2005)
2. Foreign exchange reserves had increased to $180billion (2007)
3. Export growth has increased to a maximum of 20 percent per annum.
4. Current account deficit of 3% has reduced to 1.1%.
5. Reduction in external debt crisis from 8 billion in 1990 to $3billion in 2006

Benefits to consumers: Consumers were able to get large variety of goods with improved quality at a reasonable price.

Globalizing - World Evidence:

1. Expanding Trade
2. Increasing capital flow
3. Rising tourism and migration
4. Linking of farthest corners of the world by new technology.

Forces Of Globalization:

1. Revolutionary changes have taken place in the field of Information technology.
2. Advancement in travel and transportation
3. Liberalization of trade regimes
4. Emergence of trading blocs

Upshot Of Globalization:

1. Unprecedented economic growth
2. Multi-locational manufacturing
3. Surge in international trade
4. Explosive growth in capital movements
5. Increase in labour movement
6. Emergence of cultural commonalities

The Way Forward:

1. Build on your strength
2. Develop a global force
3. Achieve excellence in areas of one’s comparative advantage
4. Build up an effective regulatory system
5. Develop a good social security network

Thus we can conclude by saying that globalization is progressing well world over, whether we like it or not it is bringing together different nations as one. We can see the evidence in the Indian economy. Government of India has also taken many steps towards globalization which has its own merits and demerits. It is evident that India has potential to face the situation. This is the macroeconomic environment prevailing in India as well as in other parts of the world.

Review Questions:

1. Distinguish between economic growth and economic development.
2. List out the sources of economic growth and development of India.
3. Describe the pre and post economic scenario of India.
4. What are the major barriers to our economic transition?
5. Discuss the growth potential of the Indian economy after transition.
6. Justify the need for Liberalization, Privatization and Globalization of our country.
7. What are the major weaknesses of LPG?
8. Why government should own and run firms?
9. Define privatization. What are the advantages and disadvantages of privatization of public enterprise in India?
10. Discuss the effects of globalization on consumers, business and economy.

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