UNIT 1 ECONOMIC POLICY: AN

INTRODUCTION
Structure
1.0 Objectives
1.1 Introduction
1.2 Need for Economic Policy in India
1.3 Aims of Economic Policy in India
1.4 Instruments of Economic Policy in India
1.5 Process of Economic Policy Formulation
1.5.1 Planning Commission of India
1.5.2 Central Statistical Organisation
1.5.3 ICSSR
1.5.4 Lobbyists
1.5.5 NGOs
1.5.6 International Politics and Multilateral Lending
1.6 Disappointing Outcomes
1.7 Let Us Sum Up
1.8 Exercises
1.9 Some Useful Books
1.10 Answers or Hints to Check Your Progress Exercises

1.0 OBJECTIVES
After going through this unit, you shall be able to:
• state the need and objectives of economic policy;
• explain the various instruments of economic policy;
• examine the dynamics of formulation of economic policies in India; and
• identify the causes of failures of economic policies in India.

1.1 INTRODUCTION
Economic policies are statements of aims and ideals to be achieved through
various instruments outlined by the Government to guide the process of
economic development. In a way, it can be termed as a structural response to
correct economic imbalances (and inequality). Government, by manipulating
economic and social variables, influences the process of resource allocation to
achieve desired level of economic development with social justice and
stability. An economic policy essentially relates to either or all of the three
basic economic decisions viz., ‘what to produce’, ‘how to produce’ and ‘for
whom to produce’ at macro level.
Generally, it is believed that economic policy-makers are guided by economic
considerations supported by economic theories in framing various subsets of
economic policies. However, in the democratic countries like India, the
decisions about public policy in general and economic policy in particular are
taken by the elected representatives at different levels. Hence, these are
essentially political decisions. Apart from legislators, different shades of
public opinion, through mass-media, bureaucracy, judiciary, trade 5
Framework of Indian organisations, experts’ bodies, voluntary organisations (NGOs), and other
Economy
interest groups exert ‘pulls and pressure’ to influence the process of economic
policies formulation. Hence, comprehension of the interaction between
politics and economics can help us to gain insight into the key questions of
‘making, implementation and failure’ of economic policies and programmes.
This unit aims to introduce you to economic policy formulation process
wherein apart from interaction between economists and politicians, a large
number of institutions/organisations influence the policy formulation process.
To begin with, let us discuss the need and importance of economic policy and
its various instruments.

1.2 NEED FOR ECONOMIC POLICY IN INDIA

Why do we need economic policies (outlined by governments)? Seemingly
naive but it is an important question. The answer to this question leads us to
the most exciting and ceaseless ideological debate in Economics and is
beyond the scope of this unit. However, a brief discussion on this topic will
help you to develop a perspective about economic policies and plans of the
Government of India.
Market system is an institutional arrangement that has persisted and evolved
over the past few hundred years because it has contributed greatly to our
economic well-being. It is not perfect, however, and in some situations, our
economic well-being can be raised by regulating it or even by side-stepping it
altogether. Failure of market is the most important reason behind ‘making of’
an economic policy.
Economic literature says that competitive markets generate a Pareto optimal
solution and an economy that reaches a Pareto optimal solution is commonly
said to be efficient. Pareto optimal solution is based on certain assumptions.
You might have learnt about these assumptions in Unit 14 of MEC-001
course. If one or more of these assumptions does not hold good, the market
system does not give rise to an efficient outcome. These inefficient outcomes
are called ‘market failures’.
Choices through time, under-provision of public goods, presence of
externalities, existence of common property resources, imperfect competition,
asymmetric information, etc., are some of the well-documented reasons for
‘market failures’. These need some sort of Government intervention in the
form of ‘economic policies and programmes’. Further, even if under Pareto
optimal solution resources are efficiently allocated, the distribution may not
be ‘equitable one’. State through participation in the production activities can
give a direction to the resource allocation in more efficient manner in the
larger public interest. It can directly own and manage various public utility
services (also called social consumption of public goods). Competition is
wasteful in such industries, and, hence, these can be best entrusted to the state.
The state itself can undertake the production and distribution of public goods
meant by collective consumption. Production of public goods is necessary not
only for itself but also for generating new opportunities to secure the goal of
full employment. The state may engage itself in production of such services
that are beneficial but which do not attract private enterprise either because
they are too risky or because the rate of return on capital employed is too low.
There are certain goods of strategic importance that cannot be left in the hands
of the state. The state can also act as a countervailing power to private
monopolies. The state may: (i) prevent consumption of noxious products, and
(ii) protect the consumers against fraudulent practices.
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Further, if certain well-specified conditions are met, the Government can shift Economic Policy: An
Introduction
the economy from one Pareto optimal solution to another by redistributing
purchasing power and then allowing people to trade in competitive markets.
The need for ‘redistribution that takes the economy to any desired Pareto
optimal solution’ underlines the need of economic policy.
Moreover, India at the time of independence was socially and economically
backward. In order to solve these problems, the framers of the Constitution
provided certain Directive Principles. Under ‘directive principles’, it is the
duty of the state to ensure to all its citizens the right to an adequate means of
livelihood; to ensure a fair distribution of the material resources of the country
for the common good; and to distribute the wealth in such a way that the
wealth is not concentrated in the hands of a few people.
All such constitutional obligations can be fulfilled by a sound economic
policy.

1.3 AIMS OF ECONOMIC POLICY IN INDIA

The principal goal of economic policy in a developing country like India is to
accelerate the process of economic development and thereby ensuring swift
economic development. It is worth to mention here that the concept of
economic development is distinct from the concept of economic growth as
traditionally defined. You will find details on this issue in Unit 3. The goals of
economic development are listed below:
1) Rapid Economic Growth: In a developing economy, the principal goal of
economic policy is to ensure rapid economic growth. Growth, i.e.
increased output of goods and services, helps to build up backward and
forward linkages that are so essential to ensure trickle-down and other
spread effects.
2) Full Employment: Linked to the growth objective is the goal of full
employment, i.e., to find productive use for all available resources in the
economy. The economic gains from full employment are enormous. Full
employment yields the individual security, which, in turn, promotes
progress, contributes to human dignity and weakens non-functional
discrimination.
3) Better Distribution of Income: Market mechanism left to itself promotes
inequalities in the distribution of income and wealth. Inequalities lead to
misallocation and misutilisation of resources. They lead to a serious
breach of social welfare. Economic policy can be so designed as to
achieve a somewhat better distribution of income and wealth.
4) Human Development and Decent Work: Human development as an
indicator of improvement in the quality of life is considered an important
objective of economic development. Several factors like education and
illiteracy rate, life expectancy, the level of nutrition, consumption of
energy per head etc. are involved in the measurement of such qualities.
With the growing concern of human development, decent work has
emerged another goal of economic development. There are four
dimensions of decent work: work and employment itself, rights at work,
security, and representation and dialogue.
5) Stability of Prices and Rates of Foreign Exchange: Monetary instability
adversely affects both the growth process and the welfare. Fluctuations in
the rate of foreign exchange affect international trade and introduce an
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Framework of Indian element of uncertainty into the economic life of the country. Economic
Economy
policy is a powerful instrument to ensure stability.
6) Maintenance of Fair Competition: Competitive conditions are essential
for welfare maximisation. These can be ensured by an effective
antimonopoly policy.
7) Avoidance of Cyclical Fluctuations: An essential feature of free market
economies is what we call business cycles or trade cycles. These refer to
regular cyclical fluctuations in economic activity with attendent
consequences. An important goal before economic policy is to rid the
economy of these ups-and-downs.
Having discussed the major objectives of economic policy, let us know what
are the weapons available in the state’s armoury to address the targets, i.e., the
instruments of economic policy.
Check Your Progress 1
Note: i) Space is given below each question for your answer.
ii) Check your answer(s) with those given at the end of the unit.
1) What do you mean by the term ‘Economic Policy’?
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2) Why do we need state intervention in the economic affairs of a country?
Give two reasons in support of your answer.
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3) Why is ‘full employment’ included among the objectives of economic
policy?
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1.4 INSTRUMENTS OF ECONOMIC POLICY IN

INDIA
Though there is no theoretical framework about the necessary components of
an economic policy, based upon our historical experience, we can outline a
few of them.
Properly defined targets, explicitly outlined strategy to achieve those targets,
specific programmes for implementation and objective methods of evaluating
outcomes are some of the basic ingredients of a ‘sound economic policy’.
Further, a good backup of statistical data helps to generate alternate options, to
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set targets in quantitative term to determine the best course of action(s), i.e., Economic Policy: An
Introduction
strategy to achieve these targets. Many a time, it is observed that ‘failure to
achieve desired outcomes’ is due to errors on ‘estimation front’.
Good use of statistical techniques to analyse public policy problems and
policy options are quite imperative in a complex modern world. Some of the
techniques employed are use of simple and general linear regression
modeling, use of intercept-dummy variables and interaction variables, linear
probability model and the probit model of discrete choice, and simultaneous
equation models. You might have learnt all these techniques in MEC-003
course on ‘Quantitative Techniques’.
The instruments of economic policy vary between the types of economic
policies. Broadly speaking, we can distinguish between two types of economic
policies, viz., (i) macro-economic policies (or aggregative policies), and (ii)
micro-economic policies (or sectoral policies).
1) Macro-economic Policies are designed to address the big aggregative
macro variables, like national output, employment, general price level,
investment, saving, rate of exchange, etc.
2) Micro-economic Policies are sectoral policies and are designed to direct
and contribute to the growth in the individual sectors of the economy, like
agriculture, industry, services, etc.
1) Macro-economic Policies
It is in the macro-economic arena that the state finds its full flow. It
encompasses the whole spectrum of economic activity. The state has to
employ different weapons to achieve the targeted goals. Before we attempt to
prepare a brief catalogue of these weapons, we need to reiterate that these
different weapons cannot be seen in isolation; these have to be employed in an
integrated manner to achieve a balanced growth.
The principal instruments of macro-economic policy can be identified as
follows:
i) Fiscal Policy: The foremost among the instruments of macro-economic
policy is the fiscal policy, also called the budgetary policy. As the name
implies, the policy operates through the budgetary operations. A budget is
an annual financial statement of the Government’s transactions. Public
revenue and public expenditure form the core constituents of budget. The
principal sources of public revenue are taxes of different kinds. Besides,
governments can and do raise large sums of money by way of borrowings,
both internally and from external sources. On the expenditure side,
subsidies, economic and social sector, etc. constitute the principal heads.
Each of the items on the revenue side and the expenditure side has the
potential to affect the course of economic activity, both in aggregative
sense and in the sense of individual sectors.
ii) Monetary Policy: Monetary policy deals with the volume and price of
money in an economy. Volume of money refers to the amount of money in
circulation in the economy. While an inadequate quantity of money in an
economy may fail to provide the required liquidity for the growing volume
of transactions in the economy, and may, thus, adversely affect the process
of economic growth, an excessive supply of money, on the other hand,
may prove inflationary, and, hence, in turn, may adversely affect the
process of economic growth. Therefore, the state (or the monetary
authority, i.e., the Central Bank of the country) would have to exercise
9
Framework of Indian judicious control over the creation of money (both by the Central Bank
Economy
and Commercial Banks) in the economy.
Domestic price level also affects the external value of currency.
Fluctuations in the external value of currency, i.e., the rate of exchange,
may, in turn, have adverse effect on the domestic economic activity. This
becomes another important reason why too-little or too-much of money
cannot be created in an economy.
The total supply of money (along with its demand) also affects the rate of
interest, i.e., the price of money. Rate of interest, in turn, is an important
determinant of various macro variables, like consumption, saving and
investment.
iii) Commercial Policy: A third important component of macro-economic
policy is commercial policy. Commercial policy defines, broadly
speaking, the Government’s attitude towards the external sector of the
economy, i..e., policy towards investment by foreign capital in the host
country (both in the form of portfolio investment and direct investment),
policy towards inflows and outflows of foreign exchange, goods and
services. A state may opt for a total open-door policy; another extreme
could be when at every entry or exit, a call is to be made to the state. A
mild protection may be a middle way. Which of the policies, absolute free
trade or protection, or mild protection comes to be selected is determined
by obtaining economic environment, both domestic and international.
2) Micro-economic Policies
The state need not be content with restricting itself to broad macro-economic
aggregates. The state can and does define its attitude towards activity in
different individual sectors of the economy, like agriculture, industry, and
services of different types. The state may permit and promote certain lines of
activity in agriculture, industry and services. On the contrary, the state may
prohibit and discourage certain lines of action. The different instruments of
micro-economic policies may be identified as: (i) industrial licensing, (ii)
quota-permit system, (iii) import control, (iv) export control, (v) competition
or anti-monopoly policy, (vi) procurement policy, (vii) policy of minimum
support prices, (viii) policy of buffer stocks, etc. These are only a few
illustrations of micro-economic policy, by way of examples.

1.5 PROCESS OF ECONOMIC POLICY

FORMULATION
As hinted in section 1.1 above, the process of formulation of economic policy
in India involves people of different inclination and interest. Legislatures as
political institutions are primarily responsible for policy-making. Policy-
makers in a democracy like India are accountable to the electorate either by
direct election or by appointment by elected officials. Thus, in the Indian
context, the political decision-making is supreme. However, the political
parties and the members of Parliament have little professional and research
support to articulate alternative (public) choices.
Normally, the Government picks up a clue (or a problem) from public domain,
constitutes a committee or a task-force to generate policy options, makes
‘necessary political changes’ in those recommendations, and, then, announces
its decision at appropriate forums either in the form of an executive order or a
legislative resolution.
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The character of political system plays a crucial role in identifying and Economic Policy: An
Introduction
prioritising problems. As we observe, democracy in India has evolved from a
formal democratic system of 1950s to more meaningful and participative
democracy after 1990s. This led to an environment of ‘more consultative and
responsive’ process of policy formulation. It is being reflected in changing
‘policy rhetoric’. Nowadays, no political party talks of setting up of ‘big
Public Sector Enterprises’. Instead they are speaking about creating ‘village
business hubs’.
Further, role of mass-media and non-governmental organisations advocating
new policy options got acceptance in policy-making process. Creation of
National Advisory Council (NAC) consisting of non-governmental activists
and headed by chairperson of the ruling coalition is one such example of
widening of consultative process.
Notwithstanding the fact that formulation of economic policies is a political
process, economists and experts play very important role in the deliberative
processes. They are incorporated in Government institutions to make an
ongoing consultation possible. They generate policy options based on ‘rational
economic and technocratic criterion’. We have in India a large set of
technical, scientific, development organisations/institutions to provide for an
institutional forum for expert advice. The task of detailing the policy
documents still lies with the bodies consisting of specialists and bureaucrats
within administration. Some of such bodies/agencies involved in preparation
of policy documents for consultation are as follows:
1.5.1 Planning Commission of India
Planning commission is one such organisation. The Planning Commission was
set up by a resolution of the Government of India in March 1950 in pursuance
of declared objectives of the Government to promote a rapid rise in the
standard of living of the people by efficient exploitation of the resources of
the country, increasing production and offering opportunities to all for
employment in the service of the community. The Planning Commission was
charged with the responsibility of making assessment of all resources of the
country, augmenting deficient resources, formulating plans for the most
effective and balanced utilisation of resources and determining priorities.
1.5.2 Central Statistical Organisation
The Central Statistical Organisation is responsible for coordination of
statistical activities in the country, and evolving and maintaining statistical
standards. Its activities include National Income Accounting; conduct of
Annual Survey of Industries, Economic Censuses and its follow up surveys,
compilation of Index of Industrial Production, as well as Consumer Price
Indices for Urban Non-Manual Employees, Human Development Statistics,
Gender Statistics, imparting training in Official Statistics, Five Year Plan
work relating to Development of Statistics in the States and Union Territories;
dissemination of statistical information, work relating to trade, energy,
construction, and environment statistics, revision of National Industrial
Classification, etc. It has a well-equipped Graphical Unit. The CSO is headed
by the Director-General who is assisted by 2 Additional Director-Generals and
4 Deputy Director-Generals, Directors & Joint Directors and other supporting
staff. The CSO is located in Delhi. Some portion of Industrial Statistics work
pertaining to Annual Survey of industries is carried out in Calcutta.

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Framework of Indian
Economy
1.5.3 Indian Council of Social Science Research (ICSSR)
ICSSR was established in the year 1969 by the Government of India to
promote research in social sciences in the country. The Council was meant,
inter-alia, to advise the Government of India on all matters pertaining to social
science (including economics) research as may be referred to it from time to
time; and take such measures generally as may be necessary from time to time
to promote social science research and its utilisation.
The Indian Council of Social Science Research (ICSSR) with 27 research
institutes is established to provide regional orientation to research that can be
used for policy purposes. All these institutes receive state grants and,
therefore, act according to the requirements of the pay-master.
Subsequently, few private funded research organisations have come up, viz.,
National Institute of Public Finance and Policy, Centre for Science and
Environment, Tata Energy Research Institute, Tata Institute of Social
Sciences, etc. Apart from conducting research, these institutes play an
important advocacy role by publicising their studies in the media and holding
seminars for the relevant policy-makers. Time to time, the Government also
constitutes committees and task forces in which social and other scientists
play major roles.

1.5.4 Lobbyists
There are other forms of organised advocacy by private interests in the
formulation and implementation of public policy. Organised labour (Trade
Unions) and their counterparts Trade Associations (FICCI, ASSOCHAM, CII)
also influence the policy process through representation and collective actions.
These private organised interest groups are normally well-connected to
different political parties as latter depend upon their support for funds and
workers during elections. The cost of elections has become almost obscene,
requiring candidates to raise hundreds of thousands of rupees just to seek a
legislative seat. The only ready source for such huge sums of money is
‘special interests’. They, of course, have a very direct stake in economic
policies.
1.5.5 Non-governmental Organisations (NGOs)
Recently, with the adoption of economic reform policies in 1991, there has
been explicit recognition of the role of markets and non-governmental
organisations (NGOs). In fact, the Eighth Plan made a strong plea for greater
role of the voluntary organisations. This resulted into mushrooming of non-
governmental organisations, popularly known as NGOs. Most of these NGOs
are registered under the Societies Registration Act, which gives them legal
recognition to raise funds from Government and non-government sources. The
numbers of such NGOs run into thousands. They also try to influence policy
using their micro-level experience as a basis of suggestions for policy options.
1.5.6 International Politics and Multilateral Lending
In the guise of guidance based upon ‘cross-country experiences’ the external
forces also influence the policy formulation in India. We have observed
‘socialistic’ influences during 1950s; and have been feeling ‘pressure for
privatisation and liberalisation’ since 1990s. There has been constant pressure
of developed countries to open up fast growing Indian economy for
multinational corporations. The subsequent shift in ‘policy framework’ in
recent years may be viewed in this perspective.
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Anyway, on the record, it is the departments and ministries of Government of Economic Policy: An
Introduction
India headed by political functionaries (ministers) who supervise the making
of economic policies in their respective domains. Normally, these policies are
announced with approval of the Union Cabinet. Occasionally, these policy
statements are approved by the Parliament in the form of Resolutions/Acts.

1.6 DISAPPOINTING OUTCOMES

With above discussion, you must have got a fair understanding about the
process of policy formulation. You should also have an idea about the process
of implementation, as it is equally important for the purpose of ‘evaluating
outcomes’.

We have democracy in India. The economic policies of local and national

governments (and parties) set the direction and parameters for the formulation
of laws, governmental programmes and budgets. After the policy is finalised
and programmes are launched, the role of bureaucracy i.e., the implementing
agency becomes important. The task of implementation of Government’s
economic policies and programmes is delegated to the bureaucracy. The
bureaucracy (agent) is the instrument for implementing the policy laid down
by the political leadership (principal). Bureaucracies are necessary for policies
to be carried out with some predictability, equity, and due process.

The Government could seldom meet the policy targets in the past. Earlier, we
have argued that the way to rein in “market failures” is to introduce
Government intervention, i.e., policies and programmes. But we have
experienced that there also is such a thing as “Government failure”.

The outcomes of policies enunciated by the Government were invariably

disappointing due to more than one reason. The failure is so widespread and
the success is so rare that pointing the finger at any single component is futile.

At formulation stage, the political interests get precedence over economic

reasoning. The policy-makers might settle for or even prefer deliberate
vagueness as a momentary expedient to finalise a plan (or programme), thus,
authorising a policy which often proves unworkable, unsatisfactory, or even
contradictory to other policies. The failure to articulate precise and operational
goals, objectives, procedures, and plans leaves enough scope for task
ambiguity for implementing agencies.

At times, it happens that the ‘policy-makers’ have poor information on the

effort the ‘bureaucracy’ is making. In other words, policy-makers have no
mechanism to monitor performance of ‘implementing agency’. The
bureaucracy may, then, be tempted to shirk. You will find more details about
the issue in Unit 21 and 22.

The policy-makers, including economists, do not have time to seek access to

information about the performance or suitability of implementing ‘agents’.
This may result into under-achievement of the policy goals.

Another hurdle encountered is the large structure of bureaucracy. In a federal

structure, there is enough scope for buck passing. Moreover, within
administration, there is no proper system of ‘reward for extra efforts and/or
penalty for non-performance’.

13
Framework of Indian Multiplicity of similar type of schemes is another important reason
Economy
responsible for failure of schemes. Due to lack of inter-ministry or Centre-
State co-ordination, similar kind of ‘benefits’ compete to reach to same
segment of ‘beneficiaries’. Success of one programme leads other
programmes to failure.

For successful undiluted outcomes of economic policies in India, the policy-

makers, particularly economists, shall have to prepare policy by taking into
account all the above mentioned ‘influences’ so that immediate benefits from
deviating becomes negligible. The policy-makers have to develop tools and
technique to check ‘performance and suitability of implementing agencies.’ In
other words, policies and programmes should be outlined in such a manner
that ‘deviations’ are easily and instantly observed. Moreover, economists have
to devise ways to enhance ‘technical expertise’ of politicians on economic
issues. In other words, process reform should go hand-in-hand with policy
reform.

Check Your Progress 2

Note: i) Space is given below each question for your answer.
ii) Check your answer(s) with those given at the end of the unit.
1) State the principal instruments of macro-economic policy.

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2) Do you think that economic policies are essentially political decisions?
Give two reasons in support of your answer.
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3) How is CSO useful in policy formulation process?

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4) State any two disappointing outcomes of Indian Economic Policy.
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 Economic Policy: An
1.7 LET US SUM UP Introduction

Economic policies are statements of aims and ideals to be achieved by various

instruments outlined by the Government. Due to several ‘market failures’,
state intervention manifested in the form of economic policies is needed.
Insuring swift economic development is the principal objective of economic
policy. Rapid economic growth, full employment, human development and
decent work, stability of prices and exchange rate, maintenance of fair
competition and avoidance of cyclical fluctuations constitute the important
objectives of economic policy. Broadly, economic policies can be classified
under two categories: (i) macro-economic policies, and (ii) micro-economic
(sectoral) policies.
Economic policies in India are political decisions. However, economists and
technocrats play major role in the process of formulation of economic policy.
Further, the policy-makers have to take into account opinions expressed by
mass-media, trade unions, trade associations and NGOs. Even international
politics and Multinational Corporations (MNCs) influence the process of
making of economic policy in developing countries including India.
Over the period, several indigenous institutions have come up to generate
macro level policy options. Most of them are funded and/or financially
supported by the Government. The task of implementation of economic
policies and programmes in India is delegated to bureaucracy.
There are many reasons for failure of economic policies and programmes in
India. Although, major responsibility for under achievement (or failures) lies
upon inflexible bureaucracy, a few of these reasons can be traced to flaws at
formulation stage.
By articulating precise workable goals, operational procedures and ‘inbuilt
mechanism for performance monitoring’, the policy-makers can improve the
chances of meeting the development goals.

1.8 EXERCISES
1) ‘Economic Policy in India is a purely political process’. Comment.
2) Examine how different shades of public opinion influence the process of
economic policy formulation. Give illustrations in support of your answer.
3) Discuss the various disappointing outcomes of the poor implementation of
economic policies.
4) Suggest some measures to improve implementation of economic policy
and programmes in India.

1.9 SOME USEFUL BOOKS

Buchanan, James M. and Tullock, Gordon (1962); The Calculus of Consent.
Dixit, A.K. (1996); The Making of Economic Policy, The MIT Press.
Gwartney, James D. and Stroup, Richard L. (1992); Economics: Private and
Public Choice, 6th ed. Especially chaps. 4, 30.
Leach, John (2004); A Course in Public Economics, Cambridge University
Press.
Samuelson, Paul and Nordhaus, William; Economics (latest edition).
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Framework of Indian
Economy 1.10 ANSWERS OR HINTS TO CHECK YOUR
PROGRESS EXERCISES
Check Your Progress 1
1) See Section 1.1
2) See Section 1.2
3) See Section 1.3
Check Your Progress 2
1) See Section 1.4
2) See Section 1.5
3) See Sub-section 1.5.2
4) See Section 1.6

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