BLOCK 1 : ECONOMIC DEVELOPMENT: CONCEPT AND

MEASUREMENT

The Economic system decides the development prospects of a country. There

are economic systems like capitalism, socialism and mixed economy prevailing
in different parts of the world. These economic systems are based on the
historical legacies of the country but objective of these systems is to attain
growth and development. It was increasingly being felt that majority of the
population in most of the developing world did not benefit much from the
growth process; therefore development is more comprehensive, which includes
promoting the standard of living and economic condition of a country. Such
efforts can involve development of human capital, critical infrastructure,
regional competitiveness, environmental sustainability, social inclusion, health,
safety, literacy, and other initiatives.

Economic development is a comprehensive term that generally refers to the

sustained, concerted endeavour of policymakers and community to promote the
standard of living and economic condition in a country. Economic development
can involve efforts in multiple areas such as development of human capital,
critical infrastructure, regional competitiveness, environmental sustainability,
social inclusion, health, safety, literacy, and other initiatives. It should be noted
that economic development is different from economic growth. Economic
development is a policy intervention endeavour which aims to increase
economic as well as social well-being of people. The Indian economy, like
every other economy, performs three vital functions, viz. production,
consumption and growth; it produces different types of goods and services; it
enables its people to buy and consume them. While USA, Sweden, West
Germany, Japan, etc. are developed economies with technologically advanced
agriculture, industry, transport and communication system, etc. the Indian
economy has been struggling to become a developed economy.
You will learn all these aspects of Indian Economy in detail in this course.

Unit 1: Economic Development: explains how an economy works. The

concept of economic development, difference between development and
underdevelopment, measurement of economic development and determinants of
economic development have been elaborated.

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Unit 2: Features of Indian Economy: An Emerging Economy: highlights
the success story of the Indian economy. India has emerged as the fastest
growing major economy in the world after economic reforms of 1991 and is
expected to be one of the top three economic powers in the world over the next
10-15 years. India is also backed by its robust democracy and strong
partnership. The institutional changes embarked after economic reforms have
been eloquently explained.

Unit 3: Growth: Pre and Post Reforms: explains the process of planning after
India achieved independence. A detailed account of each Five-Year Plan
starting from the first Five-Year Plan in 1951including its targets, achievements
and failures is given. An Assessment of Indian Economy before Economic
Reforms and post reforms has been presented.

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Unit -1: ECONOMIC DEVELOPMENT

Structure
1.0 Objectives
1.1 Introduction
1.2 How an Economy Works
1.2.1 Capitalism
1.2.2 Socialism
1.2.3 Mixed Economy
1.3 Concept of Economic Development
1.3.1 Development and Underdevelopment
1.3.2 A Developing Economy
1.3.3 Economic Growth
1.3.4 Big Push Approach
1.3.5 Poverty Trap
1.3.6 UN Development Decade
1.3.7 Sustainable Development
1.3.8 Millennium Development Goals (MDGs)
1.4 Measurement of Economic Development
1.4.1 GNP per capita
1.4.2 Population Growth
1.4.3 Occupational Structure of the Labour Force
1.4.4 Human Development Index
1.5 Determinants of economic development
1.5.1 Capital Formation
1.5.2 Capital Output Ratio
1.5.3 Natural Resources
1.5.4 Non- Economic Factors in Economic Development
1.5.5 Institutional factors affecting development
1.6 Role of Government in Development
1.7 Let us Sum Up
1.8 Key Words
1.9 Answers to Check Your Progress
1.10 Terminal Questions

1.0 OBJECTIVES
After going through this unit, you will be able to:
• Discuss the working of an Economy in different Economic Systems
• State the concepts of economic development, under development and
developing Economy
• Describe the various development related concepts
• Explain the determinants of economic development
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 • Discuss the Role of Government in Development
1.1 INTRODUCTION

The Economic system also decides the development prospects of a country.

There are economic systems like capitalism, socialism and mixed economy
prevailing in different parts of the world. These economic systems are based on
the historical legacies of the country but objective of these systems is to attain
growth and development. It was increasingly being felt that majority of the
population in most of the developing world did not benefit much from the
growth process; therefore development is more comprehensive, which includes
promoting the standard of living and economic condition of a country. Such
efforts can involve development of human capital, critical infrastructure,
regional competitiveness, environmental sustainability, social inclusion, health,
safety, literacy, and other initiatives.

1.2 HOW AN ECONOMY WORKS

The economic system and the historical context of a country also decide the
development prospects to a great extent. The policy of leissez faire (i.e. leave
free) was favoured by the classical economists. Capitalist system, centrally
planned economic system and mixed system with efficient market and rational
interventionist role of the state restrictive and liberalization policy are also
shaped in the process of evolution
Economic system of country provides its broadest process of working of major
economic activities. There are three kinds of economic systems.
• Capitalism
• Socialism
• Mixed Economy
1.2.1 Capitalism
In a capitalist economic system, activities of a business firm are market
determined. In a capitalist economy, neither an individual nor any institution
takes decisions in a centralised or planned manner concerning its day-to-day
functioning of economic activities. However, the people of capitalist countries
know that in spite of all this the producers generally produce those commodities
which are effectively demanded in the market. The producers also find it
necessary to demand services of factors of production like land, labour, capital
and organization. There is payment by producers for these services, which is in
the form of rent, wages, salaries, interest and profit. This is also known as
income in lieu of rendering services to the producer. It is only by spending this
income that the people can buy goods and services of their choice.

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In a free market economy, the invisible behaviour of the consumers and
producers based on their needs develop a system of price mechanism. This
system decides ‘What to produce’, ‘How to produce’ and ‘Whom to produce’.
This system not only solves the central problems of working of te economy but
also helps in reaching the state of equilibrium. This can be understood with the
help of the following Figure.

Individual preferences and Production Functions of

Disposable income (objective of Firms (objective – Profit

Separately Determine
determine
Supply
Schedule
Supply schedules
Of
Demand of product and
Schedules for demand
Products schedules for
and

Which all Together

Equilibrium values of
gives
Prices and Quantities

Figure 1- Working of the Price Mechanism

It is clear from the figure that the choice and preferences of the individuals for
consumption goods and their income which they wish to spend on buying these
will together determine the demand for various goods in the market. The
production function and the quantity and proportion in which labour, capital,
land and other factors are used in the productive process determine the supply
of the products in the market. It is these conditions of demand and supply in the
commodity market which determine the prices of all products which enter it.
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The other factors, such as wage, rate, rent, etc. are determined in more or less
the same manner.
In free market or in the capitalist countries, it is through the working of this
price mechanism that the free enterprise economy takes decisions regarding the
three central problems, viz. what to produce, how to produce and for whom to
produce in favour of maximum social welfare.
This price mechanism works efficiently under the conditions of perfectly
competitive market structure and equitable distribution of income and wealth.
But major challenge in most of the capitalist countries today is neither the
equitable distribution of income nor the perfect competition. Therefore, a
number of weaknesses can be noted in the way in which the price mechanism
regulates the economy. It is very often seen in capitalist countries that on the
one hand, there is scarcity of necessities like wheat and milk, while on the other
hand, liquor, motor car, television and other luxuries are freely available.
Moreover, whereas the children of the poor fail to get basic necessities like food
and clothing due to very low income, rich have all luxuries of life because of
high income.

1.2.2 Socialism
Socialism is an economic system where private sector does not have any kind of
control over price fixation by market forces. The production, distribution and
consumption resulting from all major economic activities are centralised. By
centralization means, it is controlled by the state or state-established agencies.
This kind of system is also known as command economy.
According to Paul M. Sweezy, “Socialism is a complete social system which
differs from capitalism not only in the absence of private ownership of the
means of production but also in its basic structure and mode of functioning.”
Market system or market determined prices have no role to play in the working
of a socialist economy. China and Russia are examples of Socialist Economy. In
these economies, generally the planning commission or central decision making
agencies, are required to solve the basic central problems, i.e. what to produce,
how to produce, and for whom to produce. In order to do this, the Planning
Commission or central agencies have to, on the one hand, make an estimate of
the available economic, human and natural resources at its command, while on
the other hand, it has to determine the requirements of the nation for various
goods and services. This process can also be termed as Command Economy.

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To put it more clearly, the Commission has to decide upon the various
commodities which the economy should produce with the available resources.
There can be many different ways of achieving the output targets. The Planning
Commission in a socialist country takes into consideration the social welfare
aspect and the development related goals of the nation while choosing the
technique of production to be used. In this system, disposable income of people
are given by state in an equitable way by taking into consideration the poorest
section of the society also. The price mechanism in a capitalist economy
operates in such a way that production takes place only to meet the demands of
all those people who have considerable amount of disposable income. Under
this system, not much attention is generally paid to the production of those
commodities which belong to the poor man’s basket. In a socialist economy,
however, income inequalities are drastically reduced so that everyone has an
adequate amount of disposable income. While determining the pattern and size
of the output, the Planning Commission has to see to it that its decisions in this
regard are such that they ensure the availability of commodities for all in the
market.
Economists view socialist planning as equivalent to planning for economic
development. Therefore, every economic plan of the nation which determines
its economy’s pace and pattern of development should necessarily incorporate
two elements: First, the way in which national income is to be distributed
between consumption and accumulation, and secondly, the manner in which
investment is to be allocated among the different sectors of the economy.

1.2.3 Mixed economy

A mixed economy represents a mixture of features of the two types of
economies, capitalism and socialism. Under this form of economic system, the
production is partly in the hands of private individuals and partly owned by the
State. The public authority usually owns public utility services like supply of
water and electricity, roadways and railways, shipping and air services. The
Government tries to remove disparities and inequalities in the income
distribution by various measures, such as taxes and their levies and through
public expenditure.
According to Samuelson, a mixed economy is characterized by the existence of
both public and private institutions exercising economic controls. In this
economy, price mechanism and partial planning both play an important role.

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Indian is perhaps the best example of such an economy and can legitimately be
called a mixed economy.
A mixed economy contains the good features of both socialism and capitalism.
Every possible effort is made to make the best possible use of available
economic resources. The price mechanism and the profit motive and all kinds
of freedoms result in the efficient allocation and utilisation of the available
resources. As a result, shortages and surpluses are easily avoided and business
fluctuations are eliminated.
Check Your Progress: A

1. Define public sector.

2. Write two characteristics of capitalism.
3. Write two characteristics of socialism.
4. Define the mixed economy.
5. State whether the following statements are True or False.
i) In a capitalist economic system, activities of a business firm are
market determined.
ii) Market system or market determined prices have no role to play in the
working of a socialist economy.
iii) In socialist system, workers are motivated to work hard.
iv) A mixed economy is characterized by the existence of both public and
private institutions exercising economic controls.
v) A mixed economy contains the good features of both socialism and
capitalism.

1.3 CONCEPT OF ECONOMIC DEVELOPMENT

Economic development is a comprehensive term that generally refers to the
sustained, concerted endeavour of policymakers and community to promote the
standard of living and economic condition in a country. Economic development
can involve efforts in multiple areas such as development of human capital,
critical infrastructure, regional competitiveness, environmental sustainability,
social inclusion, health, safety, literacy, and other initiatives. It should be noted
that economic development is different from economic growth. Economic

8
development is a policy intervention endeavour which aims to increase
economic as well as social well-being of people,
1.3.1 Development and Underdevelopment
The Indian economy, like every other economy, performs three vital functions,
viz. production, consumption and growth; it produces different types of goods
and services; it enables its people to buy and consume them. While USA,
Sweden, West Germany, Japan, etc. are developed economies with
technologically advanced agriculture, industry, transport and communication
system, etc. the Indian economy has been struggling to become a developed
economy.
Economists world over have indicated certain features of underdevelopment.
Economic development may be defined as the process by which a traditional
society employing primitive techniques and capable of sustaining only a low
level of income is transformed into a modern, high technology, high-income
economy. Such a developed economy uses capital, skilled labour and scientific
knowledge to produce wide variety of products for the market. Capital goods
and human capital and relevant scientific knowledge play a major role for the
development of an economy.
The underdeveloped countries face poverty, high and rising burden of
unemployment, growing disparities in income distribution, low and stagnant
agricultural productivity, sizeable gap between urban and rural levels of living,
lack of adequate education, health and housing facilities, dependence on foreign
and often inappropriate technologies and more or less stagnant occupational
structure. Some of the features of the underdeveloped economy are as follows:
1. Low Per Capita Income: Per capita income refers to the average income of
people of a country. It is calculated by dividing national income by total
population of the country. Per capita income is also often used to measure a
country's standard of living. You must be aware that the national income of an
under developed country is low and the population is high. As a result, the
under developed countries have low per capita income.

2. Inequitable Distribution of Income and Wealth: Disparity of incomes

among different population segments is known as disparities in income.
Growing inequality in the distribution of wealth and poverty has become a
major problem all-over the world. The inequality affects the economic
development of the under developed countries. Disparities in wealth is one of
the important reasons for inequitable distribution of income.

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3. Heavy Dependence on Agriculture: A large proportion of population is
dependent on agriculture in underdeveloped countries. The natural calamities
adversely affect the agriculture. As a result, the farmers get less output from
agriculture. These days, the contribution of agriculture to the GDP of under-
developed countries has been rapidly declining.

4. Heavy Population Pressure: Growth of population in underdeveloped

countries is very high as compared to the developed nations. The public
investments in education and health have been very meagre. Therefore, the
human resources of underdeveloped countries are not properly harnessed. The
majority population has to depend on informal employment.

5. Unemployment and Underemployment: A situation of unemployment

arises when the people seeking jobs do not find opportunities to work.
Underemployment is a condition in which people in a labour force are
employed on part-time or gig jobs or at jobs inadequate with respect to their
training/skills or economic needs. Many people in underdeveloped countries are
either unemployed or underemployed.

6. Capital Scarcity and Low Rate of Capital Formation: One of the

important problems of underdeveloped countries is scarcity of capital. Capital
formation refers to addition of capital goods, such as equipment, tools,
transportation assets, and electricity. Countries need capital goods to replace
the older ones that are used to produce goods and services. If a country cannot
replace capital goods due to lack of resources, the production starts declining.
Generally, the higher the capital formation of an economy, the faster an
economy can grow its aggregate income. Underdeveloped countries face the
problem of shortage of capital due to low levels of income of people and
savings.

7. Use of Primitive Technologies: Technological development is very low in

underdeveloped countries as compared to the developed countries. Most of the
technologies used in underdeveloped countries are outdated and primitive.
Therefore, the cost of production becomes very high. The products are not able
to compete in the international markets. The domestic industry may not be able
to compete with imported goods.

8. Disparities in Rural Urban Living Standards: There has been wide

variation between rural and urban people in the underdeveloped economy. The
disparities are measured in terms of income, consumption and other non-
monetary aspects of standard of life such as access to education, health,
transport, protected water, sanitation etc.

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9. Low Financial Inclusion Rate: The lower strata of the society, particularly
in rural areas is less financially inclusive in underdeveloped countries. Financial
inclusion means access of people to useful and affordable financial products,
such as banking services, insurance, etc. The less financial inclusion rate
reduces the number of opportunities for growth.
1.3.2 A Developing Economy
After Independence, the government took keen interest in the economy which
was given a big push through the sector enterprises in the core sectors. As a
result, per capita income has been rising, although not steadily. The dominance
of agriculture is gradually reducing; the secondary and tertiary sectors (services)
are slowly expanding. In the last seventy years, the Indian economy has
developed a large number of basic industries that produce capital equipment and
useful raw materials. India is now in a position to maintain the growth of most
of her industries by the domestic production of capital goods, supplemented
with only marginal imports. India has also built a large number of canals and
storage works, hydro and thermal power generation and largely electrified
railway system, expanding post and telecommunication system covering most
of the countries and linking its important business centres with other countries,
expanding system of banking and finance; and so on.
1.3.3 Economic Growth
The basic aim of economic policy of the Government of India has been to
remove poverty and create means for better standard of living of the people.
This aim can be achieved through rapid economic growth. Economic growth
can be defined as the process whereby an economy’s real national income
increases over a long period of time. Economic growth is an increase (or
decrease) in the value of goods and services that a geographic area produces and
sells in comparison to an earlier time. If the value of an area's goods and
services is higher in one year than the year before, it experiences positive
growth, usually known as "economic growth”
However, as economist Amartya Sen points out: “economic growth is only one
aspect of the process of economic development.”
1.3.4 "Big Push" Approach
It is the measure of help to the developing countries trapped in the vicious circle
of poverty trap, by injecting large sums of financial supports, so as to break the
cycle and improve the local living standards based on industrial development
and investment.
1.3.5 Poverty Trap

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Poverty trap is a self-perpetuating condition where an economy suffers from
persistent underdevelopment where poverty breeds or perpetuates poverty.
Poverty trap has to be distinguished from (possibly temporary) bad market
outcomes, such as recessions and financial crises.
1.3.6 UN Development Decade
The UN General Assembly declared each decade of the 1960s, 1970s, 1980s
and 1990s, as the first, second, third, and fourth UN Development Decade,
respectively. The first Development Decade was announced by President John.
F. Kennedy of the United States in 1962. Each decade put forth specific sets of
development goals. No announcement of the development decade was made for
the first decade of the 21st century; however, the Millennium Development
Goals (covering the period up to 2015) were adopted at the UN Millennium
Summit in 2000.
1.3.7 Sustainable Development
It is the process of development that "meets the needs of the present without
compromising the ability of future generations to meet their own needs" (the
Brundtland Report, 1987). While the central issue of sustainable development
is the reduction/prevention of environmental degradation, but it must be done
without unduly forgoing the needs of economic development, social equality
and justice.
1.3.8 Millennium Development Goals (MDGs)
The eight goals covering a wide range of social and economic development that
the UN member states have agreed to strive for with the year 2015 as the target
time-limit. The MDGs were adopted on the occasion of the 2000 UN
Millennium Summit. Since then, the UN system has been mobilized to their
achievement, and many NGO have rallied around the UN campaign. The
MDGs specifically concern the eradication of extreme hunger and poverty;
achieve universal primary education; promote gender equality and empower
women; reduce child mortality; improve maternal health; combat HIV/AIDS,
malaria, and other diseases; ensure environmental sustainability; develop a
global partnership for development.
1.4 MEASUREMENT OF ECONOMIC DEVELOPMENT
Economic development refers to the total quality of life of a population. It
includes the standard of its education, medical care and diet. The greater a
country’s economic development, the better the living standard of people should
be.
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A major goal of poor countries is economic development or economic growth.
The two terms are not identical. Growth may be necessary but not sufficient for
development. Economic growth refers to increases in a country's production or
income per capita Production is usually measured by Gross National
Product (GNP) or Gross National Income (GNI), used interchangeably, an
economy's total output of goods and services.
Economic development is accompanied by changes in output distribution and
economic structure. These changes may include an improvement in the material
well-being of the poorer half of the population; a decline in agriculture's share
of GNP and a corresponding increase in the GNP share of industry and services;
an increase in the education and skills of the labour force; and substantial
technical advances originating within the country. As with children, growth
involves a stress on quantitative measures (height or GNP), whereas
development draws attention to changes in capacities (such as physical
coordination and learning ability, or the economy's ability to adapt to shifts in
tastes and technology). Currently measurement of development are:-

• GNP per capita

• Population Growth
• Occupational Structure of the Labour Force
• Human Development Index (HDI)

1.4.1 GNP Per Capita

GNP is the total market value of all final goods and services produced by a
country in one year. It is a measure of economic activity, or how much is
produced in a country. The more that country produces per person, the more
"developed" it is assumed to be.

GNP is measured in US dollars, so that comparisons can be made with other

currencies in the world. For example, in India US$1 will buy far more than in
the USA. This is called Purchasing Power Parity (PPP). This converts a
national income to its equivalent in the USA

Gross Domestic Product (GDP) is closely linked with GNP. It is the value of the
goods and services produced in the country only. It includes all goods and
services produced by foreign owned companies. GDP excludes all goods and
services produced outside the country. The average GDP per person can be
calculated by dividing the GDP by the total population of the country

1.4.2 Population Growth

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In general, poorer countries have higher rate of population growth. Many of the
world's countries, including many in Sub-Saharan Africa, the Middle
East, South Asia and South East Asia, have seen a sharp rise in population in
the last few years. The fear is that high population numbers may put further
strain on the natural resources, food supplies, fuel supplies, employment,
housing, etc. in underdeveloped and developing countries. It has been seen that
in underdeveloped and developing countries, rapid growth of population is an
important hindrance to the economic growth. Higher population means less
resources per capita. Since economic growth is measured in terms of an increase
in per capita income, a part of the increase in national income is utilised to
maintain the additional population. In other words, in terms of per capita
income, on account of a rise in population, the country is left with small
potential of spreading benefits of growth across its population. This highlights
the need for a large and active programme of family planning so that the
benefits of the massive developmental efforts do not get dissipated.

But it may be emphasized that it would not be proper to isolate the population
factor because history has shown that birth rate only falls significantly when the
standard of living rises significantly for the majority of the population. Hence
economic development and population are interconnected. Whereas population
hinders economic development, the latter, as it gathers momentum, leads to the
creation of more appropriate conditions to control population.

1.4.3 Occupational Structure of the Labour Force

Economic activities of any country are broadly classified into primary activities,
secondary activities, and tertiary activities.

Primary activities are known as primary because they directly remove resources
from the earth, for examples, agriculture, mining, fishing, and lumbering.

Secondary activities involve converting primary resources into finished

products by further adding values. These are classified as manufacturing
activities.

Tertiary activities comprise the service sector of the economy. These facilitate
further adding values to the primary and manufacturing activities. The tertiary
activities include retailing, transportation, education, banking, etc.

As countries develop, the occupational structure of the labour force changes. It

has been observed by developmental economists that in underdeveloped or
developing countries, most people are engaged in the primary activities. In
developed countries like the United States, U.K., France, Japan and South
Korea most people are involved with the tertiary sector. Experience from all
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over the world suggests that in the process of development, transfer of
workforce from primary to secondary and then secondary to tertiary sector of
the economy has invariably taken place. For instance between 1870 and 1930,
the proportion of work force engaged in agriculture declined from 54 to 23
percent in U.S.A., from 43to 25 percent in France, and from 80 to 48 percent in
Japan. Currently we are witnessing in countries like China, India and newly
industrialised countries, persons employed in territory sectors are
proportionately increasing. The process of shift in the occupational structure
implies the shift of work force from low productivity of primary sector to the
high productivity secondary and tertiary sectors. Therefore, it is essential that as
economic development proceeds, there is an optimum distribution of the work
force in different occupations. This will not only improve the utilisation of
labour but will also boost the overall level of productivity of the economy.

1.4.4 Human Development Index

Human Development Index developed by the United Nations Development

Program (UNDP) computes a Human Development Index for each country each
year. Currently, this has been considered a very effective indicator of
development. It takes into consideration social conditions including GNP per
capita. Although it is the most used indicator of development, yet there are
some significant problems with it.

The human development index (HDI), is composed of three indicators, namely

life expectancy, education (adult literacy and combined secondary and tertiary
school enrolment) and real GNP per capita.

Check your progress B

1. Define economic development.

2. Write any four characteristics of underdevelopment.
3. What is the per capita income?
4. Write three indicators of human development index.
5. State which of the following statements are True or False.
i) Economic development refers to the total quality of life of population
ii) Production is usually measured by Gross National Product (GNP) or
Gross National Income (GNI).
iii) United Nations Development Programme (UNDP) computes Human
Development Index for each country.
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 iv) The average GDP per person can be calculated by dividing the GDP by
the total population of the country.
v) Economic growth refers to decrease in country’s production or income
per capita.

1.5 DETERMINANTS OF ECONOMIC DEVELOPMENT

The process of development depends on a host of factors like natural resources,

physical and human capital, technology, socio-politico-economic structure of
the country. Determinants of development are broadly classified into economic
factors and non-economic factors.
Economic determinants of the economic development

1.5.1 Capital Formation

Growth rate of the national income in the developed nations’ high capital
formation has contributed to higher economic growth. A higher rate of capital
formation leads to productive capacity of a nation, which results into higher
production of goods and services and higher national income.

Capital includes the stock of machines, tools and equipment (which produce
consumer goods as well as machines) and improvements in skill formation of its
work force, which has enhancing effect on the process of growth. Any
increment to this stock year to year are called Capital Formation. Investment is
also generally known as amount of capital formation.

It is therefore very essential for developing and underdeveloped countries to

increase the stock of Capital formation for accelerating the economic
development and growth. Along with capital, it is also important for these
countries to focus on skill formation so that the machines and equipment created
can be utilized efficiently to achieve a rising level of production.

In underdeveloped countries, the level of income is low and due to this, saving
ratio is also low. Low saving results into low investment and lower level of
capital formation. Therefore, increase in income leads to more capital
formation. To make optimum use of the natural wealth, necessary amount of
capital is needed so that they can be used to their fullest. If the level of income
is low, the savings will also be low. In such a case, a country may use foreign
capital. The actual requirement of capital depends upon growth target and
capital output ratio.
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1.5.2 Capital-Output Ratio

Capital-output ratio is one of the most important determinants of development.

The ‘capital-output ratio' may be defined as ‘number of units of capital required
to produce one unit of output’. In other words, capital-output ratio measures the
productivity of capital that is employed in various sectors of the economy at a
point of time. Also in a developing country like India where there is shortage of
capital, it becomes all the more important to conserve its use by utilizing it
efficiently. But the capital-output ratio is different for different industries. In
capital intensive industries, capital output ratio is higher as compared to the
labour intensive industries. The Capital output ratio therefore varies across
different economies and also over a period of time.
"There is no unique capital-output ratio applicable to all countries at all times.
Much depends on the stage of economic development reached but also on the
precise form of further expansion." (First Five-Year Plan).

1.5.3 . Natural Resources

Natural resources include both renewable and non-renewable resources. It has

been observed that availability of natural resources in abundance is an important
but not an essential factor in a country’s economic development. Some
developed countries like the USA, Canada, Australia, New Zealand, etc. have
abundance of natural resources but Japan lacks natural resources as compared to
these countries but it is a developed country. Therefore, it does not mean that all
these countries that have natural resources in abundance, are among the
developed nations. The countries which are in their process of economic
growth must direct their efforts to make fuller use of their existing resources.
Renewable and non-renewable resources increase income, Per Capita
Employment, Income and Efficiency.

1.5.4 Non-economic Factors in Economic Development:

Human Resources – Optimum level of population can be a boon as well, as

the increasing population provides opportunity for expanding market base in
terms of demand and supply of goods and services, and more work force for
producing such output. Over population can be a problem. Optimum level of
population also provides working age population, educated and skilled
manpower, health and nutrition, demographic dividend of human capital.

Human capital is one of the most important factor of economic development.

Japan is a developed nation because of creation of capabilities and capacities in
people to work efficiently and competently in various economic activities. It has
17
been realised that investment on human beings in the form of education,
training and health facilities contributes to increased productivity which is very
significant for development

In developed nations, the health and education levels are much higher as
compared to the underdeveloped countries. Developed countries with better
health and education produce larger output and higher incomes. The role of
human capital formation in economic development can be stated in terms of
increase in output, in productive capacity, improved quality of life and increase
in inventions and innovations.

Technical Know-how: Technology and technical know-how are also very

significant factors in the process of economic development. More sophisticated
techniques of production always facilitate in increasing the level of production
and productivity levels. As the scientific and technological knowledge
advances, there is more sophistication in the level of technology. Information
technology and digitization are bringing more and more sophistication in the
techniques of production. To incorporate new technology in the production
process or in order to modify the existing plants, a larger investment to procure
or produce new equipment is required. Hence a higher rate of capital formation
is necessary to support technological progress. Since technology has now
become highly sophisticated, still greater attention has to be given to Research
and Development for further advancement.

1.5.5 Institutional Factors Affecting Development

There are a number of non-economic factors that act as catalyst in the process of
economic development. These institutional factors are organisations, structures,
rules, education and educational institutes, healthcare infrastructure and political
stability. Other institutional factors that have impact on the process of
development are legal system, financial system, credit and micro finance,
taxation, the use of appropriate technology and the empowerment of women.
1.6 ROLE OF GOVERNMENT IN DEVELOPMENT

If the economy depends solely on the price mechanism to solve its central
problems, then given the income and wealth inequalities, there is a possibility
that a large number of people die of starvation while a handful possess the good
things of life very much in excess of what is required by them. Here
intervention of government to facilitate inclusive and sustainable development
is required. Any enlightened government finds it necessary to curb inhuman
traits in the working of the price mechanism.

18
It has been seen that price mechanism due to the individualistic orientation of
human behaviour cannot adequately allocate resources for education, medical
facilities and other social services. Government must allocate resources for
education, medical facilities and other social services by keeping in mind that in
a country like India, there is sizable population living in poverty and they lack
resources to buy these services. Other services of immense national importance,
like transportation, communications, water and electricity, defence, space are
also very important for development. The Government cannot solely depend on
private sector or by the price mechanism alone. Because then it is likely to
result in a very short supply of each one of them. Therefore, it becomes
imperative for the government to participate directly in the production of these
services.

1.7 LET US SUM UP

The economic system and the historical context of a country also decide the
development prospectus to a great extent. Economic system of country provides
its broadest process of working of major economic activities, namely
Capitalism, Socialism and Mixed Economy.

In a capitalist economic system, activities of a business firm are market

determined. In a capitalist economy neither an individual nor any institution
takes decisions in a centralized or planned manner concerning its day-to-day
functioning of economic activities. Socialism is an economic system where
private sector does not have any kind of control over price fixation by market
forces. The production, distribution and consumption resulting from all major
economic activities are centralized. By centralization means, it is controlled by
the State or State-established agencies. This kind of system is also known as
command economy. A mixed economy represents a mixture of features of the
two types of economies, capitalism and socialism. Under this form of economic
system, the ownership of means of production is partly in the hands of private
individuals and partly owned by the State. Economic development is a
comprehensive term that generally refers to the sustained, concerted endeavor

19
of policymakers and community to promote the standard of living and economic
condition in a country. Economic development refers to the total quality of life
of the population. It includes the standard of its education, medical care, the
diet, etc. The greater a country’s economic development, the better the living
standard of people is. Currently, measurement of development are:

• GNP per capita

• Population Growth
• Occupational Structure of the Labour Force
• Human Development Index (HDI)
There are a number of non-economic factors that act as catalyst in the process of
economic development. These institutional factors are organisations, structures,
rules, education and educational institutes, healthcare infrastructure and political
stability. If the economy depends solely on the price mechanism to solve its
central problems, then given the income and wealth inequalities, there is a
possibility that a large number of people die of starvation while a handful
possess the good things of life very much in excess of what is required by them.
Here intervention of government to facilitate inclusive and sustainable
development is required.

1.8 KEY WORDS

Capitalism: The economic system in which business are owned and run for
profit by individuals and not by the state.

Socialism: The political idea that is based on the belief that all people are equal
and that money and property should be equally divided.

Mixed economy: A economy system combination with private and state

enterprise.

20
Development: The process of becoming bigger, stronger better etc. or of
making somebody something do this.

Underdevelopment: Is low level of development characterized by low real per

capita income wide-spread poverty, lower level of literacy, low life expectancy
and underutilization.

Economic growth: An increase in the amount of goods and services produced

per head of the population over a period of time.

Sustainable Development: Economic development that is conducted without

depletion of natural resources.

Gross National Product (GNP): Total market value of the final goods and
services produced by a nation’s economy during a specific period of time a year
computed before allowance is made for the depreciation or consumption of
capital used in the process of production.

Gross Domestic Product (GDP): GDP is the most commonly used measured
for the site of an economy.

1.9 ANSWERS TO CHECK YOUR PROGRESS

(A) 5 i) True ii) True iii) False iv) True v) True

(B) 5 i) True ii) True iii) True iv) True v) False

1.10 TERMINAL QUESTIONS

1. Discuss in detail about the working of an economy in capitalism,
socialism and mixed economy
2. What is the difference between underdevelopment and development?
Explain with appropriate examples.
3. What are major determinants of development? Discuss.
4. Discuss the role of non-economic factors in economic development.
5. What are the millennium goals? Discuss in detail.

21
22
UNIT 2: FEATURES OF INDIAN ECONOMY: AN EMERGING
ECONOMY

Structure

2.0 Objectives
2.1 Introduction
2.2 India an Emerging Economy
2.3 India in Transition
2.4 Institutional Changes
2.5 Liberalization
2.5.1 Industrial Sector Reforms
2.5.2 Financial Sector Reforms
2.5.3 Fiscal Reforms
2.6 Privatisation
2.7 Globalization
2.8 Structural Changes
2.9 Major Issues Controlling Indian Economy
2.9.1 Poverty
2.9.2 Unemployment
2.9.3 Inequalities In Income Distribution
2.9.4 Regional Disparities
2.10 Let Us Sum Up
2.11 Key Words
2.12 Answers to Check Your Progress
2.13 Terminal Questions
2.0 Objectives
After going through this unit, you will be able to:
• Discuss the evolutionary process of Indian Economy;
• State the concepts of Liberalization, Privatisation and Globalization;
• Describe the various economic challenges which India is facing and
• Explain Major Issues Controlling Indian Economy highlighting the issues
relating to poverty, unemployment, inequalities in income distribution
and regional disparities.

2.1 Introduction
Theodore Roosevelt remarked, “A peep in the past prepares you better for the
future”. Thus for understanding the present state of the Indian economy and its
future prospects a brief comment on its past will be appropriate. The Indian
economy, before the British came around the middle of the nineteenth century,
was quite sound. According to an estimate, the Gross Domestic Product (GDP)
of India in the sixteenth century was about 25% of the world economy, the
second largest in the world. However, after the arrival of the colonial rule the
Indian economy faced disaster; from being an exporter of processed goods it
changed to being an exporter of raw materials and a buyer of manufactured
goods. As per British economist, Angus Maddison, India’s share of the world
income went from 27% in 1700 A.D. (compared to Europe share of 23%) to 3%
in 1950.
After India got independence in 1947, the process of rebuilding the economy
started. However, it was mostly centralized and the period from 1947 to 1991
was termed as the licence raj, because the successive governments followed
protectionist economic policies. This trend led to a balance of payments crisis in
the year 1990. The year 1991 turned out to be watershed in the Indian economy
when the government of India in June 1991 announced major liberalization
policies in Indian economy. Dr. Manmohan Singh while presenting the budget
in 1991, quoted victor hugo, “no power on earth can stop an idea whose time
has come”. The emergence of India as a major economic power in the world
happens to be one such idea.” Since then Indian economy has progressed
immensely with GDP progressing at the rate of 6 to 8% per annum and is
expected to be one of the top three economic powers in the world over the next
10-15 years. India is also backed by its robust democracy and strong
partnerships. India has finally arrived in the category of fast emerging
economies. It is fast entering the league of high growth nations. The future
seems to have much more in store. But a lot depends on how the grey areas are
tackled.
We have finally been able to unshackle ourselves from the stigma of being a
low growth economy and have infused dynamism into our economic system.
Not only is India achieving higher growth rates year after year, the rate at which
it is moving towards higher growth targets is also higher.

2.2 India an Emerging Economy

India's economy over the last three decades is a success story; after a major
economic crisis in 1991, followed by Economic reforms, the economy has
experienced a high and sustainable economic growth rate, attracted large
amount foreign investment, and a boom in the information technology sector
and pharma sector. These characteristics are good enough to classify India as an
emerging economy. Since the start of the 21st century, annual average GDP
growth 6% to 7% and from 2013-2018 India was the world’s fastest growing
major economy. It was the robustness of Indian economy that unlike US and
Europe India was not affected by global financial crisis in the year 2008.

India's key growth factors are a young and rapidly growing working-age
population, rising education and engineering skill levels, accentuating growth in
the manufacturing sector, a rapidly growing middle-class, implementing a
sustained growth of the consumer market.
Among all the emerging markets, it is India’s robust growth in manufacturing,
business friendly reforms, infrastructural development and political stability that
makes the country the most prominent emerging market to invest in for
investors. According to the IMF World Economic Outlook, April 2016, India
ranks fourth among the list of the world’s fastest growing economies with a
growth projection of 7.2 percent for the fiscal year 2017 and 7.7 percent for the
fiscal year 2018, surpassing China.

2.3 India in Transition

• Emerging or ‘frontier’ markets are economies which are in a transition

phase, Indian economy is an emerging economy and currently India is in
transition. It is characterised as emerging because financial and regulatory
infrastructure are less mature compared to developed economies. Though
characterised by low per capita income, Indian Economy is growing at an
unprecedented rate.

• Economic reforms that began 25 years ago have transformed India. What
used to be a poor, slow growing country now has the third largest gross
 domestic product (GDP) in the world with regard to purchasing power
parity and is projected to be the fastest‐growing major economy in the
world in 2016 (with 7.6 percent growth in GDP).The Indian GDP rose
from $266 billion in 1991 (inflation adjusted) to $3 trillion in
2019 (1100% increase) while its purchasing power parity rose from $1
trillion in 1991 to $12 trillion in 2019 (1100% increase).

• The growth in India's economy has fostered the emergence of a sizeable

middle class after Economic Reforms. It was pointed out that much of the
market potential in India lies in its consumer market, which is seen to
have immense potential. It is accepted that India's middle class will
determine the consumer potential for India. At this stage of Indian
development, the middle class is predominantly rural and it is argued that
this market potential has scarcely been tapped. It was suggested that
although consumption of some trade items has increased rapidly, a large
gap exists between actual and potential consumption: Statistics reveal a
high level of aspiration, a fast changing pattern of consumption, and a
higher level of penetration at these lower income levels than would be
expected. India is currently in the throes of a boom for consumer
products. It is leading to the emergence of new values in consumption
and in new aspirations

• The external sector of Indian Economy is also performing well under the
new economic policy. Exports, which had been treated as a residual
category before economic reforms have now received a place of
prominence in our economic strategy. Various promotional steps have
been taken to increase the rate of growth of our exports which has been
around 10% in the entire post-liberalisation period. Imports, on the other
hand, were deliberately compressed in 1991-92, but have been growing
since then owing to the renewal of economic activity. But during the
entire period, between 1990-91 and 1995-96, the rate of growth of
imports has been lower than that of exports and this has led to an
improvement in our balance of trade. But, since 1993-94, the high saving-
investment gap has led to an increase in the trade and current account
deficit.

• The high rate of capital inflows since 1991 have been another positive
feature of our balance of payments situation. Furthermore, these inflows
have been preponderantly of the non-debt creating variety, with net
foreign borrowings constituting only about 20% of the total capital
inflows during 1993-95. Capital inflows are mainly taking the form of
 foreign investment which has grown by around 85% from 1990-91 to
1995-96.

2.4 Institutional Changes

In 1991 India embarked on major reforms to liberalize its economy after three
decades of socialism and a fourth of creeping liberalization. Beginning with
mid-1991, the govt. has made some radical changes in its policies related to
foreign trade, Foreign Direct Investment, exchange rate, industry, fiscal
discipline etc. These were major elements of New Economic Policy. The New
Economic Policy has been towards creating a more competitive environment in
the economy as a means to improving the productivity and efficiency of the
system. This was to be achieved by removing the barriers to entry and the
restrictions on the growth of firms.
The measures adopted in the new economic policy can be grouped in the three
categories, namely liberalization, privatization and globalization.
2.5 Liberalization
Liberalization of economy was a key component of the New Economic Policy
(NEP). Prior to 1991, there were several types of controls on private business
enterprises imposed by the government. Some of these controls were: seeking
licensing from the government, price control, import license, foreign exchange
control, monopoly restrictions, etc. As a result of these controls there were
several hindrances in the economic growth. These included corruption, delays,
inefficiency. In the NEP the emphasis was placed on market forces, namely
supply and demand. Liberalization steps can be broadly grouped into two
categories: industrial sector reforms and financial sector reforms.
2.5.1 Industrial Sector Reforms - These reforms included the following:
(i) Abolition of industrial licensing and registration except for the following five
industries namely
a) defence equipments
b) Industrial explosives
c) Cigarette
d) Alcoholic drinks
e) Dangerous chemicals
(ii) Diminished role of the public sector and establishment of disinvestment
ministry to withdraw from the public sector enterprises. It has been explained
later under privatisation.
 (iii) De–reservation of production areas – Many production areas hitherto
reserved for small scale industries were de-reserved.
(iv) Abolition of Monopolies and Restrictive Trade Practices (MRTP) Act 1969
‐ All those companies having assets worth Rs. 100 crore or more were called
MRTP firms and were subjected to several restrictions. Now these firms have
not to obtain prior approval of the Govt. for taking investment decision. Now
MRTP Act is replaced by the competition Act.
(v) Freedom to import capital goods - The industries were given freedom to
import capital goods and new technology.
2.5.2 Financial Sector Reforms
It includes
(i) Banking and non banking financial institutions.
(ii) Stock exchange market – The companies were given more freedom to sell
and purchase equity shares in the stock market.
(iii) Foreign exchange market i.e. FDIs. The companies were allowed to accept
FDIs.
(iv) The role of Reserve Bank of India was changed from “a regulator” to a
facilitator. It allowed foreign institutional investors to invest in Indian
financial markets such as mutual funds and pension funds.

2.5.3 Fiscal Reforms

Tax reforms constitute as the principle component of fiscal reforms. Some of
the examples of fiscal reforms are: GST (Goods and Services Tax). Prior to this,
tax structure was quite complex and evasive.

(i) Increase in the investment limit for the Small Scale Industries (SSIs): The
role of small and medium enterprises (SME) sector was recognized as an
important contributor to the Indian economy. It was for the first time defined
in terms of a separate act, governing, promotion and development of Micro,
Small and Medium Enterprises (MSME) Act, 2006. SME’s not only play
important role in providing employment opportunities at comparatively lower
capital cost but also usher in industrialization of the rural areas. This sector
consists of about 36 million units, as of now, and provides to employment to
over 80 million persons. Some of the advantages of SME’s include low
investment requirements, operational flexibility, low intensive imports,
appreciable export earnings, development of domestic technology, etc. For
upgrading machinery and improve their efficiency in SMIs, Investment limit
of the small scale industries was raised to Rs. 1 crore in 1991
(ii) Freedom for expansion and production to Industries:
 Industries are free to diversify their production capacities and reduce the cost of
production. Earlier government used to fix the maximum limit of production
capacity. No industry could produce beyond that limit. Now the industries are
free to decide their production by their own on the basis of the requirement of
the markets.

2.6 Privatisation

Privatisation is the process of involving the private sector-in the ownership of

Public Sector Units (PSU’s).
The main reason for privatisation was in currency of PSU’s are running in
losses due to political interference. The managers cannot work independently.
Production capacity remained under-utilized. To increase competition and
efficiency privatisation of PSUs was inevitable. The following steps were taken
for privatisation:

(iii) Sale of shares of PSUs:

Indian Govt. started selling shares of PSU’s to public and financial institution
e.g. Govt. sold shares of Maruti Udyog Ltd. Now the private sector will acquire
ownership of these PSU’s. The share of private sector has increased from 45%
to 55%.

(iv) Disinvestment in PSU’s:

The Govt. has started the process of disinvestment in those PSU’s which had
been running into loss. It means that Govt. has been selling out these industries
to private sector

(v) Minimisation of Public Sector:

Previously Public sector was given the importance with a view to help in
industrialisation and removal of poverty. But these PSU’s could not able to
achieve this objective and policy of contraction of PSU’s was followed under
new economic reforms. Number of industries reserved for public sector was
reduces from 17 to 2.

2.7 Globalization
Globalisation means the interaction of the domestic economy with the rest of
the world with regard to foreign investment, trade, production and financial
matters. Following steps are taken for Globalisation:

(vi) Reduction in tariffs:

Custom duties and tariffs imposed on imports and exports are reduced gradually
just to make India economy attractive to the global investors.

(vii) Long term Trade Policy:

- Liberal policy
- All controls on foreign trade have been removed
- Open competition has been encouraged
- Partial Convertibility of Indian currency:

Partial convertibility can be defined as to convert Indian currency (up to specific

extent) in the currency of other countries. So that the flow of foreign investment
in terms of Foreign Institutional Investment (FII) and foreign Direct Investment
(FDI).
This convertibility stood valid for following transaction:
(a) Remittances to meet family expenses
(b) Payment of interest
(c) Import and export of goods and services.

- Increase in Equity Limit of Foreign Investment:

Equity limit of foreign capital investment has been raised from 40% to 100%
percent. In 47 high priority industries foreign direct investment (FDI) to the
extent of 100% will be allowed without any restriction. In this regard Foreign
Exchange Management Act (FEMA) will be enforced.
If the Indian economy is shining at the world map currently, its sole attribution
goes to the implementation of the New Economic Policy in 1991.

Check your Progress A

1. Which of the following statements are True or False?
(i) After British arrival in India Indian economy improved a lot.
(ii) India’s key growth factors include young and rapidly growing working
age population.
(iii) New economic policy abolished Indian licensing.
(iv) New economic policy assigned greater role to PSUs.
 (v) Under NEP, the tariffs on imports of capital goods were increased.
2. Name the three sectors covered in liberalization of economy.
3. Name three regions why privatization of PSU became inevitable.

2.8 Structural changes

The 1991 balance of payments crisis led to India's 'plunge into structural
reforms. The strategy of reforms introduced in India in July 1991 presented a
mixture of macroeconomic stabilization and structural adjustment. It was
guided by short-term and long-term objectives. ... Besides this, structural
reforms were initiated in the field of trade, industry and the public sector.
The purpose of economic development is not only to increase the output, but
also to change the composition of output. Economic development is not only
to increase the output, but also to change the composition of output. As the
community’s needs are satisfied, new wants inevitably appear and these have
to be met through supplies of new types of products. Moreover, while some
new demands are met through higher imports, some new supplies get
diverted towards exports. Thus structural change in an economy consists of
change in the composition of output and there are four sources of the same.
They are:
(viii) Change in Final Demand
(ix) Change in Exports
(x) Change in Import Structure
(xi) Change in Technology
During reforms structural adjustment programs and loans were arranged
through the International Monetary Fund (IMF) and the World Bank. The
Indian Government was to review its trade policies to allow more foreign
investment and reduce trade restrictions so that India's economy could be
restored to its former level. Import tariffs underwent significant reductions
and import/export licensing system procedures were simplified. The opening
up of capital markets to include more foreign participation has allowed
multinationals companies entrance into otherwise untapped markets.
The Indian economy has responded vigorously to a program of stabilisation
and reform measures started in 1992. The Indian Government took drastic
action including devaluation, the imposition of higher interest rates, fiscal
and monetary restraint and import compression. In succeeding budgets long
term measures were introduced which removed the protection for Indian
industry and commerce from international competition.
2.9 Major issues controlling Indian economy
2.9.1 Poverty

Although there is no unanimity about the definition of poverty, it can be defined

in terms of the “deprivation of certain basic necessities of life”, but beyond that,
there is no unanimity as to what constitutes poverty. Poverty should be
conceived in terms of human needs which are considered essential by the
society and are capable of being measured objectively. A person may then be
regarded as poor if he is not in a position to meet out these needs. The concept
of poverty which implies non-fulfilment of the needs, considered essential for
human beings, is known as absolute poverty. In measurement, it involves
stipulation of a minimum level of per capita consumer expenditure which is
adequate for purchasing the goods and services needed for the purpose. People
having expenditure less than this are considered to be poor. Further in its
application there are certain problems about the inclusion of essential needs.
While some writers confine themselves to food alone, others include additional
items like shelter, health and education. Robert S. McNamara, for example, in
the 1978 World Development Report of the World Bank, regards poverty as a
condition of life characterised by malnutrition, illiteracy, disease, squalid
surroundings, high infant mortality and low life expectancy as to be beyond any
reasonable definition of human decency.
The other concept of poverty is a relative one. Between two households or two
persons, one may be considered as poor while the other, on the basis of income
comparison, may not be considered poor. But the entire definition of poverty
will be diluted by this approach if both are satisfying the minimum basic needs
of society. In this connection, persons having standard of living below a certain
cut off point, fixed in the light of the income distribution of the population, are
viewed as poor. For instance, poverty level may be fixed at half the median
point of the distribution or it may be measured in terms of full dispersion
between the highest and lowest standards. In this connection it was pointed out
by Prof. Peter Townsend, “Poverty must be regarded as a general form of
relative deprivation due to the maldistribution of resources”. Through this
definition of relative poverty, the inequality in the distribution of income and
assets can be measured. Further, the problem of poverty can be linked “to the
problem of unemployment, disguised unemployment, under-employment, etc.
Many of our marginal farmers, landless labourers and rural artisans are below
the poverty line even though they are reported as employed. Therefore, it can be
said that provision of employment is not a sufficient condition for the removal
of poverty.
Niti Aayog constituted a Task Force in March 2015. Following were the broad
issues before the Task Force:
• To measure poverty in India
• To assess the need of an official poverty line
• Combating poverty:
Employment-intensive sustained rapid growth,
Making social programmes more effective and
New approaches.
In 2005, the Government of India appointed the Tendulkar committee to take a
fresh look at the poverty lines. Reporting in 2009, the Tendulkar Committee
revised upward the rural poverty line. After the criticism of the Tendulkar
committee report, another committee, Rangarajan Committee was constituted
in 2012 which submitted its report in June 2014. The committee recommended
raising further both the rural and urban poverty lines. The percent population
below poverty line (2011-2012) according to the Tendulkar and Rangrajan
reports are shown in Figure 2.1.

Figure 2.1. Percent population below poverty line.

The percent population below poverty line for the years 1993-94, 2004-05 and
2011-12) according to the Tendulkar methodology are shown in Figure 2.2

Figure 2.2. Rural and urban poverty percentages for the years 1993-94, 2004-05
and 2011-12.
The percentage of the poverty personnel according to the social groups are
shown in Figure 2.3.
Figure 2.3. Poverty by social groups for the years 1993-94, 2004-05 and 2011-
12
For combating poverty, it was realised that two-pronged strategy will have to be
followed:
1. Modernize agriculture and accelerate agricultural growth
2. Create job opportunities in industry and services.

2.9.2 Unemployment
Indian economy is a developing economy and the problem of unemployment is
very grave in India. But here the nature of unemployment differs from most of
the developed western countries. In western countries, unemployment is due to
shortfall in demand. More or less it is a form of cyclical unemployment. It
implies that in such economies, machines become ideal and demand for labour
falls because the demand for the products of industry is no longer there. Thus,
most of Keynesian remedies concentrated on measures to keep the level of
effective demand sufficiently high so that the economic machine does not
slacken the production of goods and services.
But more serious than cyclical unemployment or frictional unemployment in an
undeveloped economy like India, is the existence of chronic under-employment
mainly in the rural sector and the existence of educated unemployment in the
urban areas. There is disguised unemployment by which a situation we mean
where the productivity of workers is almost zero or near zero. This contention
of zero productivity is a very controversial issue among the economists. But
finally it has been concluded that productivity of employed disguised worker is
low. Educational unemployment is due to the gap between manpower planning
and number of educated personnel and is mainly due to the structural
inadequacy to absorb all the educated persons in the system.
Therefore, it is quite clear that unemployment in underdeveloped economies
like India is not the result of deficiency of effective demand in the Keynesian
sense but a consequence of shortage of capital equipment or other
complementary resources.
Poverty in India is also associated with unemployment, unlike in industrially
advanced countries. “The miseries of unemployment in India are sometimes
partly cushioned by the institution of joint family. Yet for a given family, the
lack of adequate employment opportunities for its adult members and a non-
earner who is dependent are among the common characteristics of poverty”.
It has been said that unemployment is mainly the result of emphasis on heavy
industry during the planning process. Early planners had almost a mystic faith
in the twin gods of technology and heavy industry which has turned out to be
misplaced. Western technology, which developed in the west in response to a
shortage of labour and the consequent need to replace men with machine,
provides no short cut to prosperity in countries with a large number of
underemployed and undernourished labour and an acute shortage of capital.
Planners and economists have often debated whether employment is a by-
product of development and economic growth or whether employment creating
policy should be a primary objective of the planning process. The primary
objective of such a policy has to be the maximisation of economic welfare of
all. The attainment of this objective would require structural changes in the
development process.
Thus, the problem of unemployment cannot be viewed as a residual one and all
measures and policies concerning economic affairs of the country have to be
directed in such a way that they aim at the elimination of various forms of
unemployment.
Manpower planning is a part of the entire labour force organisation which
requires policy and programmes for the development and effective utilisation of
human capital on its optimum basis. This process involves the available and
future supply of human capital, simultaneously, while keeping close watch on
the demand pattern. Thus, manpower planning is an inter-disciplinary subject. It
is intimately connected with social and economic factors of demographic
composition.
There is no formal report by the Niti Aayog about the unemployment data.
However according to the National Sample Survey (NSS) Office’s Periodic
Labour Force Survey, the country’s unemployment rate was at a 45-year-high of
6.1 per cent in 2017-18. This reported generated much controversy and Niti
Aayog claimed that the data released by NSS were not verified.
2.9.3 Inequalities in income distribution
Income inequality is a significant disparity in the distribution of
income between individuals, social groups, populations, or countries. It is a
major factor of social stratification and social class. Other elements included in
inequalities are wealth, political power, and social status. Income is a major
determinant of quality of life, affecting the health and well-being of individuals
and families, and varies by social factors such as sex, age, and race or ethnicity.
As per the 'World Inequality Report 2022', India is among the most unequal
countries in the world, with rising poverty and an 'affluent elite.' The report
highlights that the top 10% and top 1% in India hold 57% and 22% of the total
national income respectively while the bottom 50% share has gone down to
13%.
According to another report by the Johannesburg-based company New World
Wealth, India is the second-most unequal country globally, with millionaires
controlling 54% of its wealth. In India, the richest 1% own 53% of the country’s
wealth, according to the latest data from Credit Suisse. The richest 5% own
68.6%, while the top 10% have 76.3%.At the other end of the pyramid, the
poorer half held a mere 4.1% of national wealth. The Credit Suisse data shows
that India’s richest 1% owned just 36.8% of the country’s wealth in 2000, while
the share of the top 10% was 65.9%. Since then they have steadily increased
their share of the pie. The share of the top 1% now exceeds 50%.
The average national income of the Indian adult population is Rs 2,04,200.
Here, the bottom 50% earns Rs 53,610 while the top 10% earns Rs
11,66,520, over 20 times more.

Causes of Inequalities:
Major causes of the inequalities are te following:
(i) Inheritance: It plays a significant role in inequality. The persons born in
rich family have a significant advantage. If they are prudent enough,
 they maintain the lead. On the other hand, people born in poor
families are at disadvantage in this respect.
(ii) Difference in natural traits: Different people have different talents and
initiatives. The people gifted with natural traits and entrepreneurship
multiply their prosperity as compared the people who lack these
qualities.
(iii) Opportunities of higher education and skill development: Some
people get opportunities of better education and skill development.
With this background, they succeed in getting jobs of higher
emoluments.
(iv) Family influence: It is often found that family influence plays
important role in getting one a lucrative job.

Consequences of Inequality
The consequences of inequality are summarised in diagram 1.
(i) Social unrest:
Inequality in society creates two classes: ‘haves’ and ‘have-not’. The people
who are deprived of essential requirements feel frustrated and create unrest. The
caste-based agitations demanding reservations in jobs and other fields are the
examples of the social unrest. Thus inequality of incomes is an important cause
of social and political instability.

(ii) Rise of economic populism: This word refers to irrational economic

policies followed by the government to gain populism. Waiving off
farmers’ loans, distribution of freebies during the elections are some of the
examples of economic populism.
(iii) Derailing of the economic reforms: It is related to the economic
populism. Under the pressure of ‘have-nots’ the government is not able to
pursue economic reforms which strengthen economy.
(iv) Distress migration: Millions of footloose and impoverished men,
women and children in India, migrate from the countryside each year
to cities – in crowded trains, buses, trucks and sometimes on foot –
their modest belongings bundled over their heads, in search of the
opportunities and means to survive. They themselves live under pathetic
conditions and at the same time, they create problems for the civic
authorities of the cities.
(v) Rise in intergenerational inequality and poverty: Unfortunately, due to
various reasons, poverty of one generation percolates to the next
generation and it becomes perpetual.
(vi) Increase burden of subsidies on the government: It is related to
economic populism and derailing of economic reforms. In democracy, te
party in power is compelled to give different types of subsidies to keep its
vote-bank intact. Overall, it harms economic growth.
(vii) Exploitation:
There is exploitation of the poor. They are compelled to work on liwer
wages. At the same time, they are not given fringe benefits, such as paid-
leave, healthcare, insurance in case of accident, etc.
Measures to Reduce Inequalities:
As discussed above, inequalities in income distribution cause many social and
political problems. In view of this, the government endeavours to reduce
 inequalities by following appropriate policy matters. The important measures
followed for reducing inequalities are as follows.

(i) Fixing minimum wages: Guaranteeing a minimum wage consistent with

a minimum standard of living is an important step.. In India, the Minimum
Wages Act was passed in 1948 in pursuance of which minimum wages are fixed
for agricultural labour and labour in what are called the ‘sweated trades’. The
minimum wage is revised from time to time in accordance with the price index.
Depending on the local conditions, minimum wages may be different in
different States. For example, according to the Delhi minimum wage
notification (Oct. 2021), the minimum wages for the unskilled, semi-skilled and
skilled labour were Rs. 618/-, 681/- and 749/- respectively.
(ii) Social security: The government must ensure adequate social security
schemes which must include provision of free education, free medical and
maternity aid, old-age pension, liberal unemployment benefits, sickness and
accident compensation, provident fund and schemes of social insurance, etc. As
an example, recently, the State and Central governments provided compensation
to the kin of the persons died due to Covid.
(iii) Need to promote labour-intensive manufacturing: There is need to
promote labour-intensive manufacturing like; Construction, Textile,
Clothing, Footwear etc. to reduce rising inequalities. The Labour-intensive
manufacturing has the potential to absorb millions of people who are leaving
farming.
(iv) Skill development: The development of advanced skills among the youth
is a prerequisite if India wants to make use of its demographic dividend. The
skilling of youth by increasing investment in education is the only way we
can reduce inequality. India needs to become a Skill-led economy.

(v) Progressive Taxation: Progressive Taxation on the rich and the luxuries will
help reduce income inequalities. Other direct taxes like the super tax, excess
profits tax, and capital gains tax and limitation of dividends, etc., may also be
imposed.

(vi) High Taxes on Luxuries: There should be heavy taxation on the

consumption of luxuries. This will take away from the rich the power to
display their wealth. This will also take away the incentive to amassing
wealth for exclusive private enjoyment. Expenditure tax in India sought the
same objective. (This tax has, however, been abolished.
 (vii) Ceilings on Agricultural Holdings and Urban Property:
Ceilings on agricultural land holdings can be imposed to reduce inequality
between big and small farmers. This has been done in India and recently the
ceilings have been lowered to 10-18 standard acres. The main purpose of
land ceilings is to bring about a wider and equal ownership and use of land.

Similarly, a ceiling on urban property can be imposed so that inequalities in

urban areas can also be toned down. More radical socioeconomic reforms
seem to be in the offing in India.

There is also need of policies and some sort of machinery by the Government,
which may provide equal opportunities to all rich and poor in getting
employment or getting a start in trade and industry. In other words, something
may be done to eliminate the family influence in the matter of choice of a
profession. For example, the government may institute a system of liberal
stipends and scholarships, so that even the poorest in the land can acquire the
highest education and technical skill.

2.9.4 Regional disparities

Regional imbalances or disparities means wide differences in per capita income,

growth rate, per capita consumption, investment rate, literacyrates, health and
education services, levels of industrialization. This is prevailing between
different regions in the country. Regions may be either States or regions within
a State.
The regional disparities as per some important criteria are shown in the
following Table.
Source: https://www.yourarticlelibrary.com/india‐2/regional‐disparities‐in‐india‐top‐8‐indicators/63004

There are diverse geographical factors responsible for disparity among states.
Among these, it has been seen that adverse climate and proneness to flood are
two factors responsible for poor rate of economic development of different
regions of the country. These are reflected by low agricultural productivity and
lack of industrialization. Thus these natural factors have resulted uneven growth
of different regions of India.

Historically British regime is also responsible for creating regional imbalances

in India. They developed only those earmarked regions of the country which as
per their own interest were possessing rich potential for prosperous
manufacturing and trading activities. They mostly preferred to concentrate their
activities in two states like West Bengal and Maharashtra and more particularly
to three metropolitan cities like Kolkata, Mumbai and Chennai. They
concentrated all their industries in and around these cities neglecting the rest of
the country to remain backward.

Locational advantages are playing an important role in determining the

development strategy of a region. Due to some locational advantages, some
regions are getting special favour in respect of site selections of various
developmental projects.

While determining the location of iron and steel projects or refineries or any
heavy industrial project, some technical factors included in the locational
advantage are getting special considerations. Thus regional imbalances arise due
to such locational advantages attached to some regions and the locational
disadvantages attached to some other backward regions.

The most important indicator of regional imbalance in India is per capita

income. Punjab, Haryana, Maharashtra, Gujarat and Tamil Nadu have more
than average per capita income of India. Bihar has the lowest per capita income.
States of the southern region of India, Tamil Nadu, Andhra Pradesh, Kerala etc.

To remove regional disparities, various five year plans aimed at the expansion
of power, transport, irrigation, education and training facilities and the
development of village and small industries. Some backward areas in different
States were given special considerations for location of industries

In our planning process from second five year plan onwards, balanced growth
was one of the major objectives of economic planning in India but regional
disparities increased due to lack of specific backward state development policies
Rather, in the process of implementation , planning mechanisms has enlarged
the disparity between the developed states and less developed states of the
country.
There was more allocation plan outlay relatively to developed states as
compared to less developed states. From First Plan to the Seventh Plan, Punjab
and Haryana have received the highest per capita plan outlay, all along. The
other three states like Gujarat, Maharashtra and Madhya Pradesh have also
received larger allocation of plan outlays in almost all the five year plans.
On the other hand, the backward states like Bihar, Assam, Orissa, Uttar Pradesh
and Rajasthan have been receiving the smallest allocation of per capita plan
outlay in almost all the plans. Due to such divergent trend, imbalance between
the different states in India has been continuously widening, inspite of framing
achievement of regional balance as one of the important objectives of economic
development in the country.
Inter-state economic and social disparities in India have been increasing in spite of
various governmental measures to develop backward areas. The increased
disparities is i in terms of demographic indicators, female literacy, state domestic
product and poverty, development and non-development expenditure by state
government, shares in plan outlay, investments, banking activities and infrastructure
development.

Check Your Progress B

1. Name four factors covered under structural changes in the economy.
_____________________________________________________________
_____________________________________________________________
_____________________________________________________________
_______________________________________________________
2. Define poverty.
_____________________________________________________________
_____________________________________________________________
_____________________________________________________________
_______________________________________________________
3. . Which of the following statements are True or False?
i) The concept of poverty is a relative one.
ii) The early emphasis on nearly industry was one of the reasons of
unemployment.
iii) India is the second most unequal income distribution country globally.
iv) Income inequalities can be reduced by lowering the taxation on the rich
and luxuries.
v) The skilling of youth by increasing investment in education is the only
way to reduce inequality.
2.10 Let us Sum Up

After India got independence in 1947 the process of rebuilding the economy
started. However, it was mostly centralized and the period from 1947 – 1991
was termed as the licence raj because the successive governments followed
protectionists economic policies. This trend led to a balance of payments crisis
in the year 1990. The year 1991 turned out to be watershed in the Indian
economy when the government of India announced major liberalization policies
in Indian economy.

Under the new economic policy some radical changes related to foreign trade,
foreign direct investment, exchange rate, industry, fiscal discipline, etc were
made. The NEP has been towards creating a more competitive environment in
the economy as a means to improving the productivity and efficiency of the
system. Under NEP liberalization was a key component. It included industrial
sector reforms, financial sector reforms and fiscal reforms.

The second component of NEP was privatization which included sale of shares
of PSUs, disinvestment in PSUs and diminished role of PSUs. The third
component of NEP namely globalization included reduction in tariffs and long
term trade policy. Under the latter all controls on foreign trade have been
removed; open competition is encouraged and partial convertibility of Indian
currency permitted. The NEP presented a mixture of macro economic
stabalization and structural adjustment. The structural changes include change
in final demand, change in exports, change in import structure and change in
technology.

Inspite of the Indian economy responding vigorously and positively to the new
changes, it still suffers from certain issues. The major issues controlling Indian
economy comprise poverty, unemployment, inequalities in income distribution
and regional disparities.

2.11 Key Words

Emerging economy – The economy that registers high growth.
Liberalization – The process of removing controls and giving more freedom to
do business.
Privatization - The process of transferring government owned enterprises to the
private parties.
Globalization – The integration of national economy with global economy.
Inequalities – Disparity in the distribution of income and other national assets
between individuals and social groups.
Labour intensive activities – The activities that employ more labour such as
construction, textile, clothing, footwear, etc.

2.12 Answers to Check your Progress

A1 i) False ii) True iii) True iv) False v) False
B3 i) True ii) True iii) True iv) False v) True
2.13 Terminal Questions
1. “Indian economy is growing at an unprecedented rate”. Elaborate.
2. What do you mean by liberalization? Explain different types of
liberalization provided under the new economic policy.
3. Explain different steps taken for the globalization of the Indian economy.
4. “The concept of poverty is relative one”. Elaborate.
5. What is meant by inequalities in income distribution? How can it be
overcome?
6. What are the main causes of regional disparities? How can they be
overcome?
Unit-3: Growth: Pre & Post Reforms

Structure
3.0 Objectives
3.1 Introduction
3.2 Growth of the Indian Economy during Plans : Early Phase
3.2.1 Growth of Indian Economy in First Five Plan (1951-1956)
3.2.2 Growth of Indian Economy in Second Five Plan( 1956-61)
3.2.3 Growth of Indian Economy in Third Five Plan( 1961-66)
3.2.4 Growth Rate in Plan Holiday (66-69)
3.2.5 Growth Rate in Fourth Five Year Plan (1969-74)
3.2.6 Growth Rate in Fifth Five Year Plan (1974-78)
3.2.7 Growth Rate in Rolling Plan (1978-80)
3.2.8 Growth Rate in Sixth Five Year Plan (1980-85)
3.2.9 Seventh Five year Plan (1985-90)
3.2.10 Annual Plans:
3.3 An Assessment of Indian Economy before Economic Reforms
3.4 Economic reforms
3.4.1 Eighth Five Year Pan (1992- 1997) Reform Phase
3.4.2 Ninth Five Year Plan ((1997-2002)
3.4.3 Tenth Five Year Plan (2002-2007)
3.4.4 Eleventh Five-Year Plan (2007–2012)
3.4.5 Twelfth Five-Year Plan (2012-2017)
3.5 Growth of Indian Economy in Post Planning Era
3.6 Let us Sum Up
3.7 Key Words
3.8 Answers to Check your progress
3.9 Terminal Questions
3.0 Objectives
After going through this unit, you will be able to:

• Describe the growth of Indian Economy in Planning Era

• Discuss the growth of Indian Economy before Reforms
• Evaluate the progress of Indian Economy after reforms
• Explain growth of Indian Economy in Post Planning Era
3.1Introduction
During the struggle of India’s freedom, the leaders has committed that India
would after attainment of independence, launch a programme of planned
development of the country. In pursuance of this objective, the Indian National
Congress, in 1938, appointed the National Planning Committee with Jawaharlal
Nehru as the chairman to draft a plan for the development of India. The
Committee considered all aspects of planning and produced a series of reports
on various subjects related with economic development. The Chairman of the
Committee, Jawaharlal Nehru, became the first Prime Minister of India. His
ideas and the policies initiated for the planned development of India reflected
the consensus arrived at in the deliberations of the National Planning
Committee. The Committee rejected the Soviet model of total ownership of the
means of production by the state on the one hand and the free capitalist
enterprise model on the other hand. It opted for mixed economy framework as
the most suitable economic environment for India.
The Committee, therefore, felt that:
a) The state should own or control all key industries and services, mineral
resources, railways, water ways, shipping and other public utilities and, in
fact all those large scale industries which were likely to become
monopolistic in character. In other words, the Committee specified the
industries which were to be owned or controlled by the public sector;
b) The remaining industries were to be in the private sector, but could be
called upon to work in national interest. In case, the state at any stage felt
that the monopolistic activities of private businessmen worked against
national interest, it reserved the right to take over such industries;
c) The Committee strongly held the view that it was not possible to draw a
scheme of national planning without giving a primary place to
agriculture; and
d) The Committee aimed at doubling the standard of living of the people in
10 years.
The government, therefore, opted for mixed economy within the parameters laid
down in the Directive Principles of the Indian Constitution. The Directive
Principles stated:
“The State shall, in particular, direct its policy towards securing –
a) that citizens, men and women equally, have the right to an adequate
means of livelihood.
b) that the ownership and control of the resources of the community are so
distributed as best to subserve the common good.
 c) that the operation of the economic system does not result in the
concentration of wealth and means of production to common detriment.
The distinguishing feature of the Indian mixed economy was that it aimed to
deliberately enlarge the sphere of the public sector so as to cover areas of
defence, heavy and basic industries, infrastructure – both economic and social-
and public utilities. For development of the economy, the primary role was
given to the public sector. It was, therefore, referred to as the engine of growth.
The mixed economy framework did permit the private sector to operate in the
remaining areas. However, the state emphasised that private sector should
reconcile the element of self-interest with social interest. In-case, the private
sector failed to subordinate its greed for profit maximisation and continued
unbridled exploitation of the working masses, the state possesses the right to
take over the control of such sector(s) of the economy. The private sector had,
therefore, to work within the limits of a regulatory system so that it did not
seriously come in conflict with social interest. The state, following the Directive
Principles, decided to limit ownership in areas where it felt that ownership came
in conflict with social interest.
In agriculture, for instance, zamindari system was abolished and the ownership
of surplus lands acquired by the state after payment of compensation were
transferred to small farmers and/ or landless labourers. The legislation provided
for ceiling on holdings. The purpose of the agrarian legislation was that land
being the principal source of livelihood in rural areas, its ownership should be
more evenly distributed.
In the sphere of small scale industries, private ownership was accepted. The
state decided to facilitate the growth of such industries by providing credit and
marketing facilities. These industries were considered important from the point
of view of providing employment to a very large number of persons.
To direct investment in the desired lines of production, the state decided to
nationalise banking and insurance. If it is left to the private sector, investment
would be driven by market forces based on profit motive. But the areas of profit
maximization may not be areas of maximising social welfare. For example,
private sector was not willing to invest in economic infrastructure such as
multipurpose hydro-electric projects, irrigation, roads and communication.
Similarly, private sector may not provide adequate investment in education and
health facilities so that access to education and health facilities becomes
available to the poor and deprived sections of the society.
The state, therefore, decided to undertake the development of economic
infrastructure energy, irrigation, transport and communication – in the public
sector. It also sought to provide social infrastructure in the form of education
and health so that the poor are enabled to acquire these facilities either free or at
a very low and affordable cost. The network of schools, colleges, technical
training centres, primary health centres, dispensaries, hospitals, etc., has to be
planned in the public sector.

It was considered necessary that the public sector should undertake investment
in defence, heavy and basic industries. Since these industries required lumpy
investment and has a long gestation period, the private enterprise was unwilling
to undertake investment in these areas. It sought investment in areas of short
gestation and maximum profit. The state, therefore, planned the development of
defence, heavy and basic industries in the public sector.
The mixed economy framework in India was particularly marked with the
deliberate development of the public sector in (a) defence, heavy and basic
industries, (b) the development of economic and social infrastructure and (c) in
controlling the commanding heights of the economy, viz., banking and
insurance.
Thus, the environment provided by the mixed economy framework permitted
the co-existence of both the public and private sectors on an enduring basis.
Both had to work for the attainment of the socio-economic goals of planning.
In 1950, the Government of India set up the Planning Commission with the
objective of making an assessment of the resources of the country, both physical
and human and formulate a plan for the development of the country. The
Planning Commission laid down the long-term goals of planning. They were:
i) To increase production to the maximum possible extent so as to achieve
higher levels of national and per capita income;
ii) To achieve full employment;
iii) To promote industrialisation of the country with special emphasis on the
growth of heavy and basic industries so as to achieve self-reliance;
iv) To reduce inequality of income and wealth; and
v) To establish a socialist pattern of society based on equality and social
justice and absence of exploitation.
3.2 Growth of the Indian Economy during Plans: Early Phase
To solve the immediate problems of shortage of food and control of inflation,
the First Five Year Plan (1951 – 56) adopted the strategy to achieve food self-
sufficiency and also control inflation. For this purpose, it was decided to
increase irrigation. The strategy worked and India was able to reduce her
imports of food grains to just 0.5 million tonnes by the end of the year 1956. As
a result of increase in food grains production and utilisation of capacities in
industry, shortages of food grains and consumer goods were taken care of. This
helped the country to stabilise the price level and control inflation. Thus the
country at the end of the First Plan presented a picture of an economy which
had overcome shortage of food and brought about price stability. This provided
a climate for adopting a strategy for industrialisation of the economy.
The strategy emphasised the rapid development of heavy industry so as to build
an industrial base of the economy. The objective was to make the economy self-
reliant in terms of the capital –goods sector. Arguing for the acceptance of the
strategy, the Second Five Year Plan stated:
“In the long run, the rate of industrialisation and the growth of the national
economy would depend upon the increasing production of coal, electricity, iron
and steel, heavy machinery, heavy chemicals and heavy industries generally –
which would increase the capacity for capital formation. One important aim was
to make India independent as quickly as possible of growth of producer goods
so that the accumulation of capital would not be hampered by difficulties in
securing suppliers of essential producer goods from other countries. The heavy
industry must, therefore, be expanded with all possible speed.”
The main arguments which provided justification for heavy industry strategy
were:
a) The British rule deliberately denied the development of heavy industry
and kept India, primarily an agrarian economy as an appendage of the
British colonial system.
b) Indian industrial structure had a narrow base, mainly dependent on
consumer goods industries. It was necessary to enlarge this base by the
development of heavy industries and infrastructure. A diversified
industrial structure, it was argued, could absorb a large proportion of
labour force. This would also reduce dependence of excessive population
for its livelihood on agriculture.
c) Productivity of labour being higher in manufacturing than in agriculture,
and industrialised economy promised to bring about a rapid increase in
national and per capita income.
d) Rapid industrialisation was essential, not only for the development of
agriculture, but also for development of all other sectors of the economy.
Role of public and private sector - Since the private sector was not likely to
undertake investments in heavy industry sector which has a long gestation
period, but had low profitability, the government decided to give this
responsibility to the public sector. The government conceived of the public
sector as the engine of growth of heavy industries and infrastructural facilities.
The role of the private sector was complementary to the public sector in
expanding the production of consumer goods and such other areas in which
public sector investment was directed.
However it was realized that overemphasis on the heavy industry sector, would
not enlarge employment significantly, since such investments are capital
intensive. It would, therefore, be necessary that in order to encourage the
production of consumer goods and generate more employment, investment be
made in small industry.
However, there were certain shortcomings noticed in the process of
implementation:
1. Although agriculture did progress, but with relatively small allocation for
agriculture, the progress could not be considered adequate. Development
of agriculture required greater investment in irrigation, electricity,
fertilisers, implements, pesticides etc.
2. Heavy industry strategy was heavily dependent on imports for capital
intensive goods. It, therefore, developed a capital – intensive pattern of
development. This resulted in a relative neglect of small industries and
industries producing consumer goods. Thus, heavy industry strategy
created balance of payments difficulties on the one hand and failed to
absorb the rapidly growing labour force, on the other. This resulted in a
failure to enlarge employment adequately.
3. The public sector expansion led to the emergence of high cost economy
with much less emphasis on efficiency. Both the undertakings of the
Central Government and those of the State Government like state
electricity boards, road transport undertakings and irrigation works etc.
incurred losses year after year and the state exchequer was required to
pay these losses out of the general tax revenues of the government.
4. Failure of exports to rise commensurate with the increase in imports
necessitated by the expansion of the capital goods sector, resulted in the
persistence of trade deficits and these deficits increased in magnitude
with every successive plan.
Achievements and Failures of Planning during 1951 – 1990
As a result of 40 years of planning, Indian economy recorded progress on
various fronts. It would, therefore, be desirable to list the major achievements of
the Indian economy:
1. Growth of national and per capita income: During the first 30 years (1950
– 51 to 1980-81), national income grew at an average rate of 3.4 per cent per
annum, but per capita income grew barely by 1.2 per cent per annum. In terms
of raising the level of living of the poor, this was not sufficient. However,
compared to the British period (1900-1950), when national income increased
merely at the rate of 0.5 per cent annually, the achievement in the planning
areas is significant.
Table 3.1: Growth of national and per capita income (At 1980-81 prices)
Compound Annual Net National Product Per Capita Income
Growth Rate
1950 – 51 to 1960-61 3.8 1.8
1960-61 to 1970-71 3.4 1.2
1970-71 to 1980-81 3.0 0.7
1950-51 to 1980-81 3.4 1.2
1980-81 to 1990-91 5.4 3.2
Source: CSO, National Accounts Statistics
The economy showed a much better performance during 1980-81 to 1990-91
and the national income grew at the rate of 5.4 per cent annually, and this
helped to push up the growth rate of per capita income of 3.2 percent per annual
which was quite significant. There is a need to not only maintain high growth
rate of national income, but also to raise it further, if serious impact on the level
of living has to be made.
2. Growth of savings in India : The rate of saving in India was just 10.4
per cent of gross domestic product in 1950-51 and as a result of 40 years
of planning, the rate of savings reached a fairly high level of 24.3 per cent
in 1991-92. This is a matter of great satisfaction for the economic
development of the country.
3. Rise in per capita cereal consumption: The per capita cereal
consumption which was just 334 grams per day in 1951 increased to 471
grams in 1991 – a rise by 41 per cent. This is a matter of satisfaction, but
unfortunately, the per capita availability of pulses declined from 61 grams
to 40 grams per day. However, the overall availability of food grains
showed an improvement.
4. Improvement in the per capita consumption of several basic
consumer goods: During 1950-51 to 1990-91, per capita consumption
of edible oils and vanaspati increased from 3.1 kgs. To 6.4 kg. The per
capita consumption of mil improved form 47kgs. In 1950-51 to 66.5 kgs.
In 1990-91. The per capita consumption of cloth increased from 11
meters in 1951 to 30 meters in 1991. It may be noted that there was a
much greater use of man-made fabrics by the people which has greater
durability.
 Besides this, there was much greater use of the amenities of life by a
large proportion of the population. The use of bicycles, electric fans,
sewing machines, refrigerators, scooters and mopeds, passenger cars, dry
cells, radios and television etc. enriched the life of the people.
On the basis of the above analysis, it can be concluded that there has been
increase in the consumption of necessaries of life by the common man,
though it may not be equally spread over all regions and groups.
5. Impressive industrialization action of capital goods sector with the
help of the public sector: During the British period, capital goods sector
was not developed at all. Some consumer goods industries such as
matches, sugar, cotton textiles, paper jute etc. were permitted to grow
under the umbrella of protection. It was, therefore, essential that in a
programme of industrialisation of the economy, the capital goods sector
be developed. For this purpose, since private sector was not forthcoming
to undertake heavy investment in capital goods industries, the
responsibility was given to the public sector. As a consequence, heavy
goods industries like steel, cement, locomotives, engineering, machine
goods, defence industries, air craft manufacture, shipping were
developed. Power and transport development was also accelerated. As a
consequence, with an impressive industrialisation of the economy, India
was able to provide an industrial base to its economy.
6. Development of economic infrastructure: Another important
achievement of vital significance is the creation of economic
infrastructure in the form of energy, transport and irrigation which
provided the base for a programme of industrialisation. In 1950-51, road
length in India was 400 thousand kms. and this increased to 1,770
thousand kms. by 1984-85 – a more than fourfold increase.
Similarly, there has been a rapid increase in irrigation, In 1950-51, the
total irrigated area was only 22.6 million hectares and b 1991-92, this
increased to 72.8 million hectares. As a percentage of gross cropped areas
, as against 16.7 per cent in 1950-51, irrigated area accounted for 31 per
cent in 1991-92. This sharp increase in irrigation potential gave a big
boost to increase production in agriculture.
There has been a tremendous increase in power generation and
consumption of energy. Electric energy generation was merely 6.6 billion
kWh in 1950-51 and it increased to 269.4 billion kWh in 1990-91. This
was a tremendous achievement. Consequently, our production potential in
agriculture, industry and service sector was considerably enlarge. Per
capita consumption of electric energy has also risen from 13.2 kWh in
195-51 to 220 kWh in 1990-91. This strengthened the infrastructure of
the economy.
 7. Achievement of self-sufficiency in food grains and raw materials:
With the development of irrigation facilities, it was possible to undertake
application of high yielding varieties (HYV) of seeds with chemical
fertilizers. This water-seeds-fertilizer technology in agriculture, popularly
known as green revolution helped to boost the production of food grains
from 55 million tonnes in 1950-51 to 176 million tonnes in 1990-91. As a
consequence, India became self-sufficient in food grains and stopped
imports of food grains. Not only that substantial increased in production
of sugarcane, jute, cotton etc. were also achieved. This helped to reduce
our dependence for agricultural raw materials on foreign countries and
encouraged the production of our agro-based industries.
8. Diversification of industrial structure: There has been a rapid
diversification of industrial infrastructure in India during the 40-year
period. New industries such as steel, cement, machine tools, petroleum
refining, fertilizers, power transformers, locomotives, tractors,
commercial vehicles, diesel engines, dry cells, drugs and chemicals have
sprung up. These industries were either in a state of infancy or had not
been started in the pre-independence period. This has meant a
diversification of industrial structures. All these industries required
trained scientific and technical personnel to manger them. India has
developed a very large technical and managerial cadre to meet the needs
of a diversified industrial structure. It is claimed that India has the fourth
largest pool of technical manpower in the world. This has reduced our
dependence on foreign experts. Not only that, India has started exporting
experts in engineering and technology to Middle East and African
countries. This is matter of legitimate pride for our country.
9. Diversification of exports and import substitution: As a result of
industrialisation, India’s dependence on foreign countries for the import
of capital goods had declined. Similarly, a large number of consumer
goods imported earlier are being produced within the country. This has
led to import substitution. Consequently, the composition of our exports
has changed in favour of manufactures, mineral ores and engineering
goods. The share of raw materials has considerably declined. This is an
index of the industrialisation of our economy.
To conclude, it may be stated that India made significant achievements during
40 years of planning. These included growth of national and per capita income,
a sharp increase in rate of saving, the development of economic infrastructure in
the form of energy, irrigation, transport and power generation, attainment of
near self-sufficiently in food grains and agricultural raw materials,
diversification of industrial structure, more especially the capital goods sector,
the achievement of a substantial degree if import substitution in capital and
consumer goods sector. Besides, it was able to develop a large pool of technical
manpower – the fourth largest in the world to manage the diversified industrial
structure developed in India.

3.2.1 Growth of Indian Economy in First Five Plan (1951-1956)

The First Five-year Plan was launched in 1951 which mainly focused in the
development of the agriculture. The First Five-Year Plan was based on
the Harrod–Domar model.
The target growth rate in National Income was 2.1% annual gross domestic
product (GDP) growth; the achieved growth rate was 3.6%. The performance
was commendable by assessing growth before 1947. Many capital intensive
irrigation projects were initiated first time during this period in India. These
were the Bhakra, Hirakud, Mettur Dam and Damodar Valley dams. During this
plan foundation for five Indian Institutes of Technology (IITs) were also laid as
major technical institutions. The University Grants Commission (UGC) was set
up in 1956. The objective of UGC was to take care of funding and take
measures to strengthen the higher education in the country. Contracts with
foreign countries were also signed to start five steel plants, which came into
existence in the middle of the Second Five-Year Plan. In first five year plan,
foundation for economic development was laid by initiated major irrigations
and steel plants

3.2.2 Growth of Indian Economy in Second Five Plan (1956-61)

The Second Plan was more ambitious as compared to first five year plan and
focused on the development of the public sector for "rapid Industrialisation".
The plan followed the Mahalanobis model. The target growth rate of National
Income in Second Plan was 4.5 per annum but plan was able to achieve 4
percent
Heavy capital investment was done in setting up hydroelectric power projects
and five steel plants at Bhilai, Durgapur, and Rourkela. These were established
with the help of Russia, Britain (the U.K) and West Germany
respectively. Coal production was increased. More railway lines were added in
the north east.
The Tata Institute of Fundamental Research and Atomic Energy Commission of
India were established as research institutes. The foundation for developing
capital intensive public enterprises was laid during second five year plan.
Second plan was very ambitious plan and foundation of modern India through
industrialization was laid. In second plan industrial growth rate was 8 percent
and major steel plants with foreign collaboration were set up during this plan.
These plants were essential for sustained industrial development in the country.
3.2.3 Growth Rate in the Third Five Year Plan (1961-66)
The Third Five-year Plan focussed on agriculture and improvement in the
production of wheat, but the brief Sino-Indian War of 1962 exposed weaknesses
in the economy and shifted the focus towards the defence industry and the
Indian Army. In 1965–1966, India fought a War with Pakistan. During third
plan, there were not only two wars but there was also a severe drought in 1965.
The war led to inflation and the priority was shifted to price stabilisation. The
construction of dams continued. Many cement and fertilizer plants were also
built. Focus on capital intensive public enterprises continued in third plan
also Punjab began producing an abundance of wheat. This was due to focus on
agriculture
The target growth rate in National Income in National Income was 5.6%, but
the actual growth rate was 2.4%, which was very low against the target.
Inflation rate was also very high during the third plan, national income at 1960-
61 prices rose by 20% in the first four years and recorded a decline of 5.6% in
the last year of the plan. As compared to first and second five year, third plan
was not able to achieve desired results. Two wars and severe drought further
forced up to think the need of self-reliance approach by further shifting focus on
agriculture
3.2.4 Growth Rate in Plan Holiday(66-69)
Due to miserable failure of the Third Plan due to severe drop in agricultural
production and outbreak of 1962 and 1965 wars, it became imperative for the
government to declare "plan holidays" (from 1966 to 1967, 1967–68, and
1968–69). Instead of five year plan, three annual plans were drawn by the
government during this period. The problem of drought continued during
1966–67 there was again drought in the country. Equal priority was given to
agriculture, its allied activities, and industrial sector. The New Agricultural
Strategy was adopted in 1966. The government of India also first time focussed
on increasing exports and "Devaluation of Rupee” was declared in 1966 to
increase the exports of the country. The main reasons for plan holidays were the
war, lack of resources and increase in inflation.
During the three year interruption between the Third plan end and finalisation of
the Fourth plan, which is between 1966-67 and 1968-69, national income
continued to follow uneven pattern. The growth rate in national income was
nominal at 0.9% only in 1966-67 in the wake of a severe drought, followed by a
magnificent growth of 9% induced by a record increase in agricultural output in
1967-68 and only a modest increase of 1.8% in 1968-69.
3.2.5 Growth Rate in Fourth Five YearPlan (1969-74)
The Fourth plan, aims for higher economic growth. The fourth plan took long-
term view of fifteen years for economic growth. The long-view of economy was
termed as ‘Perspective Planning by the Planning Commission. The planned
average rate of growth was 5.7% for the Fourth plan period, 6.2% for the seven
year period 1974-75 to 1980-81 and 6.5% thereafter. At the same time the rate
of growth of population was postulated to decline from the estimated 2.5%
during the fourth plan to 1.7% by 1980-81. This fall in the population growth
rate was based on the success of the family planning programme. As a result of
this success, it was thought that birth rate would decline from 14 per 1000 of
population to 9 over the same period.
The major objective of plan was on the removal of poverty. It was quite clear
that increase in domestic output will come mainly from agriculture and
therefore, had to be given top priority in the Fourth plan. “New Agriculture
Strategy”, which was adopted during 1966, to increase agricultural output
continued in the Fourth Plan.
The annual economic growth rate during the fourth plan period (1969-1974)
was of the order of only 3.4% per annum, thus showing a substantial shortfall in
the targeted rate of growth 5.6%. This was due to the poor performance of the
agricultural economy. The growth rate in food-grains production which is the
important single determinant of economic growth rate. The sluggish growth
registered during the fourth plan was due to serious shortfalls in achievement of
the target for food grains and agricultural production and number of other
crucial industrial sectors.
3.2.6 Growth Rate in Fifth Five YearPlan (1974-78)
In the fifth five year plan (1974-79) the target for growth in national income
was 4.4 percent.This was lower than fourth five plan ( 5.6%) because of the oil
crisis and unprecedented inflation that occurred in subsequent year. The plan
was terminated in 1978 because of change in Government. But plan was able to
achieve 5.2% growth rate.
Table -3.2 Details from First Five Year Plan to Fifth Five Year about targeted
growth rate and actual rate of growth achieved during these plans

Table 3.2: Targeted and Actual Growth Rates

Plan Target Actuals Growth rate for

First Plan 2.1 3.6 National income
Second Plan 4.5 4.0 National income
Third Plan 5.6 2.2 National income
Fourth Plan 5.7 3.3 Net domestic
 product
Fifth Plan 4.4 5.2 Gross domestic
product
Source: Draft Fifth Plan
The overall growth performance of the national economy under the various
plans is portrayed by the above table which shows that apart from first and fifth
plan, when the actual growth rates for national income far exceeded the targeted
rates, in all other plans, there was a wide gap between the two. Except for the
Third plan when the economic performance was hardly hit by drought, the rate
of growth has ranged between 3% and 5% which can be considered no mean an
achievement in itself, but is far less than what is desired.

3.2.7 Growth Rate in Rolling Plan (1978-80)

After the Janta party came in power in the year 1977 it terminated the 5th five
year plan before its completion and instead launched yearly plans for the period
1978 – 83 which were called “Rolling Plans”. It was called “Rolling Plan”
because it was decided to assess the performance of the plan every year and a
new plan will be launched next year with modification, it necessary.

The main advantage of the rolling plans was that they were flexible, and if
necessary, the targets, projections and allocations could be revised as per the
prevailing conditions.. Thus in contrast to the five year plans, in case of the
rolling plans the yearly reviews were made.

It was realized later that in case the targets being revised each year, it was
difficult to achieve targets which required longer periods. Furthermore, frequent
revisions made it difficult to maintain right balances in the economy which was
absolutely necessary for a balanced development. After the Janta party
government, the new government shelved the concept of rolling plans and
resumed the customary five year plans and the new 6th Five year plan was
launched on April 1, 1980.

3.2.8 Growth Rate in Sixth Five Year Plan (1980-85)

The sixth five year plan was again taken long term perspective of fifteen years
from 1980-81 to 1994-95.The plan was formulated by considering the
achievements and shortcomings of the earlier plans. This vision visualizes
accelerated progress towards the removal of poverty and generation of gainful
employment.
A large number of social and economic indicators have been used in
formulating the perspective development strategy. These were conventional
national income aggregates like Gross Domestic Product (GDP) consumption,
saving and investment, employment, per capita income and consumption. Other
social welfare indicators were number of people below the poverty line, per
capita consumption basket, life expectancy, etc.
The sixth plan aimed at a growth in gross domestic product of 5.2% a year and
per capita income 3.3% per annum. By 1984-85 per capita income was expected
to reach Rs 1,744 at 1979-80 prices as compared with Rs 1,488 in the base year.
Table 3.3: Development Perspective 1979-80 to 1994-95: Selected
Economic and Social Indicators

S.No Item 1979- 1984- 1994-95

80 85

1 GDP ( Rs Crore at 1979-80 prices) 97051 125050 213600

2. Saving as per cent of GDP at market 21.24 24.48 27.52
prices
3. Investment as per cent of GDP at 21.76 25.11 25.92
market prices
4. Population (millions) 654.1 712.2 843.0
5. Per Capita GDP Rs.p) 14.85 17.44 25.34
6. Per Capita monthly consumption (Rs) 95.62 109.67 151.98
(2.79) (3.32)
7. Percentage of people below poverty 48.44 30.00 8.74
line
8. Employment (Millions, standard person 151 185 248
years)
9. Monthly per capita consumption of 12.95 14.32 15.50
food-grains
(Kg.) (2.03) (0.80)

10. Monthly per capita consumption of 0.68 0.79 1.15

 sugar (kg.)
(3.00) (3.82)
11. Monthly per capita consumption of
clothing
(metres) 0.85 0.92 1.41
(1.60) (4.36)
12. Monthly per capita consumption of
electricity
(Kwh) 14.27 22.19 39.05
(9.23) (5.81)
13. Value added in education per capita 20.32 24.72 36.60
(Rs)
(4.00) (4.00)
14. Life expectancy (Year ) M 52.6 55.1 60.1
F 51.6 54.3 59.8

Note: Figures in brackets represent annual compound growth rate.

Source: Draft Fourth Five Year Plan
Although the broad target of the growth rate, which was 5.2%, was achieved,
yet this was mainly due to higher output in agriculture which was 4.3% while
the target was 3.8%. It was also due to the rapid growth of the services sector.
Removal of poverty and unemployment were crucial components of the strategy
for growth with equity and they were unequivocal objectives of the Sixth plan.
Information on the incidence of poverty is available from quinquennial surveys
conducted by the National Sample Survey Organisation and the relevant
estimates based on the last two surveys are summarised in table 3.4.
Table 3.4: Trends in Percentage of People below Poverty line

Percentage of 1977-78 1983-84

population (Provisional)
 below the poverty line
Rural 51.2 40.4
Urban 36.2 28.1
Total 48.3 37.4
Source: Draft Sixth Five Year Plan
Thus there has been a decline in the incidence of poverty in this period. The
main reasons for this welcome trend are the higher rates of economic growth
and the increases in agricultural production.

3.2.9Seventh Five year Plan(1985-90)

The objectives of Seventh Plan were set within the framework of, growth,
equality and social justice and the pursuit of self-reliance. The planned growth
rate was targeted to increase gross national industrial and agricultural output by
38 percent within five years, or by an average annual rate of 6.7 percent, gross
agricultural output by 4 percent a year, and gross industrial output by 7.5
percent. To increase gross national output by 44 percent within five years, or by
an average annual rate of 7.5 percent.
The employment creation was one of the major objective in the seventh plan.
This was linked with a significant reduction in poverty. These objectives would
have been achieved through agricultural and rural development and of larger
food production.
Poverty alleviation was continued to be one of the basic components of the
seventh plan strategy and aim was to reduce the percentage of the population
below the poverty line to 23%, i.e., a reduction by 14%. This was combined
with long-term perspective of reducing poverty to around 10% of the population
by 1994-95.
Output value of the primary industry increased at an annual growth rate of 4.1
percent, the secondary industry at a rate of 17.3 percent, and the tertiary
industry at a rate of 9.5 percent. Output composition of the three sectors stood at
20.3: 47.7:32.0; it was 28.4:43.1:28.5 at the end of the 6th, and 27.1:41.6:31.3 at
the end of the 7th Five-Year Program periods respectively
3.2.10 Annual Plans:
Eighth Five Year Plan could not take place due to the volatile political situation
at the centre. Two annual programmes were formed for the year 1990-91&
1991-92.

Check Your Progress A

 1. Which sector was mainly emphasised on in the first five year plan?
2. What was the main drawback of overemphasis on heavy industries in the
second five year plan?
3. Which of the following statements are true or false?
a) After independence the government decided to follow the
Soviet Model of economy in total.
b) The planning committee felt that agriculture should be given the
primary place in planning.
c) After independence India followed mixed economy framework.
d) The public sector gave opportunity for healthy competition in the
production of consumer goods.
e) During 1951-1991 per capita cereal consumption increased.

3.3 An Assessment of Indian Economy before Economic Reforms

As a result of the various five year plans, performance of the Indian economy
during the last four decades of planning has been significant. The major
achievement of our planning process has been that the country’s economy has
been freed from shackles of prolonged stagnation from 1900-1947 and launched
on the path of growth. The growth of GDP which was around 3.5% a year
between 1960-61 and 1977-78 moved to a much higher path of 5% during the
sixth and seventh plan period.
This was also reflected in the transformation of a traditional economy into an
industrial economy. There was a rapid and almost continuous growth in
industrial production during the first 15 years of the planning period. In the first
decade of planning, 1951-60, the rate of growth of industrial production was
7%. During the next five years it increased to around 9%. Due to various factors
the industrial growth rate slide back in the subsequent period when the average
annual growth rate was 4% during 1965 to 1975. Subsequently there was
notable recovery in the rate of industrial growth and during the period 1979-80
to 1984-85 compound growth rate of 5.5% was achieved. This has been
sustained during the seventh plan period. Thus a solid foundation for
industrialisation and its diversification of economy from traditional economy to
modern economy has been laid. This was a achievement keeping in mind that
India has adopted democratic system.
The overall growth rate of the Indian economy has substantially improved since
the beginning of the eighth plan period. India was able to create considerable
level of infrastructure inagriculture. India almost achieved self-sufficiency in
industrial growth in addition each and every year, we were making investment
in heavy industry. This kind of investment was thought to be vital for the
strategic growth of the economy in recent years, the availability of consumer
durable goods has also substantially increased. For removal of poverty and
social inclusiveness in the matter of social justice, various steps have been taken
under different plans as a result of which the number of persons living below
the poverty line has substantially come down.
Although, it was felt that there are also some serious concern at the emerging
pattern of development in the country. These could be divided into structural
and some were immediate, which were requiring immediate attention. Some of
the major a concern are as follows:
i. Overall employment has grown at a slower rate than labour force.
The problem of unemployment, underemployment and disguised
employment was continuing
ii. The overall growth of agricultural production was
concentrated in certain parts of the country. There has also been
growing awareness of the divide between rural and urban areas and
of disparities between different parts of the country. This disparity
was visible between different social groups, wage labourers and
property owners, workers in organised and unorganised sectors and
men and women in employment and sustainable development
process.
iii. Public sector performance was disappointing and majority of the
public enterprises were incurring huge losses because of inefficient
management.
iv. Balance of payment ( BOP) was also not favourable because of
excessive imports and less exports . Exports were less due to the
low quality and high prices of our goods as compared to that of the
foreign goods
v. There was a decline in foreign exchange reserves. It was not
sufficient enough to maintain fifteen days imports. The government
was not in a position to repay its borrowings from abroad.
vi. Government debt also increased substantially and domestically
government expenditure increased in large proportion as compared
to revenue. It became essential for government to borrow money
from banks, public and international financial institutions like the
IMF, etc. India received financial help of $7 billion from the World
Bank and the IMF on an agreement to announce its New Economic
Policy or Economic Reforms
3.4 Economic reforms It refers to the fundamental changes that were launched
in 1991 with the plan of liberalising the economy and quickening its rate
of economic growth. ... The essential features of the economic reforms are
– Liberalisation, Privatisation, and Globalisation, commonly known as LPG
The main characteristics of new Economic Policy 1991 are:
• Delicencing. ...
• Entry to Private Sector. ...
• Disinvestment. ...
• Liberalisation of Foreign Policy. ...
• Liberalisation in Technical Area. ...
• Setting up of Foreign Investment Promotion Board (FIPB). ...
• Setting up of Small Scale Industries.

The entire process, meaning and need for reforms also New Economic Policy
1991 have been summarized in diagram 1
3.4.1 Eighth Five Year Pan (1992- 1997) Reform Phase
The eighth plan approach paper has projected a 5.6% per cent Gross Domestic
Product (GDP). It assumes a domestic saving rate of 21.6 per cent of GDP and a
foreign resource inflow of Rs 49,000 crore (1.4 per cent of GDP). Export
growth rate has been estimated at 13.6 per cent per year. The incremental capital
output ratio (ICOR) has been assumed as 4:1. (Approach paper of Eight Five
Plan 1991).
Significant achievements were also made in the reform of the economic system.
The new financial system with tax decentralization at its core, and the new tax
system with value-added tax as its main component, were set up. Policy finance
and commercial finance were gradually separated. A macro regulating system
emerged, and the market started to play a more major role in resource
allocation. Also mapped out were the beginnings of a dominant public sector.
The growth rate in eight five year plan was 6.6 percent. This was higher than
the projected growth rate of 5.6%. There was a substantial growth in
agriculture, industry and services. The agricultural sector grew at the rate of
4.69 percent, manufacturing at the rate of 7.58 percent and services 7.45
percent. Table 4
3.4.2 Ninth Five Year Plan ((1997-2002)
The rate of growth of GDP during the ninth plan dropped to 5.3 percent from
6.6. The rate of growth declined particularly in the agriculture and
manufacturing sectors, whereas in the services sector there was a marginal
increase in the growth rate.
The GDP from agriculture alone declined by 0.4 per cent in 2000-01 compared
with an increase of1 per cent in 1999-2000. According to the quick estimates of
national income for 2000-01 provided by the Central Statistical Organisation on
January 31, 2002, the overall GDP growth rate decelerated significantly from
6.1 per cent in 1999-2000 to 4 per cent in 2000-01. The gross value added in
agriculture and allied sectors declined by 0.2 per cent in 2000-1 compared with
an increase of 1.3 per cent in 1999-2000.
Within the industry sector, there was marked improvement in the growth rates
of manufacturing (from 4.2 per cent in 1999-00 to 6.7 per cent in 2000-01) and
mining and quarrying (from 2 per cent to 3.3 per cent during the same period)
Growth rates of services sector decelerated significantly in 2000-01. In
particular, the growth rate of trade, hotels and restaurants reduced considerably
from 7.3 per cent in 1999-2000 to 3.8 per cent in 2000-01, while the growth of
transport storage and communications remained almost unchanged at around 8.2
per cent during 1999-00 and 2000-01.
Financial, real estate and business services performed poorly with growth rate
of only 2.9 per cent in 2000-01 compared with a growth rate of 10.6 per cent in
1999-00.
Table 3.4 provides a comparative growth of Indian Economy during Eighth and
Ninth Plans

Table 3.5: Growth of Indian Economy during Eighth and Ninth Plans:

(per cent Per annum)

Eighth Plan Ninth Plan

Agriculture 4.69 2.06

Manufacturing 7.58 4.51

Services 7.54 7.78

Total 6.68 5.35

3.4.3 Tenth Five Year Plan (2002-2007)

This plan aimed to double the Per Capita Income of India in the next 10 years. It
also aimed to reduce the poverty ratio to 15% by 2012 by reducing poverty ratio
by 5 percentage points by 2007. The target for growth rate was 8.1% GDP
growth per year.

The plan also focussed on providing gainful and high-quality employment at

least to the addition to the labour force. The plan also aimed at reduction in
gender gaps in literacy and wage rates by at least 50% by 2007. The Tenth Plan
was expected to follow a regional approach rather than sectoral approach to
bring down regional inequalities. The plan was able to achieve the growth rate
of 7.7 percent against the target growth of 8.1%.
The primary aim of the 10th Five Year Plan is to renovate the nation
extensively, making it competent enough with some of the fastest growing
economies across the globe. It also intends to initiate an Economic growth of
10% on an annual basis. In fact, this decision was taken only after the nation
recorded a consistent 7% GDP growth, throughout the past decade.

The 7% growth in the Indian GDP is considered to be considerably higher than

the average growth rate of GDP in the world. This enabled the Planning
Commission of India to extend the GDP limit further and set goals, which will
drive India to become one of the best industrial countries in the world, to be
clubbed and recognized with the world’s best industrialized nations.

3.4.4 Eleventh Five-Year Plan (2007–2012)

The aim of Eleventh Five-Year Plan was to accelerate GDP growth from 8% to
10% and then maintain at 10% in the 12th Plan in order to double per capita
income by 2016–17 and to ensure higher growth rate plan also focus to increase
agricultural GDP growth rate to 4% per year to ensure a broader spread of
benefits. The target growth rate was 8.4 percent but actual growth achieved was
7.9 percent.

The Economic Survey 2012-13, reveals that the growth rate of GDP at 2004-05
prices was 9.7 per cent in 2007-08, 6.5 per cent in 2008-09, 8.6 per cent in
2009-10, 8.8 per cent in 2010-11 and 6.4per cent in 2011-12. GDP growth rate
is likely to average 8.0 per cent over Eleventh Plan.

Thus during last two years, the plan experienced a slow growth rate as a result
of global economic slowdown.

The Economic survey, 2009-10, observed in this connection, the fiscal year
2009-10 began as a difficult one. There was significant slowdown in the growth
rate in the second half of 2008-09, following the financial crisis that began in
the industrialized nations in 2007 and spread in the real economy across the
world. The growth rate of the gross domestic product (GDP) in 2008-09 was 6.7
per cent, with growth in the last two quarters (of 2009-10) hovering around 6
per cent.

The continued recession in the developed world, for the better part of 2009-10,
meant a sluggish export recovery and a slowdown in financial flows into the
economy. Yet, over the span of the year, the economy posted a remarkable
recovery not only in terms of overall growth figures but, more importantly, in
terms of certain fundamentals, which justify optimism for the Indian economy
in the medium to long term.
On 24th March 2010, a meeting of the full Planning Commission conducted a
mid-term review of the Eleventh Five Year Plan and lowered Indian’s targeted
growth of 9 per cent per annum because of past performances and prevailing
situations.

The appraisal document which was placed in the meeting stated that “the
average rate of growth in the plan period could be a little over 8 per cent.
The economy would be well positioned for the transition to a growth rate
higher than 9 per cent in the Twelfth Plan period.”

Thus at the end of the Eleventh Plan, it is stated that although the draft plan set
the target of attaining 9.0 per cent annual average growth rate of GDP but it
could manage to attain annual average growth rate of 7.7 per cent during the
Eleventh Plan under the prevailing global economic environment. While this is
well behind China’s average growth of 10.4 percent over the past decade

3.4.5 Twelfth Five-Year Plan (2012-2017)

The 12th five year plan (2012-17) document that seeks to achieve annual
average economic growth rate of 8.2 per cent, down from 9 per cent envisaged
earlier, in view of fragile global recovery. 12th five-year plan is guided by the
policy guidelines and principles to revive the following Indian economy, which
registered a growth rate of meagre 5.5 percent in the first quarter of the financial
year 2012-13.

The plan aims towards achieving a growth of 4 percent in agriculture and to

reduce poverty by 10 percentage points by 2017. The main aim of this plan is to
achieve Faster, More Inclusive and Sustainable Growth. In 2014, there was a
change in government and five year planning was suspended. 1 January 2015, a
Cabinet resolution was passed to replace the Planning Commission with the
newly formed NITI Aayog (National Institution for Transforming India).
3.5 Growth of Indian Economy in Post Planning Era
The growth rate was 6.6 per cent in 2014 in the last year of terminated twelfth
five year plan . This was lower than the targeted economic growth 8.2 percent.
During 2015, there was an increase in growth rate from 6.6 percent to 7.3
percent. The trend of increase in growth further continued and GDP growth rate
increased to the level of 8 percent in 2016. The growth rate was again declined
to 7.1 percent in 2017 and 6.7 percent in the financial year 2018. The economy
slowed in 2017, due to shocks of "demonetisation" in 2016 and the introduction
of the Goods and Services Tax in 2017.
In 2019-20 the Indian economy grew by 4.2 percent . Economic growth slowed
to an 11 –year low of 4.2 % in 2019-20. In last quarter of 2019-20, January-
March , the growth rate of Gross- domestic Product (GDP) fell to 3.1 percent,
reflecting the impact of the first week of the COVID-19 lockdown which began
on March 25 .
The impact of COVID -19 and lockdown was severe and this has impacted
growth rate badly. First time growth rate was in broad negative range. The
provisional estimates of national income released by the National Statistical
Office (NSO) on May 31, 2021 placed India's real gross domestic product
(GDP) contraction at 7.3 per cent for 2020-21, with GDP growth in Q4 at 1.6
per cent year-on-year (y-o-y).

The measures of complete lockdown taken by the government to contain spread

of the Covid-19 pandemic have had negative impact on the economic activities.
The coronavirus pandemic is the largest public health crisis in living memory,
which has generated a major economic crisis unarguably for every sector of a
economy, with a halt in production, collapse in consumption and confidence.
Hotel industry, tourism sector and logistic have witnessed a sharp drop in
business. The cash –flow has affected the purchasing capacity also having a
cascading effect across the value chain.

Consumer goods, garments, footwear, utensils, automotive segments were

directly impacted by the crisis. Sectors, which were dependent on high imports
of raw materials were also impacted by the crisis.

Meanwhile, the third quarter GDP data released by the National Statistical
office( NSO) showed that the Indian economy came out of the recession and
expanded by 0.4 per cent. The economy had contracted by a record 24.4 per
cent in the first quarter the current financial year due to the coronavirus
pandemic and consequent lockdowns. However, the contraction narrowed to 7.5
per cent in the second quarter as economic activity picked up.

RBI estimated that Indian Economy will attain growth rate of 9.5 percent in
2021-22. Earlier this estimate was 10.5% but due to second wave again, RBI
revised estimate to 9.5%.

Domestic credit ratings agency Crisil has revised India's real GDP growth
projection for 2021-22 downwards to 9.5 per cent from 11 per cent estimated
earlier. The downward revision has been attributed to the decline in private
consumption and investments following the second wave of Covid-19.
Though the ride had been bumpy over the past two years after 2019, the Indian
economy managed to be labelled as the fastest growing economy of the world in
2018. The World Bank has forecasted that India’s economy is all set to grow at
a rapid pace than the other major economies of the world. Now India economy
is the third largest in Asia and the trends seen at present can move Indian
economy to the upper slots in the years to come. A significant recovery in
private instruments and a strong growth in the consumption of goods and
services in the private sector is expected to fuel the growth of Indian economy
over the next few years.

The economy of India is now regarded from low income and developing
economy to a middle income developing market economy. Indian economy is
now classified as the world's sixth-largest economy by nominal GDP and
the third-largest by purchasing power parity (PPP) by International Monetary
Funds and other credit agencies .
The long-term growth perspective of the Indian economy remains positive due
to its young population and corresponding low dependency ratio, healthy
savings, and investment rates, increasing globalisation in India and integration
into the global economy.
Check Your Progress B
1. Which of the following statements are True or False?
a) Before economic reforms, employment grew at a faster rate than the
labour force.
b) Public sector performance was disappointing.
c) Before the economic reforms, balance of payment situation was quite
favourable.
d) The emphasis of the economic reforms as on delicensing.
e) Under economic reforms the scope of the private sector was enlarged.
2. Name four important concerns of the Indian economy before economic
reforms.
3. Name four important priorities of the economic reforms.
3.6 Let Us Sum Up
After independence, India followed mixed economy and accepted the
coexistence of the public and the private sector. The public sector covered areas
of defence, heavy and basic industries, economic and social infrastructure and
public utilities.
National planning commission was set up in 1950 and was assigned the task of
formulating a plan for the economic development of India. The commission laid
down the long term goals of planning: a) to increase production (b) to achieve
full employment (C) to promote industrialization and (d) to reduce inequalities
of income and wealth. With these objectives the first five year plan was
launched in the year 1951. This process continued upto 1978 when 5th five year
plan was completed. However in the year 1978, the then government of India
discontinued 5 year planning and instead launched yearly planning known as
the rolling plans. But in the year 1980 when the government changed at the
centre the process of 5 year planning was resumed.
The year 1990-91 turned out to be very critical for the Indian economy. There
was a serious crisis of balance of payments. Furthermore, the foreign exchange
reserves dipped to a critically low level and it was not sufficient enough to
maintain 15 days imports. India received financial help of dollar 7 billion from
the World Bank and the IMF on the agreement to announce its new economic
policy known as economic reforms.
The new economic policy was launched in June 1991 with the plan of
liberalizing the economy and quickening its rate of economic growth. The
essential features of the economic reforms are: Liberalization, Privatization and
Globalization, commonly known as LPG. The economic reforms ushered in a
new era of economic growth, which was 6.6% in 201. The next year it increased
to 7.3%. it reached 8% in 2016 but it declined to 7.1% in 2017 and 6/7% in
2018. During 2019-20 the economic growth slowed down due to Covid 19
lockdown.
The impact of Covid 19 and lockdown was severe and it impacted growth rate
badly. However, after May 2021 the economy is on the path of recovery.
3.7 Key Words
Rolling Plan - the plan launched for short period that is one year with the
possibility of modifications.
Economic Infrastructure: indicates creation of infrastructure in the form of
irrigation, energy, transport and communications.
Globalization: refers to the process by which the economy of the country is
integrated with the world economy. It involves four parameters: (i) Reduction of
trade barriers so as to permit free flow of goods and services across national
frontiers; (ii) Creation of an environment in which free flow of capital can take
place among nation-stages; (iii) Creation of an environment permitting free flow
of technology; and (iv) Creation of an environment in which free movement of
labour can take place in different countries.
Plan Holiday: a term coined to describe the period in which the country
abandoned the formulation of the five year plans and shifted to a system of
annual plans. The period referred to was 1966-67 to 1968-69.
Privatisation: refers to transfer of ownership of a public sector undertaking to
the private sector – may be company, a workers’ cooperative or an individual.
When 100 per cent ownership is transferred, it is a case of denationalisation.
Transfer of ownership can be partial as well. In such cases, the public sector
undertaking is transformed into a joint venture.
Public Distribution System: refers to the system of fair price shops to
distribute articles of essential consumption to the poor at reasonable prices. The
government takes the responsibility to procure and distribute essential
commodities.
Social Infrastructure: indicated infrastructure in the form of schools, colleges,
technical training institutes, primary health centres, hospitals, family planning
and welfare centres etc.
3.8 Answers to Check Your Progress
A3 i) False ii) True iii) True iv) False v) True
B1 i) False ii) True iii) False iv) True v) True

3.9 Terminal Questions

1. Discuss the main features of the mixed economy followed by India after
independence.
2. Explain the concept of public sector originally envisaged by India. What
were its short comings?
3. Assess the Indian economy before economic reforms briefly.
4. Describe the main critical features of the Indian economy before the
economic reforms.
5. Discuss salient features of the new economic policy.
BLOCK 2 ECONOMIC DEVELOPMENT:
CONCEPT AND MEASUREMENT
You have learnt about Economic Development in Block 1 and this Block 2
discusses in detail about economic, social and human resource infrastructure,
their types and their role in economic development, present position of these
infrastructures in our country and government’s initiatives related to the
development of infrastructure in India are assessed. This block has three units.
Unit 4 deals with Economic Infrastructure. The unit begins with the concept of
infrastructure, the role of infrastructure sector in economic growth and vice-
versa, various types of infrastructure and difference between physical
infrastructure and social infrastructure are discussed, the present state of
infrastructure sector in India and government’s initiatives on infrastructure sector
are assessed in the end.
Unit 5 deals in Social Infrastructure. The unit begins with the achievement of
the role of social infrastructure in economic growth and identifying the
constituents of the social infrastructure, the progress in various heads of social
infrastructure is discussed and in the end various issued and government’s
initiatives in various social infrastructure sectors are discussed.
Unit 6 deals in Human Resource Infrastructure. The unit begins with human
resource, its importance and various indicators, the role of human resource in
economic growth is discussed, factors that enhance human resources are
identified and explained, the present position of human resources in India and the
employment profile of the Indian economy are discussed in the end.
Determinants of
Growth UNIT 4 ECONOMIC INFRASTRUCTURE
Structure
4.0 Objectives
4.1 Introduction
4.2 Importance of Infrastructure
4.2.1 Infrastructure Promotes Economic Growth
4.2.2 Economic Growth Promotes Infrastructure
4.2.3 Characteristics of Infrastructure

4.3 Privatisation and Commercialisation of Infrastructure

4.3.1 Need for Privatisation and Commercialisation
4.3.2 Prerequisites for Private Investment
4.3.3 Lessons from Private Investment

4.4 Infrastructure Development in India

4.4.1 State-wise Distribution of Infrastructure
4.4.2 Suggestions for Infrastructure Development

4.5 Transport Sector in India

4.6 Telecommunications
4.7 Energy Resources
4.7.1 Sources of Commercial Energy
4.7.2 Sources of Non-Commercial Energy

4.8 Energy Problem in India

4.8.1 Energy Policy
4.8.2 Energy Pricing
4.8.3 Non-Conventional Energy

4.9 Let Us Sum Up

4.10 Key Words
4.11 Terminal Questions

4.0 OBJECTIVES
After studying this unit, you will be able to
• explain the concept of infrastructure;
• appreciate the role of infrastructure sector in economic growth;
• identify the various types of infrastructure;
• distinguish between physical infrastructure and social infrastructure;
• describe the present state of infrastructure sector in India; and
• assess the government initiatives on infrastructure sector.

102
 Economic
4.1 INTRODUCTION Infrastructure

Infrastructure refers to basic physical and structural facilities, which are essential
for an economy to function. There is no universally accepted definition of
infrastructure. In India, for example, different oroganisations include different
sectors or industries under the category infrastructure. According to the National
Statistical Commission of India, infrastructure possess six characteristics: (i) high
sunk cost, (ii) natural monopoly, (iii) Non-tradability of output (produced and
sold at the same location), (iv) presence of economic “externalities”, (v) Non-
rivalness in consumption (consumption by one user does not exclude others from
its consumption), and (vi) price exclusion (enjoyment of benefits could be subject
to payment of user charge).
We give a broad list of sectors which can be included in the infrastructure sector
(See table 4.1).
Table 4.1: List of Infrastructure Sub-Sectors

Category Infrastructure Sub-Sectors

Transport • Roads and bridges
• Ports
• Inlands waterways
• Airport
• Railway track, tunnels, viaducts, bridges1
• Urban public transport (except rolling stock in
case of urban road transport)
Energy • Electricity generation
• Electricity transmission
• Electricity distribution
• Oil pipelines
• Oil/gas/liquefied natural gas storage facility2
• Gas pipelines3
Water sanitation • Solid waste management
• Water supply pipelines
• Water treatment plats
• Sewage collection, treatment and disposal
system
• Irrigation (dams, channels, embankments and
so on)
• Storm-water drainage system
Communication • Telecommunication (fixed network)
• Telecommunication towers
Social and • Education institution (capital stock)
commercial • Hospitals (capital stock)
infrastructure • Three-star or higher category classified hotels
103
Determinants of
Growth located outside cities with population of more
than one million
• Common infrastructure for industrial parks,
Special Economic Zones, tourism facilities and
agriculture markets
• Fertiliser (capital investment)
• Post-harvest storage infrastructure for
agriculture and horticultural produce including
cold storage
• Terminal markets
• Soil-testing laboratories
• Cold chain

Infrastructure can be classified as (i) social infrastructure, and (ii) physical

infrastructure. Social infrastructure is concerned with the supply of such services
that meet the basic needs of a society. Examples of social infrastructure are
provision of health services, drinking water, sewerage and sanitation facilities,
electricity, education, etc. We will discuss about social infrastructure in Unit 5.
Physical infrastructure is directly concerned with the needs of such production
sectors as agriculture, industry, trade, etc. In physical infrastructure, we include
such services as power, irrigation, transport, communications, storage, etc.

4.2 IMPORTANCE OF INFRASTRUCTURE

Infrastructure has a two-way relationship with economic growth. Infrastructure
promotes economic growth. Economic growth brings about changes in
infrastructure. Let us discuss these two aspects in detail.
4.2.1 Infrastructure Promotes Economic Growth
(i) Output of infrastructure sector such as power, water, transport, etc. are
used as inputs for production in the directly productive sectors
(manufacturing, agriculture, etc.). Therefore, shortage of infrastructure
can result in sub-optimal utilisation of production capacity of other
sectors.
(ii) Infrastructure such as transport improves productivity significantly.
(iii) Infrastructure provides key to modern technology in practically all
sectors.
(iv) A close association has been observed between infrastructure spending
and GDP growth. Studies have indicated that 1 per cent growth in the
infrastructure stock is associated with 1 per cent growth in per capita
GDP.
(v) Generally around 6.5 per cent of the total value added is contributed by
infrastructure services in low income countries. This proportion increases
to 9 per cent in middle income countries and 11 per cent in high income
104 countries.
4.2.2 Economic Growth Promotes Infrastructure Economic
Infrastructure
Growth, in turn, makes demands on infrastructure. This can be illustrated with
the help of the relationship between GDP growth and demand for infrastructure,
as in Fig. 4.1.

Fig. 4.1: Demand for Infrastructure

With increase in the level of per capital income in a country, there is a change
in the composition of infrastructure.
(a) In low income economies, basic infrastructure such as water and
irrigation are the most important.
(b) In middle income economies, demand for transport grows very fast.
(c) In high income economies, power and telecommunication occupy more
importance.
Due to such linkages between infrastructure and the rest of the economy,
efficiency, competitiveness and growth of the economy hinges upon the state of
the development of infrastructure sector.
4.2.3 Characteristics of Infrastructure
Earlier we mentioned that there are six characteristics of infrastructure. We
describe below some more characteristics of infrastructure.
The infrastructure sector has certain peculiarities that help us to distinguish this
sector from other sectors of the economy. Among these, the more important
distinguishing features can be identified as follows:
(i) Public Goods: Most of the physical infrastructure services have some
elements of public good in them. These services are available to the
public; the consumers may be charged for these services or the same may
be supplied free. But even when they are supplied against a price, it is not
always possible to exclude those consumers who choose not to pay for
them.
(ii) Externalities: The social benefit of the infrastructure services far exceeds
the cost involved in their generation. This in turn creates problems in
pricing of these services. It is difficult to charge a price in order to
recover the cost fully.
(iii) Monopolies: Due to the inherent nature of infrastructure services, it is 105
Determinants of difficult for more than one supplier to exist in one location. It thus creates
Growth
the possibility for monopolies and their regulation.
(iv) Public Sector Domination: The existence of externalities particularly in
the field of social welfare has resulted in a dominant position by public
sector in production and supply of infrastructure services.

4.3 PRIVATISATION AND COMMERCIALISATION

OF INFRASTRUCTURE
Private participation in infrastructure development depends upon its capability to
commercialise the infrastructure services.
4.3.1 Need for Privatisation and Commercialisation
The different factors that call for immediate privatisation and commercialisation
of infrastructure can be identified as follows:
(i) Massive Investment Needs: Infrastructure development requires massive
investments and it is not possible for the state to meet all the investment
needs.
(ii) Managerial Constraints in the Public Sector: While the infrastructure
business is becoming more complex, public sector has not been able to
meet the managerial challenges and as a result the supply could not grow
at the desired pace. The fiscal stringency has also created a demand for
accountability for public spending. Therefore, a demand has arisen for
commercialisation and greater privatisation of infrastructure sector in
order to inject greater efficiency.
(iii) Changes in Technology: The possibility of marginal pricing and exclusion
provides greater scope for commercialisation. Technological changes
have made it possible to unbundle the infrastructure service thereby
introducing the elements of competition. The use of new technology
enables the charging of the marginal user.
(iv) Globalisation: The availability, quality, cost and reliability of
infrastructure services are key factors in attracting foreign investment.
Globalisation has been aided significantly by advances in transport,
telecommunication and storage technology. Such advances in
infrastructure enable better management of logistics by combination of
purchasing, production and marketing function. Besides facilitating
suppliers to respond to the consumer demands promptly a significant cost
saving is achieved in investment and working capital.
4.3.2 Prerequisites for Private Investment
Entry of private capital in infrastructure sector is not merely a matter of simple
policy initiatives. A few other important and critical areas would have to be
identified and a suitable environment created.

106
 (i) Commercialisation of Infrastructure: Infrastructure services should not be Economic
Infrastructure
treated as public goods. In this regard, the possibility of
commercialisation will depend on the ability to segregate payers and non-
payers and prevention of any incidence of ‘free riding’. Thus, the
excludability is a key factor in commercialisation.
(ii) Pricing Policy: The role of private sector is not restricted to that of
provider of funds. It has to play the role of efficient and accountable
operator of the facility. The issue of pricing of infrastructure services
becomes critical here. In this sphere the long track record of uneconomic
pricing and prevalence of subsidies will be major obstacles.
(iii) Demand Orientation of Services: The existing procedure of financing
infrastructure facilities is based on plan allocation and is mainly supply-
oriented. Insufficient stress on the existing and the anticipated demand
has resulted in deviations in different countries and consequently a large
part of such investments are not providing sufficient returns. Privatisation
will necessitate a demand-oriented approach.
(iv) The challenge for policy is to find appropriate market signals which
indicate the future trend of infrastructure demand and to coordinate the
supply of such facilities in such a manner that investment in infrastructure
provides appropriate returns.
(v) Allocation of Risk: Allocation of risk is of key importance in
commercialisation of infrastructure. The risk should be appropriately
demarcated and allocated to different stakeholders. This is important for
two reasons:
(a) There is a tendency among the private shareholders to shift the risk
to the government.
(b) There is also a tendency among the shareholders to shift the risk on
each other.
(vi) Direct Participation by the Government: While the existence of elements
of monopoly in infrastructure will necessitate regulation by the
government, constraints in financing and user charging will render the
direct participation by the government necessary. Therefore, a transparent
framework for promotion of synergistic firmness of public-private
partnership in infrastructure is required.
4.3.3 Lessons from Private Investment
Lessons so far have not been encouraging. Investments in the couple of fiscals
through 2012 backfired, leaving in their wake stalled projects and a mountain of
stressed assets. After a decade, private investment capacity is yet to recover
meaningfully.
Private investments in thermal generation are already in deep trouble with
stranded capacities, stressed loans and weak demand. While airports, ports and
power transmission have robust engagement models, new investment activity is 107
Determinants of tepid. In railways, and urban infrastructure, private investments are negligible.
Growth
It’s down sharply at the state level as well.
National highways remain the only bright spot, where policy actions and the de-
risked hybrid annuity model (HAM) have revived projects. And the recent toll-
operate-transfer (TOT) auction is a good example of asset monetization and
crowding-in of private capital.
Private sector participation in infrastructure delivery helps deliver tangible
benefits, and there is anecdotal evidence to support this, even as the fiscal space
remains constrained. In highways, airports, ports and renewables, the private
sector’s role has been landscape altering. The private sector has also delivered
efficiently – both on project execution (where land and clearances have not been
a constraint) as well as operations.
However, history has taught us that public private participation (PPP) is no silver
bullet. Broad-basing private investment in infrastructure requires relentless
commitment and holistic efforts from both the Centre and the states. There are
three vectors along which this transformation ought to be steered; these could
help rev up the stalled private investment engine.

4.4 INFRASTRUCTURE DEVELOPMENT IN INDIA

Development of infrastructure has always been given highest priority in our
growth programmes. Economic returns and not success in wresting concessions
should govern the relative share of investments in each economic activity; the
rule may be different for social actions.
Table 4.2: Relative Quality of Infrastructure in India

Indicator Best (score) China India

Rank/score Rank/score

Road France (6.6) 54/4.4 85/3.4

Railways Switzerland (6.8) 21/4.6 24/4.4

Parts Singapore (6.8) 56/4.5 82/3.9

Air Transport Singapore (6.9) 72/4.6 67/4.7

Electricity Denmark (6.9) 49/5.5 112/3.1

Fixed lines Taiwan (70.8) 55/21. 113/2.9

Mobile subscription Hong Kong (190.2) 113/64 117/61.4

Overall Switzerland (6.7) 69/4.2 86/3.8

Table 4.2 provides the report’s scores for India (and the inevitable comparison
with China) for seven infrastructure indicators as well as an overall score. For
108
comparison purposes, the highest-scoring country on each indicator is listed. For Economic
Infrastructure
the first five indicators and the overall quality, scores are on a seven-point scale,
the higher the better; while for the two telecom indicators, they reflect the
numbers of connections per 100 people.
We can draw three pretty obvious messages from this picture. First,
notwithstanding pockets of success, our overall infrastructure strategy hasn’t
delivered to the extent necessary. One reason for this is that we have not
approached “infrastructure” as a fully integrated network. Two, the benefits of
successful projects are significantly diluted by their linkages on failed ones. The
“weakest link” principle is essentially why our overall infrastructure experience
is so negative, despite some strategies and projects being successful. Third, the
cost of moving from the 80-100 rank range to the 50-70 range is going to be
enormous – the trillion dollar aspiration of the 12th Five-Year Plan reflected this.
But the money needs to be spent in a consistent way across sectors and, most
importantly, over time, to get the best value from it. It is a lot easier to move
down the rankings than it is to move up.
4.4.1 State-wise Distribution of Infrastructure

Fig. 4.2: Typology of Development

109
Determinants of India’s infrastructure sector has been troubled for quite some time now. The full
Growth
extent of the crisis is becoming apparent only now, with banks facing increasing
difficulties in recovering loans made to the sector. The non-performing assets
(NPA) crisis that Indian state-owned banks face today is in large measure the flip
side of the unravelling of the infrastructure boom of the past decade. State-wise
distribution of infrastructure can be seen from Fig. 4.2.
4.4.2 Suggestions for Infrastructure Development
It was around the Ninth Plan (1997-2002) that India seriously woke up to the
infrastructure challenge. With a slew of interventions, the key indicator of
infrastructure development, gross capital formation in infrastructure (GCFI) as a
percentage of gross domestic product (GDP), started a steady upward climb.
From 2002 onwards, the government aggressively pushed public-private
partnerships (PPPs) to generate infrastructure investments. The results exceeded
expectations. The share of private capital in infrastructure investments, which
stood at 22 per cent during the 10th Plan period (2002-07), moved up to 37 per
cent in the 11th Plan period (2007-12). The 12th plan (2012-17) optimistically
budgeted for 48 per cent.
Going forward, the challenges are manifold. We can lists down 12 priority
suggestions for revitalising the infrastructure agenda.
1. Reform the Railways
Three reports provide a clear reform agenda: the Rakesh Mohan Committee
(2002), the Kakodkar Committee on Railway Safety (2012), and the Pitroda
Expert Group for Modernisation of Indian Railways (2012). The Rakesh
Mohan Committee suggested that the Railways must eventually be
corporatised into the Indian Railways Corporation (IRC). The government
would need to set up an Indian Rail Regulatory Authority (IRRA) to
distance the IRC from the government. The IRC should be governed by a
reconstituted Indian Railways Executive Board (IREB). The government of
India should be in charge of only setting policy direction, constituting the
IRRA and the IREB.
2. Privatisation of Coal Mining
India boasts the world’s fifth-largest coal reserves. Yet, we all are aware of the
bottlenecks in supply and our dependence on Coal India. Coal mining was
nationalised in 1973. It now needs to be denationalised with a sense of urgency.
3. Resurrect the river-linking plan
The government had set up a task force in 2002 to resurrect the idea in the
hope of creating another iconic infrastructure initiative. The reasons were
powerful. Increasing disposable incomes would prompt voters to demand
better water services and pay for them; similar pressures in agricultural
water demand would arise due to diversification of Indian agriculture.
Rising energy costs would make pump irrigation increasingly unattractive.
110
Rapid growth in urban agglomerations would seriously strain their ground- Economic
Infrastructure
water-dependent supply systems. The phenomenon of simultaneous droughts
and floods would be substantially addressed, and inland water transport
would be fostered.
4. Stop bidding out projects without sovereign clearances in place
Here are two ways to bite the bullet. First, have the sponsoring government
authority set up a 100 per cent government-owned special purpose vehicle (SPV)
to implement the project. This SPV should secure all permissions and clearances.
Then the authority should bid out the SPV to the highest bidder. Second, let all
infrastructure PPP bids carry a special annexure listing all of the permissions
required, thereby delineating the responsibilities of the sovereign sponsoring
authority. Get babudom and its political leadership to be publicly and monetarily
accountable. Let them not merely bid out project as bemused observers.
5. Form an infrastructure ministry
There are 12 ministries at the central level that directly look after infrastructure.
The rural development, environment, industry and commerce, and heavy
industries ministries raise the count to 16. Adding the NITI Aayog, finance
ministry, the Prime Minister’s Office and the Cabinet Secretariat (Cabinet
Committee on Infrastructure, the number comes to 20).
And they are all co-ordinating with 29 states. It is about time such “coordination”
was institutio-nalised through a ministry for infrastructure.
6. Reshape IIFCL to catalyse long-term funds
The Interim Report of the High-Level Committee on Financing Infrastructure
(August, 2012), headed by Deepak Parekh, argued for a significant restructuring
of the role of India Infrastructure Finance Company Ltd (IIFCL) from that of a
normal lender to one that provides guarantees for bonds and extends subordinated
debt. This would make HFCL a catalyst in channelling large long-term inflows
for infrastructure projects.
7. Independent regulatory authorities
The Planning Commission’s draft legislation of 2006 recommends that regulators
need to be directly responsible to the legislature. Selection should not only be fair
(Create a “National Infrastructure but also “best in class”). India should consider
opting for multi-sectoral regulators for communications, electricity, fuels and
gas, and transport. This would eliminate proliferation of regulatory commissions,
help build capacity, promote consistency of approach and check costs. In the case
of states, a single regulatory commission for all infrastructure sectors may be
more productive and cost-effective.
8. Set up land bank corporation
Enactment of the Land Acquisition Act 2013 has given rise to apprehensions on
adequate and timely availability of land for development purposes. Energetic and
visionary state land bank corporations need to be created. They should be
111
Determinants of empowered under the clause of “public purpose” to acquire large tracts of
Growth
unused, unusable or waste land. They should be sufficiently capitalised by state
governments and have the power to leverages more finance on the strength of
their land-bank inventories. They could also oversee resettlement and
rehabili-tation obligations.
9. Push hydro-electricity
India has exploited only 24 per cent of its hydro potential at an installed capacity
of around 35,000 megawatts against an “identified potential” of 148,701 Mw. A
realistic target would be to try and restore hydropower to at least an overall share
of 20 per cent in India’s energy basket by the end of the 2025. This would require
an addition of 62,000 Mw of hydro capacity over the next 5 years.
10. Implement the 74th Amendment for urban governance
The 74th Amendment to the Constitution in 1992 sought to bring about a major
change in the functioning of urban local governments. Unfortunately, very little
additional empowerment of municipal bodies has happened.
11. Clean up electricity distribution
Distribution reform requires micro-management of millions and millions of end-
users with metering, billing, collection, theft reduction, mafia control, and local
area infrastructure upgradation. This systemic micro overhaul across the length
and breadth of the country with attention to detail and a granular set of related
activities needs massive orchestration. Large-scale appointment of “distribution
franchisees in PPP mode” is the only practical solution.
12. Create a National infrastructure Partnership Commission
There is an all-pervasive belief in the private sector that the manner in which
risks are currently shared between the government and private players in PPP
contracts is heavily skewed against the private sector. Where, then, is the so-
called “partnership”? Such a partnership should be carefully nurtured. There is
the Infrastructure Concessions Regulatory Commission in Nigeria, the PPP
Advisory Unit in Ghana, the PPP Centre in the Philippines and the PPP Unit in
South Africa. In the case of South Africa, for example, one of the key functions
of the PPP Unit is “contract renegotiations”.
Self-Assessment Exercise A
1) Describe the importance of Infrastructure in an economy.
………………………………………………………………………………
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………………………………………………………………………………
112
2) Distinguish between ‘economic infrastructure and social Infrastructure. Economic
Infrastructure
………………………………………………………………………………
………………………………………………………………………………
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3) Explain how there is a two-way relationship between infrastructure and
economic growth.
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………………………………………………………………………………

4.5 TRANSPORT SECTOR IN INDIA

Transport infrastructure in India has grown at an unprecedented rate since
economic liberalisation. At the highest ever pace of construction, we have built
more than 35,000 km of national highways in the last four and a half years. The
country had never before seen world-class expressways such as the Eastern
Peripheral Expressway and Western Peripheral Expressway or engineering
marvels such as the Dhola Sadiya Bridge and Chenani Nashri Tunnel. The
Bharatmala Pariyojana is unique and unprecedented in terms of its size and
design, as is the idea of developing ports as engines of growth under Sagarmala.
The development of 111 waterways for transport, with multinational companies
already carrying their cargo over the Ganga, is also a first ever, as are FASTags,
the promotion of alternative fuels such as ethanol, methanol, biofuels, and
electricity, as well as innovative modes of travel such as seaplanes and aeroboats.
An efficient transport infrastructure is the biggest enabler for growth. To that
end, it has been one of the foremost priorities of our government to build a
transport infrastructure that is indigenous and cost-effective, links the remotest
corners of the country, is optimally integrated across various modes and is safe
and environment friendly. A lack of good transport infrastructure has been a
major hindrance for growth in the country in the past and our focus has been on
rectifying this. Bharatmala and Sagarmala programmes are going to be game
changers in this regard. They will improve both penetration and efficiency of
transport movement on land and water, respectively. In the process, they will
help connect places of production with markets more efficiently, help reduce
logistics costs, create jobs and promote regionally balanced socioeconomic
growth in the country.
Our road and sea transport networks are being developed for providing better,
seamless and more efficient access not just within the country, but also to our
neighbouring countries using an optimal mix of roads and waterways – whether it
is to Afghanistan and beyond through Chabahar, or Bangladesh, Myanmar and
Thailand through upcoming highways and waterways. 113
Determinants of Multi-Modal Integration
Growth
From a transportation perspective, India has about 18 per cent of the world’s
population and only 2.5 per cent of its land area, but accommodates a fleet of 210
million motor vehicles as of now. This adds to the stress. It is imperative that we
adopt more efficient ways of moving people in our cities.
It is fast becoming necessary to persuade personal motor vehicle users to shift to
public transport to mitigate the negative impacts of road congestion, deteriorating
air quality and increasing carbon emissions.
Today’s public transport systems, which follow fixed routes and schedules, can’t
offer such conveniences. Innovative, multi-modal integration is vital to drive a
change. Different modes, when appropriately combined, could offer inclusive,
comfortable and frequent door-to-door services to commuters. In Bengaluru and
Hyderabad, an open innovation challenge – which invited ideas from technology
and service providers, mobility entrepreneurs and citizens to improve last-mile
connectivity to mass transit systems – yielded smart solutions that were cost-
effective, innovative and easy to integrate.
Second, cities need to increase the number of public transport vehicles
significantly to ensure safe, comfortable, frequent and crowd-free commutes to
all. Third, it is time for the government to widen the definition of public transport
to include small buses, vans and pooled vehicles that offer on-demand services.
Ongoing studies indicate that bus aggregator systems – a model that uses
technology (mobile apps) to allow passengers to book seats in buses operating on
routes within city limits, pay fares online and track location – have managed to
pull people out of their private vehicles and bring about a modal shift.
Smart solutions exist, but there are major barriers in achieving these.
Improvements and upgradation could be expensive unless alternative funding
sources are identified. Also, governance is highly fragmented with different
modes being managed by different entities which do not talk to each other.
Finally, operators are often reluctant to make their data public, thereby
hampering the use of apps to integrate systems.
A progressive and forward-looking approach can help us overcome such barriers.
In India, lead transport authorities could be set up to coordinate planning and
financing of public transport modes in an integrated manner. They should have
legal backing and the financial muscle to ensure that their plans are adhered to.
International models like the Transport for London, the Land Transport Authority
of Singapore and Translink in Vancouver, are worth replicating with local
adaptations. Operators should also be mandated to allow commuters access to
data to plan trips.
Three important developmental features of the transport sector in India can be
noted as follows:
(i) A rail dominant economy in the 1950s has become a decidedly road
dominant economy presently. Road transport now accounts for over 60
114
 per cent of inter-city freight traffic (tonne-km) and over 80 per cent of Economic
Infrastructure
inter-city passenger traffic (pass-km).
(ii) During the same period, Indian Railways shifted from being a freight
dominant operation to a passenger dominant operation.
(iii) The main links of the parallel and competing road and rail networks have
become saturated under the current technological and operational regime.
What India needs at present is holistic planning for its transport infrastructure
that should minimise energy use and emissions while maximising
competitiveness of domestic industry.

4.6 TELECOMMUNICATIONS
Few areas of India’s economy have enjoyed as sharp a pace of structural change
as that in the telecom sector. The rapid pace was the outcome of the New
Telecom Policy, 1999. It brought in vigorous competition among firms and
technologies. The drastic pace of structural change highlights the possibilities in
other segments of infrastructure for eliciting massive investment by the private
sector, and for benefitting the consumers through competition between old and
new technologies.
The major features of the telecom sector can be identified as follows:
(i) The structure and composition of telecom growth have undergone a
substantial change in terms of mobile versus fixed phones and public
versus private participation.
(ii) In 1999, both mobile phones and private sector separately accounted for
5 per cent of total number of phones. Presently, mobile phones account
for a little over 92 per cent of total phones and the private sector
accounts for 78 per cent of total phones. From basic telephony to Value
Added Services (VAS) several remarkable changes have happened that
have resulted in not only expanding the base of mobile users but also
providing more user-friendly services to consumers. Mobile phone has
surpassed their primary role of voice communications and have become
more of an infotainment device for mobile users.
(iii) Although India has a 1010 million strong telephone network, including
mobile phones, the tele-density (number of phones per hundred
population) at about 80 is much less than over 120 in the UK, the US,
and Australia.
(iv) While tele-density lags behind the world, present trends suggest that
catching up is presently underway. For this, massive investments,
including FDI, are planned.
(v) India also lags behind the world to a considerable extent in the field of
broadband telecom.
(vi) The telecom market in India is a highly competitive market but is driven
115
Determinants of by regulatory and other policy issues.
Growth
Telecom operators are no longer in control of their industry with companies such
as Apple, Google, and Samsung, emerging as the new leaders and start-ups
ranging from cloud communication companies to secure chat ones scorching the
telecom highway. In the Big Data value chain too, telecom companies merely
generate the data but have little control over its usage and much less over its
commercialization. Their future depends on services such as Internet TV, mobile
payments and cloud services. But all that, for India’s telecom giants, is coming at
a huge cost. This steep cost base set against the shallow curve of their revenue
base is a mortal threat to many.
For the technology sector the issues may be considered.
• Focus areas will include Artificial intelligence, Big Data, Block-chain, Fin-
tech, 5G, loT, Massive MIMO, Network augmentation, etc.
• 5G is the next generation of broadband connection that offers 20 times faster
data transmission speed than the 4G network. The much-awaited network
trial for 5G services in the country is slated to start from June 2019 for a
period of three months, with the auctions planned for October 2019.
• Artificial Intelligence will alter the networking landscape, network
infrastructure, and enhance traffic management, as telecom companies
harness the power of AI to process and analyse huge volumes of Big Data for
better customer experiences, improve operations, and increase revenue
through new products and services.
• With less than 25 per cent towers fiberised against the global standards of 70-
80 per cent, fiber leasing in India is heading towards a $2.56 billion market
by FY2020. Fiberised towers are expected to increase from 90,000 to
330,000.
Adaption of new technologies necessitate that telecom providers continuously
realign their business strategies and restructure themselves. In order to gain a
competitive edge, they invest in network infrastructure and forge JVs with
leading media and content providers. Add to this the burden of fluctuations in the
import duties on telecom equipment; a high GST; spectrum charges; competitive
tariffs; arbitrary right-of-way charges taken by States for permits to lay fibre, etc.,
and Indian telcom are currently saddled with a debt of around $60 billion. This
has resulted in private sector consolidation, with further consolidation being
undersirable.
Recently, RBI issued a directive to banks to closely monitor the stress in telecom
accounts, as around 80 per cent of the debt is held by domestic banks. While the
industry has welcome the move, the government needs to address the other issues
plaguing the sector as well. Legislation is urgently required from the centre to
ensure that States takes a lower right-of-way permission charge. There is also a
need to review the existing tariff structure and to reconsider the decision to revise
the interconnection charges to zero. Other measures requiring relief include debt
116
restructuring, cut in licence fee and spectrum charges, etc., and efficient release Economic
Infrastructure
of locked up GST input tax credit.
Self-Assessment Exercise B
2) Describe any three features of the transport infrastructure in India.
………………………………………………………………………………
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2) State the principal weaknesses of the transport sector in India.
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3) Examine the role of the communication infrastructure in the growth of the
Indian economy.
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4.7 ENERGY RESOURCES

The need for energy in a developing economy can hardly be over-emphasised. It
is a basic input required to sustain economic growth and to provide basic
amenities of life to the entire population of a country. It is energy which is the
dividing line between a subsistence economy and a highly developed economy.
In the affluent United States, an average American consumes nearly 20 times as
much energy as an Indian does in our country. (Annual consumption of
commercial energy in per capita in India is estimated at 682 watts as against
14035 watts in the USA). Empirically, it has been established that “inadequate
supplies of energy can inhibit development and that assurance of an adequate
supply and mix of energy inputs can be a great stimulus to development.”
India with installed capacity of 147.0 mn.kw, is the fifth largest producer of
electricity in the world, behind USA, China and Russia. Energy in India is
produced from different sources; these can be classified into two groups:
(i) Commercial sources – like thermal power, hydel power, power from oil,
gas, nuclear, etc.
(ii) Non-commercial sources – like firewood, dung-cakes, etc.
Of the two sets of sources, commercial sources occupy a more prominent
position. Thermal power accounts for about 81 per cent, hydro power for about 117
Determinants of 13 per cent, and nuclear for about 3 per cent. The bulk of the commercial energy
Growth
is consumed in the industrial sector followed by the transport and household
sectors whereas a large part of the energy requirement in the rural and domestic
sectors is met from non-commercial sources. It is expected that the relative share
of non-commercial energy will fall still further over the next decade. By that time
energy requirements of the economy would also multiply by two to six times
depending upon the rate of growth of the economy. Even if India achieves only
an annual average rate of growth of 5 per cent, the per capita consumption of
energy would multiply by about 2.5 times. It, therefore, becomes crucial to
identify the sources of commercial energy.
4.7.1 Sources of Commercial Energy
There are several sources of energy for an economy. We discus some of these
sources below.
a. Coal
The Ministry of Coal’s recently released Vision 2025 document estimates the
total amount of extractable coal in India to be about 52 billion tonnes. Without
improvements in coal technology and economics, the existing power plants and
the new plants added in the next 10-15 years might consume nearly all of the
extractable coal in the country over the course of their 30 to 40-year life span.
Coal is the largest naturally occurring source of commercial energy in India and
has been one of the principal sources of power production. Presently, coal-based
thermal power stations (including nuclear) contribute about 75.0 per cent of the
total power generation. The energy policy of the country provides that to the
extent practicable and economical, coal will be the principal source of
commercial energy. It is worth mentioning that the use of coal is on decline in
advanced economies, because it inflicts huge environmental costs.

Fig. 4.3: Coal Energy

118
India’s coal reserves are mainly clustered around a belt extending over the Economic
Infrastructure
western part of West Bengal, Jharkhand, Orissa, north-eastern and central
Madhya Pradesh, the eastern fringe of Maharashtra and the northern extremity of
Andhra Pradesh. There are also some scattered deposits in Assam. The total
reserves of coal are estimated at 267 billion tonnes and proven reserves at 106
billion tonnes. Of these, about 27 per cent are of coking variety and 73 per cent
of non-coking variety. Because of the limited availability of coking coal, its use
is being limited to metallurgical purposes. The non-coking coal available in the
country is generally suitable for power generation.
The country has some lignite and tertiary coal deposits also. The total lignite
reserves are estimated at about 21,000 million tonnes; the reserves of tertiary coal
are estimated at about 900 million tonnes.
The coal sector is constrained by supply limitation, inadequate drilling capacity,
absence of a progressive regulatory framework, minimal private participation,
high turnaround time and long gestation periods in getting clearances for mining
projects. Available coal is of a low calorific value which enhances wastages and
adversely affects generation efficiency of power projects. Analysts estimate that
one tone of imported high-grade coal is equivalent to 1.56 tonnes of domestic
coal, which has high ash content.
There is a need to attract investments in making available dedicated cargo vessels
and modern and exclusive deep-sea coal terminals. In addition, the sector has to
embark on a phase of climate change related research and development and
incorporate clean technologies.
The long-term growth of the coal sector requires a confident and renewed
mindset in developing coal resources through decontrol of the coal sector, listing
of Coal India on the capital markets, establishment of an independent regulator
and a level playing competitive environment, which supplements the framework
of the holistic energy and infrastructure sector in India.
b. Oil (Petroleum)
The second half of the present century may well be called the oil age. In 1950,
the world oil consumption was only 650 million tonnes whereas by 1973 it had
increased to nearly 3,000 million tonnes. In 1973 there took place a sharp upward
revision of crude prices by the oil-producing countries (a large number of whom
organised themselves in the Organisation of Petroleum Exporting Countries or
OPEC in short. OPEC dominated the market by producing two-thirds of world oil
production and over 90 per cent of net exports. Presently, 11-member OPEC’s
share in oil production has come down to just over a quarter of global production;
their share in total world’s exports stands at about 55 per cent.) The demand for
crude oil being inelastic but persistently increasing, a rise in its prices blew up
what came to be known as an international oil crisis. India was no exception.
Ever since oil exploration work in India has been stepped up, an aggressive
campaign has been mounted to discover oil and gas in the on-shore as well as
offshore areas. 119
Determinants of
Growth

Fig. 4.4: Country-wise Oil Reserve

Another recent development of concern for policy-makers is that the number
of crude oil futures and options contracts have increased manifold. These
have led to significant speculation in the oil market. With increased futures
trading and contracts, the control of crude pricing has moved from oPEC to
banks and markets that deal with futures trading and contracts.
Recent Initiatives
The dependence on imported crude has led to focussed attention on energy
security. The various strategies being pursued for achieving energy security
include the following:
(a) Increasing exploration efforts through the New Exploration Licensing
Policy. Product sharing contracts have been signed for 100 blocks.
(b) Exploring in new areas, especially in deep water and difficult frontier
areas, and also exploring in the deeper layers of the producing fields.
(c) Developing faster the newly discovered fields and stepping up the use of
new technologies for seismic surveys, work over, stimulation operations,
drilling of wells, etc. in producing areas.
(d) Improving the recovery factor from existing major fields by implementing
Enhanced Oil Recovery (EOR)/Improved Oil Recovery (IOR) schemes.
(e) Acquiring acreages abroad.
(f) Tapping alternative sources of energy such as Coal Bed Methane,
Underground Coal Gasification and gas hydrates.
(g) Substituting fossil fuels in part by blending with hydrogen and biofuels
like ethanol and bio-diesel.
Other initiatives include: (i) creating a strategic reserve of 45 days (against 15-20
days of operational reserves), and (ii) taking oilfields on lease in countries like
120 Yemen, Sudan and Russia. The strategic reserve will be stored in non-porous
granite rocks on the west coast. The rocks will be blasted to create tanks that will Economic
Infrastructure
be below the water table.
c. Natural Gas
Natural gas has aptly been termed as the ‘Prince of Hydrocarbons’. It occurs
either as associated gas or free gas. Associated gas is produced from underground
reservoirs along with crude oil and the level of production depends entirely on
the level of crude oil production. Contrary to that, free gas, though occurring in
the underground reservoirs, is not associated with crude oil and can be produced
as required. It has the advantages of convenience and efficiency in use and is
environmentally benign.
Gas offers both technical and economic advantages, such as follows:
(i) elimination of expensive fuel stocking facilities in the station layout,
(ii) total absence of combustion wastes such as ash, slay and soot and
apparatus of plant for their removal, resulting in savings in operating and
capital costs,
(iii) absence of pollutants,
(iv) more exact measurement of fuel use and finer control of excess
combustion air,
(v) combustion chamber boiler size and that of ancillary machinery, specially
air fans, can be reduced, for the same boiler rating compared with
equivalent coal fired boilers,
(vi) elimination of sulphur products and the resulting corrosion danger in
boiler terminal apparatus, and
(vii) capability of natural gas fired boilers to operate as load-modulating units
on electrical network.
Natural gas can be used for both domestic and industrial purposes. It finds
application in the power, fertiliser and petrochemical industries. While
government policy in the past has favoured the reservation of natural gas for
fertilisers, petrochemicals and other non-fuel uses, the picture on the supply side
and in terms of the potential demand for natural gas has changed substantially in
recent years.
d. Hydro Power
Hydro-electric power plays a major role in the field of power development in the
country. Its present contribution to the total electricity generation is about 15 per
cent. Among others, there are at least five reasons why hydro-power should be
promoted.
• Peaking capacity: It is the best option to meet the peaking requirements
of the country’s demand. Gas, while eminently suitable for addressing
peaking demand, is constrained, as seen earlier.
121
Determinants of • Carbon footprint: Hydro power provides an effective mitigant to counter
Growth
the high carbon footprint embedded in fossil fuel usage.
• Energy security: Nothing can take away the need to reduce the dependence
on sources outside the country.
• Multi-purpose benefits: Hydro projects can provide multi-purpose benefits
to the country with benefits accruing for both irrigation and flood control.
• Life-cycle: Economically, these plants are far more attractive on account of
their longevity and limited maintenance requirements. Bhakra Nangal
remains a shining example of this.
Limitations
(i) The regions possessing large hydro-power resources do not have enough
demand for power to warrant development of the hydro-power resources
on a large scale.
(ii) Storage hydro-power stations with large capacities have high initial
capital requirements.
(iii) Performance of the hydro-power stations has been seasonally variable.
However, notwithstanding these limitations, the country has a sizable
quantum of untapped hydro resources, and there is a considerable scope
for development of hydro projects. In view of the intrinsic advantages of
hydro resources, they warrant development to the maximum extent
possible. In areas where adequate hydel resources cannot be developed,
thermal generation will have to be resorted to.
India has also entered into civil nuclear cooperation agreements with Argentina,
Britain, Canada, France, Kazakhstan, Mongalia, Namibia, Russia and the US.
e. New Sources
A few new sources of energy are nuclear energy, gobar gas, solar energy, wind
power and geothermal energy.
(i) It was largely in response to Homi Bhabha’s assertion that “no power
is more expensive than no power” (i.e., power at any cost is better
than no power), nuclear power generation was initiated in India in
year 1969. Since then, India has acquired all the capabilities needed
to pursue this vision, from basic research, plant designs, equipment
manufacture, heavy water manufacture, fuel fabrication, plant
construction, operation and control systems to fuel reprocessing. The
energy potential available from the nuclear fuels is much more than
that from the coal deposits. As a matter of fact there is no other
energy source that gives large amounts of power using a small
amount of fuel and space. While India is amongst the top 10
countries of the world in terms of production of electricity by hydro,
coal, oil and gas, it is nowhere near the top 10 with respect to nuclear
power generation. It generates only 4,000 MW from this source. For
122
 a large country like India, this is an anomaly in need of correction. In Economic
Infrastructure
view of this, India is building up six new nuclear plants and plans to
achieve capacity of 63,000 MW by 2030. (The latest plant located at
Kundankulam (Tamil Nadu) went in operation on September 13,
2012) amidst protests over safety issues).
(ii) Gobar gas plants were designed as early as 1962; but they acquired
significance only after 1974-75. Presently, there are more than 20.00
lakh such plants in operation.
(iii) Solar energy is non-polluting, abundant, widespread and
inexhaustible. It is increasingly being used for varied purposes, such
as water heating, distillation of water, timber seasoning, etc. Towards
the end-2010, India launched the National Solar Mission with the aim
to source 20,000 MW of electricity by 2022.
(iv) Wind Energy farms do not require large investments, nor do they
need heavy operation and maintenance costs. The Global Wind
Energy Councils report places India at fifth position in wind power
generation. Pilot projects are also on to tap tidal energy and ocean
energy.
4.7.2 Sources of Non-Commercial Energy
Sources of non-commercial energy include fuel-wood, agricultural waste and
animal dung. According to the Working Group on Energy Policy, the relative
proportion of the three sources is 65 per cent, 15 per cent and 20 per cent
respectively. About 82 per cent of non-commercial energy is used in the domestic
sector. For the rural households, non-commercial energy accounts for more than
80 per cent of the total energy consumption; for urban households the proportion
is about 51 per cent.

4.8 ENERGY PROBLEM IN INDIA

By ‘energy problem’ we mean the problem of providing fuels or energy in its
various forms at reasonable cost to those who need them, wherever they are. At
present, India faces an energy shortage of 6.7 per cent and a peak load shortage
of 2.3 per cent. Given the estimated elasticity coefficient at 0.95, an annual 9 per
cent growth in GDP would translate into 7.2 per cent annual growth in electricity.
In order to meet that demand, our power generation capacity would have to
increase more than six times by the year 2032.
That the overall energy scene is none-too-happy is evident from the reduced level
of self-sufficiency in oil, the yawning gap between power demand and supply,
the declining share of hydel power in total power generation, the increasing
dependence on coal imports and the insignificant commercialisation of non-
traditional sources of energy.
As of now, the major features of the energy problem in India are as follows:
The various energy sector policies are not consistent.
123
Determinants of (i) Freight is equalised for oil products but not for coal. This leads to
Growth
distortion in choice of fuel and industrial location.
(ii) Even the equity principle is not followed in pricing.
(iii) There are serious distortions in the pricing of most fuels. Thus, bulk
LPG costs more than double the international price, naptha for fertilisers
costs a third less, high-speed diesel costs around a third more and
kerosene costs half the international price. Natural gas, too, is priced at
below its international price, leading to a higher demand.
4.8.1 Energy Policy
For a healthy development of the power sector, the following objectives have to
be met:
(i) Minimise investment costs to enable better utilisation of available
financial resources;
(ii) Minimise net outflow of resources, especially foreign exchange;
(iii) Minimise costs of energy production to bring about economies in power
supply and keep power tariff at affordable levels without having to resort
to heavy and unsustainable subsidisation;
(iv) Maximise security of power supply and insulate from external and
international events and catastrophe.
In pursuance of these objectives, the various measures taken by the State can be
divided in two parts, viz., (a) energy pricing measures, and (b) non-pricing
measures.
A. Energy Pricing
Policies adopted in India have generally aimed at the following:
(i) Meeting the maximum energy needs of low income consumers;
(ii) Encouraging the shift from oil products to domestically produced fuels;
(iii) Providing pricing subsidies to sectors such as agriculture and specific
industries where energy prices for consumers were held down in order to
provide enough margin between output price and the costs of inputs;
(iv) Permitting price stability and avoiding frequent and abrupt adjustments;
(v) Prices should be left to be determined by administrative fiat. This should
also promote rational use and conservation of energy.
The overall trend is towards greater efficiency in pricing and recent pricing
decisions have certainly passed on the burden of increased import prices fully
and, by and large, equitably to all categories of producers.
B. Non-Price Measures
Non-price measures instituted immediately after the first oil price shock relied
largely on allocation measures.
124
 (i) The government concentrated immediately on substitution of heavy fuel Economic
Infrastructure
oil (furnace oil) by coal whenever this was technically feasible.
(ii) Efforts have also been made towards regulation and management of
energy demand, as also to improve the efficiency of energy use in
different sectors of the economy.
(iii) On the supply side, efforts have been intensified for larger production of
both crude oil and refined products, as also of alternative sources of
energy, both conventional and non-conventional.
(iv) The other important steps have been:
– Improving the existing utilisation of assets.
– Reducing the transmission losses.
– Add power generation through private sector.
– Low voltage equipment sales are largely to industrial sector and public
utilities in India. Growth of low voltage equipment industry is related
to: (a) level of investment in the power sector and availability of
electricity in India, and (b) level of investments and growth in the
industrial sector in India.
(v) In 2002, the Accelerated Power Development and Reform Programme
was launched. It has since become the focal point of reforms in the
distribution segment.
(vi) Power Grid Corporation in early 2014 has completed the National Power
Grid Project. Under this project all the existing power grids have been
joined to form a national grid. This will be accessible from any point in
the country. It will shift excess power to power-deficit States.
(vii) In early-2004, India Power Fund (IPF) was launched with the aim to:
– facilitate expeditious financial closure of power projects.
– accelerate investment in power sector.
– promote competition in line with Electricity Act, 2003.
(viii) The government has unveiled a hydrogen economy plan that envisages a
million hydrogen-fuelled vehicles on India’s roads by 2020.
In February 2012, the government brought out action plan for power reform. It
lays emphasis on the following: (i) Distribution reform to be expedited with
active involvement of states, (ii) Cost variations due to fluctuations in fuel prices
to be passed through, (iii) Rating methodology of utilities to enable lenders to
decide, (iv) Distribution franchise on the line of Bhiwandi in Maharashtra to be
promoted across India.
The government has exempted since February 2012 the power sector companies
from going through the auction route for the allocation of coal blocks for captive
use. However, for users other than public sector companies, the competitive
125
Determinants of bidding method would replace the current practice of allocating blocks for
Growth
notified capture use.
4.8.2 Non-Conventional Energy
While the strategies discussed may help us see through to meet our basic energy
needs in the short and medium term, it must be recognised that our hydrocarbon
reserves are not going to last indefinitely. In fact, at current rates of production,
our proven oil reserves may hardly last out for another 20 to 30 years, (and even
less if the rate of production is stepped up). Hence, it is imperative that along
with other countries, we will need to participate in developmental work on
commercialising non-conventional renewable sources of energy such as solar
energy, wind power, ocean, bio-mass, geo-thermal energy, etc. Power generation,
based on non-conventional energy sources, has limitations of capacity but has
their own utility for small ratings. Most of these plants are totally pollution-free.
Specialised organisational and management skills are not called for. Our country
is ideally situated to harness a large quantum of such energy sources provided
economically feasible solutions are evolved to technological problems currently
faced in exploiting these exhaustible sources.
Among all these sources, solar energy – a new source of power – is being seen as
source of future to lead the world to a low-carbon future and, thus, away from the
looming climate crisis. It has big objectives.
First, it has to become cheap so that it can achieve grid parity and compete with
the dinosaur in the market: coal and oil. This can only happen when its
deployment is greatly scaled up. Second, it has to reinvent green growth. This is
why solar energy has been “sold” as an alternative industry, which will add to
employment. It is the economy of the future. Third, it has to secure need of the
most energy-poor – in other words, this relatively expensive and certainly most
modern energy system should reach the poorest millions living in darkness. This
would mean cutting the cost of supply, building networks to distribute and doing
all that has not been done before. The Government has already initiated action on
this front. A threefold strategy has been pursued; these include:
(i) providing budgetary resources from the government for demonstration
projects;
(ii) extending institutional finance for commercially viable projects, with
private sector participation and external assistance;
Fourth, promoting private investment through fiscal incentives, tax holidays,
depreciation allowance, facilities for wheeling, power for the grid and
remunerative price for the power supplied to the grid.
Self-Assessment Exercise C
1) Mention the principal sources of energy in the Indian economy.
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126
2) Point out the principal sources of non-conventional energy in India. Economic
Infrastructure
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3) Bring out the principal features of energy problem in India.
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4.9 LET US SUM UP

India has been riding on fast growth rate for some time. The pandemic put Strong
brakes on this process. We are ready to push up the growth rates so That we
compensate for the lost time. In this endeavour infrastructure sector is poised to
play a critical role. Huge efforts are on way to ensure that growth Process is not
hindered by inadquacies in the infrastructure sector.

4.10 KEY WORDS

Infrastructure: It refers to those services and structures that help in the growth of
directly productive activities like agriculture and industry.
Economic Infrastructure: It is directly related to the needs of production sectors.
Social Infrastructure. It is concerned with the supply of such services as meet the
basic needs of a society.
Public Goods: Two characteristics of public goods are important: (i) non-
excludability and (ii) non-rivalness. The consumption of public goods cannot be
restricted because of externalities and hence are available for use to everybody
without charge.
Externalities: Effects of a private action of society; effects may be positive or
negative.
Monopoly: A market situation in which there is only a single producer of a good
or a service.
Commercialisation of Infrastructure: To treat infrastructure as private goods,
and to restrict their use to those persons who are able to and willing to pay for these
services.

4.11 TERMINAL QUESTIONS

1. What is meant by ‘infrastructure’? Highlight the characteristics of
infrastructure.
127
Determinants of 2. Distinguish between economic infrastructure and social infrastructure.
Growth
Discuss the role of infrastructure in the growth process of an economy.
3. Briefly describe the features of infrastructure. Should there be private
participation in development of infrastructure sector?
4. Highlight the shortcomings of the transport sector in India.
5. Recent growth in the telecommunications has opened up huge
opportunities for growth in the Indian economy. Discuss.
6. Distinguish between conventional and non-conventional sources of
energy in India.
7. Solar power is fast emerging as a source of energy. Discuss.

FURTHER READINGS
Dhingra, I. C., Resource Base of the Indian Economy, Manakin Press (New
Delhi, 2020)
Government of India: Economic Survey, Recent Issue.
Annual Reports of concerned Ministries of the Government of India

128
UNIT 5 SOCIAL INFRASTRUCTURE
Structure
5.0 Objectives
5.1 Introduction
5.2 Achievements of the Education Sector
5.2.1Tertiary Education
5.2.2 Primary Education
5.2.3 Human Capital Formation

5.3 Weaknesses of the Education Sector

5.4 Public Expenditure on Education
5.5 Educational Reforms in India
5.6 Health Sector in India
5.6.1 Vicious Cycle of Poor Health
5.6.2 Causes of Poor Health Condition
5.6.3 Healthcare System in India
5.6.4 Deficiencies of the Healthcare System

5.7 Issues in Healthcare

5.8 Government Initiatives in Healthcare
5.8.1 National Health Policy
5.8.2 Pro-active Healthcare
5.8.3 National Rural Health Mission

5.9 Let Us Sum Up

5.10 Key Words
5.11 Terminal Questions

5.0 OBJECTIVES
After going through this unit, you will be able to
• appreciate the role of social infrastructure in economic growth;
• identify the constituents of the social infrastructure;
• describe the progress in various heads of social infrastructure; and
• identify major shortcomings and limitations of the various social
infrastructure sectors.

5.1 INTRODUCTION
In the process of economic growth the functions performed by economic
infrastructure (e.g., power, transport, communication, etc.) are complemented by
the functions performed by social infrastructure (e.g., schools, hospitals, art and
culture, etc.). Social infrastructure not only contributes to the production of goods
and services, it also contributes to social welfare. Thus, viewed from the
Determinants of perspective of human development, social infrastructure deserves more attention.
Growth
You should note that maximisation of social welfare is the ultimate objective of
all activities, economic and non-economic. There is no dispute over this approach
to development. Rather the importance of social infrastructure is further
strengthened by the recent experiences in wake of Covid-19. Globally, countries
having strong social infrastructure have been able cope with the Covid-19
problem in a much better manner.
Education is the process of acquiring knowledge, skill, values and personal
development. It could be imparted through three channels, viz., formal, informal
and non-formal. Formal education refers to various levels of studies imparted in
schools, colleges, universities and other educational institutions. Such institutions
could be in the public sector or in the private sector. Non-formal education refers
to various structured educational programmes that take place outside the formal
education system. Informal education refers to the learning acquired at home,
work place, peer group, etc. Formal education comprises three segments:
elementary education, secondary education and higher education.
The healthcare system includes organisations, institutions and resources that
produce actions whose primary purpose is to improve health. Thus, it is a vast
network of hospitals, diagnostic centres, blood banks, healthcare professionals,
etc. Also, there are laws, policies, plans and strategies to provide between health
facilities to people.
All along the recorded history, India has sought to build infrastructure with sound
foundations. Since independence these efforts have been further energised.
Notwithstanding the fact that the education and health sectors of India suffer
from serious limitations, we cannot ignore the fact that not many emerging
economies have reached such a level.

5.2 ACHIEVEMENTS OF THE EDUCATION

SECTOR
During the past six decades, there has been substantial expansion of the
educational sector in India. The education sector has the following positive
achievements to its credit:
(i) Accessibility to education has improved over time. Education is no more
elitist; it is somewhat ‘democratised’ with a large proportion of weaker
sections participating in education at all levels, including higher
education.
(ii) There has been rapid growth in education sector in India over the years.
Indian education system is now colossal, teeming with almost 100
million students and three million teachers, and costing billions of rupees
each year. This colossus is the result of conscious public policy in
independent India. Two basic features of this policy have been: (1)
Access-based strategy, and (2) Incentive-based strategy. The main focus
of educational policy has been to increase access to education at all
102
 levels. Now, almost everyone in rural areas (over 93 per cent) lives Social Infrastructure
within 1 km of a primary school. Similarly, over 92 per cent of the
population in rural areas have a middle school within about 5 km. and 82
per cent of the rural population now lives within 8 km. of a high school.
A district headquarter town without at least an arts college is now rare.
Colleges have proliferated at even faster rate than schools. As of March
2022, there are 1027 universities in India, including 54 central
universities, 444 state universities, 126 deemed to be universities, and
403 private universities.
(iii) India has the second largest (next only to China) pool of educated and
skilled men and women in the world.
(iv) Universalisation of elementary education has been a goal of the Indian
government since commencement of the five year plans. It got a major push
in 1999 when the Sarva Shiksha Abhiyan (SSA) was implemented. Another
landmark is the 86th constitutional amendment which made right to
education a fundamental right for children in the age group of 6-14 years.
This constitutional amendment was followed by the enactment of the ‘Right
of Children to Free and Compulsory Education (RTE) Act, 2009’.
The gross enrolment ratio (GER) in higher education (i.e., the proportion of
graduates aged between 18 and 23 years entering college-level courses) at the
national level rose from 12.5 per cent in 2007-08 to 27.1 per cent in 2019-20. The
increase in GER implies a rise in the supply of skilled personnel in India. This
would somewhat remove the supply constraint of skilled labour faced by the
industrial and services sectors. There are a lot of companies ranging from
retailers to information technology enabled services (ITES) which are finding a
shortage of skilled and employable personnel in India.
5.2.1 Tertiary Education
The changing nature of work makes tertiary education more attractive in three
ways. First, rapid expansion of the IT and ITES sectors have increased the
demand for higher-order general cognitive skills such as complex problem-
solving, critical thinking, and advanced communication. Such skills are
transferable across jobs. Such skills can be acquired through tertiary education
alone. The rising demand for these skills has enhanced the wage premiums of
graduates, while reducing the demand for less educated workers. Second, tertiary
education has increased the demand for lifelong learning (e.g., open and distance
learning). Workers are expected to have multiple careers, not just multiple jobs
over their lifetime. Third, tertiary education – especially universities – has
become more attractive in the changing world of work by serving as a platform
for innovation (hand-holding, start-ups, patents, etc).
India’s tertiary education system is the second largest in the world, after China. It
is home to more than 35 million students and over 50, 000 institutions. The most
prestigious institutions within this system have global standing and are
responsible for making India a world leader in the high-tech sector. But for this 103
Determinants of success to be taken to the next level, India’s tertiary education system needs three
Growth
sets of reforms.
First, it requires more flexibility between the general and technical tracks.
Second, Curriculum should focus more on building the skills. Third, Universities
should become centres of innovation. As part of the Start-up India initiative,
seven new research parks have been established in Indian Institute of Technology
campuses to promote innovation through incubation and collaboration between
universities and private sector firms. More initiatives like these are needed. The
New Education Policy, 2020 is expected to address these issues.
5.2.2 Primary Education
Certain skills are much in demand these days. Some of these skills are: (i)
complex problem-solving and analysis, (ii) social skills such as teamwork, and
(iii) relationship management. Reasoning and self-efficacy are also important,
particularly as they improve the adaptability of a person. In a survey of
employers of engineers in India, socio-behavioural skills were ranked at par or
above technical qualifications. Building these skills requires strong foundations
at the primary education level.
In fact, most of these traits are learnt by infants up to the age of 5-6. If children
miss out during this period in life, it is hard to catch up. These foundations can be
established through effective early childhood development programmes and basic
education. Investments in nutrition, health and stimulation in the first thousand
days of life build stronger brains.
As the World Development Report 2019 argues, India needs to focus more on the
quality of education it offers to its greatest asset – its citizens. In economics we
call it human capital formation. For most children, skill foundations are formed
through primary and secondary education. Yet, the acquisition of foundational
skills that one would expect to happen in schools is not occurring.
5.2.3 Human Capital Formation
Investment in education leads to human capital formation. When we invest in
education, it brings qualitative changes in labour – there is an improvement in
productivity of labour. Improvement in productivity leads to higher output. India
can prepare its people for the coming shifts in jobs, skills and market structures
through higher investments in education. Lack of investment in education will
leave the future generations, particularly the poorest segment, at a severe
disadvantage, amplifying inequalities that already exist. In the worst scenario,
inadequate investment on human capital may create instability in the economy.
A lot of investments in human capital have already begun in India and are likely
to have a positive impact in the coming years. The shift in the education sector
towards more competitive federalism and results-based financing is expected to
improve accountability and learning outcomes. India’s agreement to participate
in Programme for International Student assessment (PISA) is a major step
forward in its policy landscape. It will help rank India with global peers based on
104
education outcomes. India also needs to think about its current stock of Social Infrastructure
adolescents and working adults. Every year, 12 million youth enter the labour
market in India. By 2030, the country will have 123 million 25- to 29-year-old
citizens. And, bolstered by social media, their aspirations will be high. For these
young people, many of whom did not graduate with a high-school diploma, adult
learning programmes and forms of tertiary education are the only remaining path
to adequate skills development. According to some estimates, only 24 per cent of
the 18 to 37-year-olds who dropped out of school before completing the primary
level can read.

5.3 WEAKNESSES OF THE EDUCATION SECTOR

The education sector of the economy has demonstrated a number of weaknesses,
among which the more important are as follows:
1. Narrow Coverage
Tertiary education has a very narrow coverage of the population. Only 2.5 per
cent of the Indian population in the relevant age group attend colleges and
universities, compared with 66 per cent in the US and Canada, 47 per cent in the
OECD countries, 37.7 per cent in South Korea and over 20 per cent in countries
such as Cuba, Costa Rica and Venezuela. Moreover, there is a very high dropout
rate in India. Of 100 children entering class I, only 60 make it to the end of
primary school (class V). In contrast, 68 per cent of world’s children complete
primary education. Further, less than 3 per cent children complete class XII. The
poor retention rate at the primary level has been traced to the general neglect of
the education sector. There has been a significant improvement in retention rate
during the past few decades. The dropout ratio in primary schools has decreased
sharply from 70 per cent in 1950s to 40 per cent at present.
2. Low Access to Education
Access to education has been highly skewed. Some segments of society do not
have access to quality education. A recent World Bank study on the subject has
established that 10 per cent of the best educated Indians received 61 per cent of
the total resources, as against 36 per cent across Asia, reflecting a very high
degree of inequality in the system. The Gini coefficient for India (on a scale of 0
to 1 representing a progressive inequity) is 0.66, against the regional average of
0.43.
3. High Cost of Education
The cost of education, particularly higher education, has been relatively high.
Unit cost, defined as the percentage of per capita GNP spent on each pupil,
ranges from 6 for primary education to 231 for higher education. Though it is
obvious that higher education would have much larger unit costs, cross country
comparisons show that India’s outlays on higher education is much above the
average. Spending on higher education is 1.55 times the Asian average; whereas
it is only 0.61 times for primary education. An implication of the above is that
given the overall adequacy of funds invested in the education sector, expenditure 105
Determinants of on higher education has left very little resources for primary and secondary
Growth
education.
4. Low Quality Education
Notwithstanding the presence of regulatory bodies such as UGC, AICTE, NCTE,
etc., the quality of higher education in India is fairly low. As per Quacquarelli
Symonds (QS) World University Ranking 2022, only three institutions from
India find a place in the top 200 universities in the world. The low quality of
education has more recently been confirmed in an international test, PISA-2013
(Programme for International Student Assessment, conducted by OECD annually
to evaluate education systems world-wide) in which India ranked second-last in a
group of 73 countries, beating only Kyrgyzstan.
The educational system suffers from what has been called ‘diploma disease’, i.e.,
it does not aim at conveying knowledge and skills at all, but is more concerned
with certification. As such, its contribution to the growth of human capital is
minimal; it is unable to meet the emerging demand for skilled professionals.
5. Gender Bias
Spread of education has been biased more towards boys than girls. The dropout
rate is higher in the case of girls compared to boys. Girls’ education is accorded
lower priority in traditional households in India. Girls are required to assist other
women in the family in household work. Boys on the other hand, are encouraged
to study. Such traditional view however is fast changing in India. The
performance of girls in senior secondary education is much better compared to
that of boys. Even in higher education institutions, there are more girls than boys
in many educational programmes.
Check Your Progress A
1) Explain why capital formation in the education sector is important for
India.
………………………………………………………………………………
...................................................………………….…………………………
……………………………….………………………………….…………..
.……………………………………………………………………………...
2) What do you mean by quality education ?
………………………………………………………………………………
...................................................………………….…………………………
……………………………….………………………………….…………..
……………………………….………………………………….…………..
.……………………………………………………………………………...
3) What are the main weaknesses of the educational system in India?
………………………………………………………………………………
...................................................………………….…………………………
106
 ……………………………….………………………………….………….. Social Infrastructure
.……………………………………………………………………………...

5.4 PUBLIC EXPENDITURE ON EDUCATION

Spending on education as a share of the central government’s total budgeted
expenditure has been falling in recent years. Compared to 2013-14, when
education got 4.57 per cent of the total expenditure, there has been a steady
decline of 3.65 per cent in 2016-17 (see Fig. 5.1).

Fig. 5.1: Declining Trend of Government Spending on Education

Fig. 5.1 presents the government expenditure on education in recent years (as a
share of the GDP). We find that the percentage share has declined from 0.63 per
cent of the GDP in 2013-14 to 0.47 per cent in 2017-18.
Public spending on education is a must for ensuring availability of education for
all. While policymakers have been congratulating themselves for bringing almost
all the children aged 6-13 years to elementary school, little attention has been
paid to the fact that after this stage, it is downhill all the way. Gross enrolment
ratio (number of students in school at a particular stage as a percentage of all
children in the concerned age group) rapidly deteriorates after elementary school.
It declines to just 54 per cent by senior secondary level. In other words, roughly
half the children are out of school by the time they are senior school age. This
works out to about 35 million kids out of school.
In the case of higher education, the situation is much worse, with a gross
enrolment ratio of just 27.1 per cent for the 18-23 age group. This includes
distance education students. In most developed countries, the ratio is close to the
107
Determinants of 50 per cent mark. In India, about 71 million youth are still out of the higher
Growth
education system. Gross enrolment ratio for scheduled castes and scheduled
tribes are much lower, implying a still higher dropout rate.
So the marginalized sections of society need to be reached out, especially in
remote areas. School infrastructure and teachers need to be provided for. NGOs
and corporate bodies cannot handle this.
The problem does not end here. Even after getting everybody into school and
college, there is a need for good and qualified teachers. In 2019-20 there were
265 million students in India and the number of teachers remained at 9.68
millions. India needs to prepare teachers through well-equipped training colleges.
The Right to Education (RTE) Act, implemented since 2010, mandates certain
basic norms such as pupil-teacher ratio and physical infrastructure. One study has
shown that only about 10 per cent of the schools fulfill all the norms. Bringing up
the other schools to the RTE standard will demand enormous funds.

5.5 EDUCATIONAL REFORMS IN INDIA

India’s education system needs reforms. Two diverse trends are visible: Family
spending on education is rising while quality of education is deteriorating. About
25 per cent students are dependent on private coaching. If adequate public
spending on education is not provided, it may adversely affect the quality of
education.
Over the past 70 years, a number of measures have been taken to reform the
education system in India. These reform measures can be put under three groups,
viz., (i) equality reforms (provision of equal educational opportunity to all), (ii)
quality reforms (improvement in education quality), and (iii) reforms for
administrative ease (simplification of procedure). A recent study on the
effectiveness of these reforms further classifies each of these into two categories
as class-oriented reforms and mass-oriented reforms, and reaches the following
inferences:
(i) The steps taken by the government to provide equal educational
opportunities for all has been less successful. At the primary and
secondary levels, equal opportunity in education is somewhat
successful, while at the tertiary level it is not. As there are inequalities
in the society (in possession of wealth, parental education and cultural
factors), it is difficult to bring in equality in mental development of all
children. The government has continued with the policy of reservation
of seats in educational institutions for certain social categories of
students. Despite this, there are relatively less persons from
marginalised sections of society in managerial positions in the
industrial and services sectors.
(ii) In the case of a majority of the educational reforms the primary
initiative was taken by the Government and the mass involvement was
108
 very much limited. The target group (people) simply followed this Social Infrastructure
initiative of the government.
(iii) The global approach to educational change seems to have received
greater attention by the policy-makers than the specific measures for
educational change meant for specific target groups. The global
measures have an implicit bias towards the socio-economically better-
off sections of society, as major benefits from such measures could be
cornered by them.
(iv) Education in India has not taken advantage of the very things that the
country is now famous for in the world. The penetration of digital
media in schools is less than 5 per cent. There is an urgent need to
figure out how this can be done in a mission mode.
In short, educational reforms have not been successful in overcoming three major
problems so far as education sector is concerned: (i) smaller coverage, (ii) lower
quality, and (iii) higher inequality. Inequality in educational attainment is visible
at three levels: (i) The disparity across regions (see Unit 10) is increasing not
only in terms of per capita income but also in educational attainment. The poorer
states have not been able to allocate adequate funds for the education sector.
There are schools without proper building and adequate number of teachers. (ii)
There is wide disparity in educational attainment across social groups.
Educational attainment among persons from Scheduled Castes, Scheduled Tribes
and Other Backward Castes is low compared to General Castes. (iii) There is
disparity across gender also. Women have lower level of educational attainment
compared to men.
Now that the demand for education is rising from across the class, caste and
community divide, the future education policy should be based on three
principles, viz., (i) expansion, (ii) inclusion, and (iii) excellence. These refer to
access, equity and quality, respectively. Expansion refers to opening up of the
education sector to all, so that all stakeholders are allowed to participate in the
education process. By equity is meant the capacity for all sections of society to
pay so that no community is left out and all are part of the mainstream. An
equally important aspect of building human capital is creating the capacity for
innovation. Further, it is the quality of education that matters and cannot be
diluted. Based on these principles, the four most important elements in future
education policy should be:
(i) to make primary education not only available but also reached to and
availed of by all children, so that at least in the next generation, we have a
more educated, alive and alert population,
(ii) to focus on the education of women, and particularly girl child, by
reaching out to them,
(iii) to make education worthwhile, and relate it to the actual needs of the
population, in terms of suitability of the education imparted for
109
Determinants of employment, for better skills, for a better understanding of health,
Growth
education, environmental and other relevant issues.
(iv) to make use of the opportunities offered by the latest advances in
information technology.
The New Education Policy, 2020 tries to eliminate some of the deficiencies of
the earlier education policy. It emphasises on vocationalisation of education –
skills to be imparted to all students starting with class six. The difference
between arts and science streams will be minimised in the sense that basic
elements of both arts and sciences will be taught to all students. Language is
found to be major hurdle for the students; therefore emphasis will be given on
regional languages. The benefits of technology will be harnessed to bring in
accessibility, equality, affordability and quality in education.

5.6 HEALTH SECTOR IN INDIA

Improvement in the health status of a population is instrumental for increasing
productivity and economic growth. Health condition in India has improved
considerably in recent decades. Generally, the improvements have been
accompanied by socio-economic progress. Life expectancy at birth is the most
reliable measure of health status of a country. It provides an index to the range and
intensity of health problems. Life expectancy at birth in India has increased from
32 years (in 1951) to 70 years in 2022. Likewise, death rate in the country has also
recorded a steep fall. The death rate in India was 27.4 in 1951; it came down to
22.8 in 1961; and further to 7.3 in 2019. Rise in life expectancy and fall in death
rate indicate that the health condition in India has considerably improved over the
years. The life expectancy at birth, however, is miserably low compared to life
expectancy found in other countries. In 2022, life expectancy in Japan and Hong
Kong is 85 years. In most developed countries life expectancy is more than 80
years. Thus, health condition in India is still bad compared to developed
countries.
5.6.1 Vicious Cycle of Poor Health
In Fig. 5.2 we present the vicious circle of poor health. Poor health condition
leads to many complicacies. There are several causes and consequences of poor
health condition in developing countries such as India. There are several factors
such as poverty, lack of family planning, lack of healthcare, lack of education,
etc. that lead to poor health status. In the figure we have presented the impact of
poor health condition on women, particularly infant girl, young girl, teenagers,
potential mothers and breast-feeding mothers. It is vicious cycle because effects
are cyclical. A person does not have good health as a result of which her
productivity is low. As her productivity is low, she has low income, and she is
poverty-ridden. As she is poor, she cannot afford to nutritious food and
healthcare. As she is deprived of nutrition and healthcare, she has poor health
condition. By looking at Fig. 5.2, you analyse several situations with which we
all are familiar.
110
 Social Infrastructure

Fig. 5.2: Vicious Cycle of Poor Health

5.6.2 Causes of Poor Health Condition

The important causes of poor health are as follows:
(i) High Birth Rate and Fast Growth of Population. A number of health
problems derive from high fertility rate in India. When a large number of
people live in poor households located in crowded, unsanitary
surroundings, the possibility of spreading communicable diseases is
higher. Such living environment leads to high mortality, especially among
children (implies, high infant mortality rate).
High infant mortality rate, in turn, induces families to have more children
so that they can assure themselves of a few surviving children. This
pattern adversely affects the health standards. Similarly, high population
growth makes it more difficult to provide adequate water supply, proper
garbage disposal and maintenance of sanitation in the community. It
increases the cost of providing healthcare facilities to all.
(ii) Malnutrition. Widespread malnutrition contributes to the incidence and
severity of health problems. It poses a major threat to the children and, in
extreme cases, threatens their lives. In addition, malnutrition creates
serious health problems by contributing to premature births and
abnormally low weight at birth. Malnutrition is also a major contributing
factor in infectious diseases. Malnutrition weakens immunity system of
the body. The problem of inadequate nutrition is compounded by rapid
population growth. Large family size and close spacing of births
frequently preclude adequate food and care for children. 111
Determinants of (iii) Unsanitary Conditions for Housing. The contamination of food, water or
Growth
soil with human waste is a cause of a number of diseases. If water is not
safe for drinking, or is insufficient for personal hygiene and sewage
disposal, diseases will spread more easily. This reduces the health status
of the country. In addition to poor sanitation and water supply, a sizeable
proportion of the population live in sub-standard dwellings lacking in
space, ventilation and sunlight. Such conditions tend to increase the
incidence of diseases.
5.6.3 Healthcare System in India
Over the past seven decades, India has built up a vast healthcare system. The
healthcare system consists of the following:
(i) Healthcare institutions: There are primary, secondary and tertiary
healthcare institutions, manned by medical and paramedical personnel.
The primary healthcare institutions provide the first level of contact
between the population and healthcare providers. These consist of
primary health centres, community health centres, sub-divisional
hospitals, dispensaries run by various government departments, medical
infrastructure of PSUs and large industries.
The secondary healthcare institutions consist of district hospitals and
urban hospitals. They take care of (1) patients referred to them by the
primary healthcare institutions and (ii) primary healthcare needs of the
population in the city in which they are located.
The tertiary healthcare hospitals are attached to medical colleges, both in
the public and the private sector.
(ii) Medical colleges and paraprofessional training institutions to train the
needed manpower and give the required academic input. Programme
managers managing ongoing programmes at central, state and district
levels; and
(iii) Health management information system consisting of a two-way system
of data collection, collation, analysis and response.
5.6.4 Deficiencies of the Healthcare System
Despite the phenomenal expansion of the healthcare facilities at all levels
(primary, secondary and tertiary) there are a few deficiencies. One,
communicable diseases have become more difficult to combat because of
development of insecticide resistant strains of vectors, antibiotic resistant strains
of bacteria and emergence of HIV infection for which there is no therapy. Two,
longevity and changing lifestyle have resulted in the increasing prevalence of
non-communicable diseases. Three, malnutrition, micro-nutrient deficiencies and
associated health problems coexist with obesity and non-communicable diseases.
Four, the existing healthcare system suffers from inequitable distribution of
institutions and manpower. Five, even though the country produces every year
112 about 20,000 doctors in modern system of medicine and a similar number of
practitioners and paramedical professionals in Indian system of medicine, there is Social Infrastructure
a hige shortage of healthcare professionals in India.

5.7 ISSUES IN HEALTHCARE

Healthcare in India these days is under transition. This transition has four
dimensions as given below.
1. Demographic Transition. With declining mortality and fertility, the age
composition of population is fast changing. The percentage of older people in
the country is increasing. The age composition of the population for the year
2020 is shown as follows in Table 5.1.
Table 5.1: Age Composition of India's Population in Year 2020

Age Group Percentage of total population

2002 2020

0-14 35 26.7 per cent

15-64 59 63.60 per cent

65 and above 6 8.80 per cent

We observe from Table 5.1 that:

• There would be a significant increase in working population
(correspondingly, number of dependents will fall). This is known as the
window of demographic opportunity. This will last for a quarter century.
• The proportion of older persons in total population will increase. Among
the increasing older population, many may be widows, without family
support.
The demographic shift has implications for the way in which healthcare is
delivered and accessed.
2. Epidemiological Transition. We are encountering a “double burden of
disease”. A high proportion of the population continue to die from
preventable infections like diarrhoea, pneumonia, under-nutrition, childbirth
related complications, TB, malaria, and HIV/AIDS. Simultaneously, the
growing incidence of non-communicable, chronic conditions of ill-health like
cardio-vascular diseases, diabetes and cancer attributed to changing life-style
is stretching the capacity of the healthcare system.
3. Social Transition. There is, on the one hand a rising demand for high quality
healthcare, including a preference for multi-speciality hospitals even if these
entail higher costs. On the other hand there is unwillingness to discard myths
and misconceptions. For example, those factors contributing to adverse sex
selection.
113
Determinants of 4. Managerial Transition. We need to develop health financing systems that
Growth
will address the shift in disease burden, the increase in health costs, and
inefficiencies across healthcare management.
Responding to these issues and existing deficiencies in healthcare system, a
comprehensive national health policy has been formulated and is being
implemented.

5.8 GOVERNMENT INITIATIVES IN

HEALTHCARE
The government has taken several steps to improve the health status of people in
India
5.8.1 National Health Policy
The National Health Policy (NHP) was formulated in 1983. It articulated the
ambition of the country (i) to provide healthcare for all, and (ii) to achieve all-
round improvements in the health indicators of the population. The NHP
provided a comprehensive framework for planning, implementation, and
monitoring of health services to be achieved by 2000. The Ninth Five Year Plan
recommended a review of the National Health Policy in view of the following:
• Ongoing demographic transition
• Ongoing epidemiological transition (epidemiology is a branch of medical
science that deals with the incidence, distribution and control of disease in
a population)
• Expansion of healthcare infrastructure
• Changes in healthcare seeking behaviour
• Availability of new technologies for diagnosis and treatment
• Rising expectations of the population and escalating cost of healthcare.
A review of the policy resulted in formulation of the New Health Policy, 2002
(NHP 2002). The NHP 2002 focused on:
• Expanding and improving primary healthcare facilities;
• Organisational restructuring of the national public health systems to
facilitate more equitable access to the healthcare;
• Area specific programmes to meet the health needs of women, children,
elderly, tribals and socio-economically under-serviced sections;
• Programmes for the control of diseases like TB, Malaria, Blindness and
HIV/AIDS;
• Disaster management plan to cope with natural and man-made calamities;
and
• Macro-policy prescriptions for coordination between the government, the
114 private sector, NGOs and other institutions of civil society.
It was expected that with effective implementation of the policies and strategies Social Infrastructure
the country would achieve set goals and complete the health and demographic
transition within the set time frame.
5.8.2 Pro-active Healthcare
The latest National Health Policy (NHP) 2017 highlights the ‘Health for All’
approach to provide assured healthcare for all at an affordable cost. However,
there is scope to do much more under the NHP 2017. Ideally, the public health
policy needs to be focussed towards proactive healthcare, not reactive healthcare.
Besides, in the case of the government’s Ayushman Bharat scheme, the Pradhan
Mantri Jan Arogya Yojana (PM-JAY), the universal health insurance scheme, has
received considerable attention and resources than the health and wellness
centres (HWCs) component. This asymmetry needs to be suitably addressed for
the growth of healthcare in the future.
While public hospitals offer free health services, these facilities are understaffed,
poorly equipped, and located mainly in urban areas. It is a known fact that
accessible and affordable healthcare in the public sector can considerably reduce
the rise in dependence on private institutions. However, governmental facilities
leave no alternatives but to access private institutions and incurring high out-of-
pocket expenses in healthcare. Most health services are, therefore, provided by
private facilities, and 65 per cent of medical expenses in India are paid out of
pocket by patients.
A possible solution to address the issue could be to increase the adoption of
health insurance. In this regard, the government and private institutions both need
to work together. Adoption of digital insurance processing solutions integrated
with the healthcare ecosystem for faster turnaround time for insurance processes
will also motivate adoption of health insurance.
What primarily ails the healthcare system in India is that there has been a general
lack of focus on the vertical from the government. For years now, knee-jerk
reaction work is being witnessed towards the improvement of quality of service.
To sum it up, there is an urgency to make healthcare service and service
providers more transparent operationally. This will help ensure people and
processes can be made easily accountable to provide better healthcare services. It
is only then that the healthcare system can breathe a bit easier.
5.8.3 National Rural Health Mission
The Government has launched a National Rural Health Mission (NRHM) in
2005.
The Vision
• Effective healthcare for rural population, especially women and children,
throughout the country.
• Health Plan for each village through Village Health Committee of the
Panchayat. 115
Determinants of • Special focus on 18 states.
Growth
• Effective integration of health with sanitation & hygiene, nutrition, and
safe drinking water.
• 24-hour functional hospital in each development block.
• Community health insurance for the poor.
The Goal
• Reduced Infant Mortality Rate (IMR).
• Reduced Maternal Mortality Ratio (MMR),
• Prevention and control of communicable and non-communicable diseases.
• Promotion of healthy lifestyle.
• Mainstream AYUSH (Ayurveda, Yoga-Naturopathy, Unani, Siddha zind
Homoeopathy).
• Promote healthcare at household level through female health activist
(ARIA).
• Full coverage of immunisation and access to institutional delivery for the
mother.
Check Your Progress B
1 Write three causes of poor health care.

2 What do you mean by proactive health care ?

3 What do you mean by national rural health mission ?

5.9 LET US SUM UP

In this unit we reviewed the status of education and healthcare infrastructure in
India. There is no denying the fact that substantial progress has been made over
the years in both the sectors. However, the harsh reality that confronts us is that
in its present form the situation is dismal. Achievements in education and health
sectors are neither adequate nor efficient. A testing ground for both the sectors
was the pandemic of COVID-19. The health system was overwhelmed due the
rapid growth in the number of patients. The education system saw a major
change, where the pedagogy changed from classroom teaching to online
education. The COVID-19, however, has provided us an opportunity to re-
examine our priorities and strategies to rebuild our social infrastructure.

5.10 TERMINAL QUESTIONS

1. Discuss the importance of education and health structure in the process of
116 economic growth.
 2. Highlight the major achievements of the education sector in India. Social Infrastructure

3. Indian education sector suffers from serious ailments. Do you agree?

Explain fully.
4. Briefly describe the state of healthcare system in India. Are we fully
equipped to meet emergent situation? Explain.

5.11 KEY WORDS

Human Capital: It refers to the labour force that is an essential input in
production of goods and services.
Human Capital Formation: It refers to improvement in the quality of labour
force so as to increase its efficiency.
Tangible Assets: Assets that have a physical shape, i.e., these can be seen,
touched and felt.
Intangible Assets: Assets that do not have any physical or material shape (e.g.,
ideas, knowledge, honesty, etc.)
Knowledge Economy: A state of economy in which knowledge and ideas
command big premium and are therefore lavishly rewarded.
Access-based Strategy: It refers to a policy that provides educational facilities
at door-steps of the people.
Incentive-based Strategy: It refers to a policy that is built to induce people to
get enrolled in educational institutions.
Diploma Disease: A person is not interested in acquiring knowledge and skills,
but is more concerned with certification.

SELECT REFERENCES
Ishwar C. Dhingra, The Indian Economy: Environment and Policy (Sultan
Chand, New Delhi, 2021).
Government of India, Economic Survey (various issues).

117
UNIT 6 HUMAN RESOURCES
INFRASTRUCTURE
Structure
6.0 Objectives
6.1 Introduction
6.2 Importance of Human Resource Development
6.3 Indicators of Human Resource Development
6.4 Human Resource Development in India
6.5 Human Resource Development and Skill Formation
6.6 Labour Force and Work Force
6.6.1 Measurement of Employment in India
6.6.2 Gender Inequality and Economic Growth

6.7 Nature of Employment in India

6.7.1 Distribution of Work Force by Gender
6.7.2 Distribution of Work Force by States
6.7.3 Distribution of Work Force by Urban and Rural Areas
6.7.4 Distribution of Work Force by Main and Marginal Workers
6.7.5 Distribution of Work Force by Occupation

6.8 Quality of Employment

6.9 Informalisation of Labour
6.10 Suggestions for Employment Generation Strategy
6.10.1 Suggestions to Promote Employment in Urban Areas
6.10.1 Suggestions to Promote Employment in Rural Areas
6.10.3 Other Measures

6.11 Let Us Sum Up

6.12 Key Words
6.13 Terminal Questions

6.0 OBJECTIVES
After going through this unit, you will be able to
• explain the concept of human resource;
• describe the role of human resource in economic growth;
• identify the factors that enhance human resources;
• evaluate the present position of human resources in India; and
• describe the employment profile of the Indian economy;
Determinants of
6.1 INTRODUCTION
Growth
Human capital is defined as the body of knowledge possessed by the population
and the capacity of the population to use such knowledge effectively. As you
know, human beings provide an important input to production of goods and
services, that is, labour. You should note that the purpose of economic growth is
to enhance the consumption human beings are also the end of economic growth.
Every economic activity is undertaken to satisfy the needs of human beings and
improve their living standards. Economic activity generates work; it creates
employment opportunities, both for labour and other resources such as capital.
Labour and capital are complementary resources. But with increasing automation
of production techniques, capital is being increasingly substituted for labour.
Such substitution of capital for labour has made production process capital-
intensive, although it has raised productivity level and generated income and
output. There is a growing fear that the capital-intensive nature of production
process and automation of production activities will displace labour.
Employment of labour may suffer, thereby defeating the very purpose of
economic growth. In the present Unit, we examine the employment situation in
the Indian economy also.

6.2 IMPORTANCE OF HUMAN RESOURCE

DEVELOPMENT
In order to enhance knowledge and skill of human beings, there is a need for
investment in human beings. The importance of investment in human beings was
stressed during the 1960s. As a result, the concept of human capital formation
came to limelight. We observe a ‘two-way relationship’ between human capital
and economic growth. On the one hand, economic growth creates conditions for
better health and education facilities; these enhance human capital. On the other
hand, increase in human capital leads to higher productivity, as a result of which
there is acceleration in economic growth. Thus there is need for human resource
development (HRD) in an economy.

Fig. 6.1: Effect of Education on Earnings of Individuals

102
If a person undertakes studies, he/she is not available for work. Thus his/her Human Resources
Infrastructure
earning is zero during that time period (see Fig. 6.1). The other option before an
individual is to work. In this case he/she will start earning at a younger age, but
his/her skill level will be low. Thus we see that a person with lesser years of
schooling/ skill will have a lower level of income throughout. A person with
more years of schooling/ skill will start earning at a later stage, but his/her
income level will be higher throughout.
Functions of Human Resource Development
In emerging economies like India, HRD is to perform the following functions:
(i) The 21st century will promote people who respond to technology at the
Speed of Thought, as Bill Gates has said through the title of his recent
book. It will reject those who refuse to move fast enough.
(ii) There is a technological shift to knowledge-based, brain-power
industries. Brainpower industries do not have a natural home and can be
located anywhere. Smart countries are those who attempt to make
themselves attractive to the brainpower industry by educating their
people and creating the brainpower through educational institutions.
(iii) In the knowledge economy, the value of intangible assets is increasing
and value of tangible assets is decreasing. In order to have a cutting edge
in this area, the right kind of technology is not sufficient – rather a proper
organisational climate and the right people competencies become more
critical.
(iv) In recent years, knowledge creation and dissemination has increased
manifold. This in turn has led to the rapid spread of modern and efficient
production techniques which has resulted in the world economy becoming
more competitive. International trade increases the number of consumers
and producers participating in the market and hence increases the level of
competition. Thus, the knowledge revolution, together with increased
globalisation, presents significant opportunities for promoting economic
and social development.
(v) Technology is becoming more and more complex over time. In order to
operate it and carry out further improvement, there is a requirement of
advances in skills acquired by people individually and collectively.
(vi) All the well-known breakthroughs in physical technology would probably
have not even taken place if they were not preceded by relevant social
innovations. The latter fostered the birth of future advances in physical
technologies, and nursed them to maturity.
(vii) Higher education is believed to promote independence and initiative, both
of which are valuable intellectual resources for the generation and
dissemination of knowledge in society.

103
Determinants of (viii) Empirical evidence in most countries, including India, establish
Growth significant
– positive relationship between proportion of people below poverty
line and the proportion of illiterate persons;
– negative relationship between female literacy and birth rate; and
– positive relationship between years of schooling and net increase
in agricultural production.
(ix) Poverty is both a cause and a consequence of deficiencies in human
development. With poverty alleviation at the top of the development
agenda, a serious assault on poverty will no doubt bring human beings
into focus as the major beneficiaries of development. Increased public
spending on aspects of human development is more likely to have a
greater impact on poverty reduction and, at the same time, in improving
human development.
(x) Human Resource Development is required to modernise attitudes. A
backward social system and primitive attitudes and beliefs cannot go
along with economic development.
In short, HRD is an important condition for improving productivity and raising the
level of production which hold the key to economic development. Indeed, the
available empirical evidence testifies that poverty ceases to be a handicap and
becomes an advantage when a poor country builds up human capital and then uses
this cheap, skilled labour in conjunction with cheap global capital to produce a
world-beating combination.

6.3 INDICATORS OF HUMAN RESOURCE

DEVELOPMENT
The UNDP has developed a composite index of human development known as the
Human Development Index (HDI). The HDI is based on three indicators:
(i) longevity, as measured by life expectancy at birth;
(ii) educational attainment, as measured by a combination of adult literacy
(two-thirds weight) and combined primary, secondary and tertiary
enrolment ratios (one-third weight);
(iii) standard of living, as measured by real GDP per capita (PPP $).
For the construction of the HDI, fixed minimum and maximum values have been
established for each of these indicators:
(i) Life expectancy at birth: 25 years and 85 years
(ii) Adult literacy: 0 per cent and 100 per cent
(iii) Combined enrolment ratio: 0 per cent and 100 per cent
(iv) Real GDP per capita (PPP $) PPP $ 100 and PPP $ 40,000
104
For any component of the HDI, individual indices can be computed according to Human Resources
Infrastructure
the general formula:
Actual 𝑋 Value Minimum 𝑋 Value
𝐻𝐷𝐼
Maximum 𝑋 Value Minimum 𝑋 Value
Of the 187 countries for which the HDI was calculated in HDR 2017, we find
that 49 are in very high human development with HDI more than 0.90. Further,
53 countries are in the high human development category with HDI more than
0.8. There are 42 countries in the medium development category with HDI
between 0.5 and 0.8. There are 43 countries in the low HDI category. Let us see
what India has done for HRD and what problems she has been faced with in the
execution of the task.

6.4 HUMAN RESOURCE DEVELOPMENT IN

INDIA
The Constitution of India, in its various Articles, gives a prominent place to the
development of the human resources. The 93rd Amendment of the Constitution
makes education to all those between 6 and 14 years of age a Fundamental Right.
India could well be one of the fastest growing economies of the world. But for
the poor, matters have only turned worse.
Comprehensive information is available in India’s Human Development Report.
The major findings of the report can be briefly summarised as follows:
(i) The rural poor were better fed two decades ago.
(ii) The overall per capita intake of calories and protein has declined
consistently over the 20 years period from 1983 to 2004-05 according to
NSS data. Calorie intake per day in rural areas has declined from 2,221 to
2,047, a decline of eight per cent.
(iii) Similarly the calorie intake in urban areas has declined by 3.3 percent
from 2,080 in 1983 to 2020 in 2004-05.
(iv) Nearly half of India’s children under the age of three years are
malnourished, which is worse than the Sub-Saharan African region.
(v) There is not a single state whose hunger index is less than 9.9, suggesting
that all states have a serious to extremely alarming situation of hunger.
(vi) Not even half of our children are fully immunised.
(vii) The total expenditure on health (both public and private) stands at 4.1 per
cent of the GDP which is less than the African region’s expenditure on
health.
(viii) Compared to 30 hospital beds per 10,000 people in China, India
has only nine.
(ix) Almost 50 per cent of households in India have no toilets.

105
Determinants of The World Bank recently released its report on the Global Human Capital Index
Growth rankings, where India currently ranks 115th out of 157 nations (China being 46th,
Indonesia 87th, Malaysia 55th). According to the index scores from the report, a
child born in India is likely to be only 44 per cent productive when (s)he grows
up, if (s)he receives education and adequate healthcare.
India, in relation to other developing economies, does poorly in its ability to
expand overall productivity with a rise in GDP per capita. The disproportional
relationship between the two axes remains connected with India’s dismal
performance in aspects such as infant mortality (with 96 per cent children born
today having the probability to survive till they are 5).
In addition to the Global Human Capital Index, another useful indicator for
monitoring India’s performance is the Global Innovation Index (GII). The GII
reflects the technological state of growth for around 180 economies, computing
the progress made in technological advancements at a national level, ranging
from intellectual property filing rates to mobile application creation, education
spending, and scientific and technical publications. India currently ranks 57th
(out of 180) in GII’s latest ranking released in 2018 (China was 17th, Israel was
11th, UAE was 38th).
The development of human resources requires adequate provision of health
services, water supply, education, housing, nutrition and family welfare facilities
which are essential determinants of the quality of life. The provision of one
without the other is bound to affect the life adversely hence the strategy of HRD
is to take an integrated view of these factors.
Self-assessment Exercise A
1) Explain how there is a two-way relationship between human capital and
economic growth.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
2) Describe the importance of human capital for an economy.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
3) Define the concepts of tangible and intangible assets. Give some examples.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
106
6.5 HUMAN RESOURCE DEVELOPMENT AND Human Resources
Infrastructure
SKILL FORMATION
Creating a skilled workforce for the future of work rests on the growing demand
for advanced cognitive skills, socio-behavioural skills, and adaptability.
Technological change makes it harder to anticipate which job-specific skills will
thrive and which will become obsolete in the near future. In the past, shifts in
skill requirements prompted by technological progress took centuries to manifest
themselves (Fig. 6.2). In the digital era, advances in technology have been much
faster.

Source: World Development Report, 2019

Fig. 6.2: Increase in Technology Diffusion over Time
Strong skill foundations are important for developing advanced cognitive skills,
socio-behavioural skills, and skills predictive of adaptability. For most children,
these skill foundations are formed through primary and secondary education.
Challenge of Skill-Gap in India
Before understanding the size of the challenge that India faces, it is important to
understand the concept of ‘skilling’. A good source in this regard is the 2018
report by the National Council of Applied Economic Research (NCAER) – aptly
titled ‘ No Time to Lose’.
This report explains that there are three types of skills. First, the cognitive skills,
which are the basic skills of literacy and numeracy, applied knowledge and
problem-solving aptitudes and higher cognitive skills such as experimentation,
reasoning and creativity. Second, there are the technical and vocational skills,
which refer to the physical and mental ability to perform specific tasks using

107
Determinants of tools and methods in any occupation. Third, there are social and behavioural
Growth skills, which include working, communicating, and listening to others.
Different levels of these three types of skills can be combined to further classify
skills into foundational, employability, and entrepreneurial skills (see Fig. 6.3).

Fig. 6.3: Types of Skills

According to the 2018 report by NCAER, India had about 468 million people in
its workforce. Around 92 per cent of them were in the informal sector. Around 31
per cent were illiterate, only 13 per cent had a primary education, and only 6 per
cent were college graduates. Further, only about 2 per cent of the workforce had
formal vocational training, and only 9 per cent had non-formal, vocational
training. That report had also estimated that almost 1.25 million new workers
(aged 15-29) were projected to join India’s workforce “every month” through
2022.
Another noteworthy observation in that report was that out of the more than 5
lakh final year bachelors students aged 18-29 who were surveyed, around 54 per
cent were found to be “unemployable”.
What is at stake?
If the skilling issue is not resolved, India risks forfeiting its so-called
“demographic dividend”. There is great opportunity for India to improve both its
social and economic outcomes if the higher number of workers are productively
employed. At precisely the year 2020, the proportion of those Indians who
belong to the working age (15 to 64 years of age) and those who are dependent
will be 50-50. Between 2020 and 2040, this proportion will turn even more
favourable.
But whether this will turn into a demographic dividend or not will depend
entirely on how many of those in the working age bracket are working and
becoming prosperous. If they are not in well-paying jobs, the economy would not
have the resources to take care of itself since with each passing year, the
proportion of dependents will continue to rise after 2040. “To put it simply, to
attain its rightful place and realise its aspirations, India must become rich before
108 it gets old,” states the report succinctly.
But why is India stuck with low levels of skilling? Indians have excelled in Human Resources
Infrastructure
technical expertise at the global level–be it medicine or engineering. Then what
explains India’s domestic skilling paradox?
A big part of the trouble is the starting condition. Over 90 per cent of India’s
workforce is in the informal sector. According to researchers at the NCAER,
India is trapped in a vicious cycle: Greater workforce informality leads to lower
incentives to acquire new skills. Faced with inadequately skilled workers,
businesses often choose replacing labour with machinery. That is because
“skilled labour and technology are complementary, but unskilled labour and
technology are substitutes”. This, in turn, leads to still fewer formal jobs.
Millions of Indians who work in agriculture continue to subsist because they do
not have the skills to take up industrial or services sector jobs even as these
sectors themselves have failed to create adequate job opportunities.
What can be done to break this cycle?
A distinct disadvantage with India’s approach towards skilling has been to ignore
the demands of the market. For the most part, skills have been provided in a top
down fashion. Thus, most skilling efforts focus almost solely on providing
certain skills but fail to “match” them with the needs of the market.
Experts argue that for skilling schemes to yield lasting results, even matching is
not enough. Given the way market demands fluctuate–for instance, look at how
the COVID-19 pandemic has upended supply chains–skilling efforts must try to
anticipate the needs of the market.
Self-assessment Exercise B
1) State the nature of relationship between the proportion of literates and the
proportion of persons living below poverty line.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
2) What do you mean by the statement that there is negative correlation
between female literacy and birth rate?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
3) How does education modernise attitudes?
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

4) What are the three components of HDI?

109
Determinants of …………………………………………………………………………………
Growth …………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

5) What are the components of human resource development?

…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

6.6 LABOUR FORCE AND WORK FORCE

The total population of a country can be divided in two groups: (1) Labour force,
and (2) Out of the labour-force.
1. Labour Force: The labour force of an economy consists of those persons (i)
who are engaged in some economic activity and contribute to the generation of
national product, and (ii) those persons who are able and willing to work but do
not find any job that generates income.
(i) Work Force. The first of the above two is also called the work force. Work
force consists of workers. A worker is one who participates in any economic
activity. His or her services are utilised by the economy to produce some
goods or services. Thereby, he or she earns a living. These persons are
classified as employed.
(ii) Unemployed. The second component of the labour force consists of those
persons who are able and willing to work, but they fail to find any job
opportunity, i.e., the economy fails to make an effective use of their abilities
and capabilities in the generation of national product. These persons
constitute the unemployed.
2. Out-of-the-labour-force: Those persons outside the labour force constitute
the out of-the-labour force of the economy. These persons are generally not able
or not available for work. They do not contribute to the generation of national
product or income. It would be seen that it is the work force that contributes to
the generation of national product.
The relationship between (i) the population, (ii) the labour force, and (iii) the
work force may be revisited. A large population can supply a large labour force,
provided if a large proportion of the population is in the working age group (15
years to 60 years), and is physically and mentally fit.
A large labour force makes available larger resources in the economy. It depends
on the availability of complementary resources whether the labour force gets
productively employed or adds to the ranks of the unemployed. More the work
force, more generally, larger would be the size of national product and income.

110
Thus, it is the work force which represents the face of employment in an Human Resources
Infrastructure
economy.
6.6.1 Measurement of Employment in India
Employment in an economy is measured by using different criteria; each gives a
different concept of employment. These are: (1) Usual Principal Status, (2)
Current Weekly Status, and (3) Current Daily Status.
(i) Usual Principal Status (UPS): In UPS, the reference period a year to
describe the activity status of a worker. A person is known to be
employed if he or she was engaged in an economic activity for a longer
period of time (183 days or more) in 365 days. Similarly, a person is said
to be unemployed if that person is available for work but is not engaged
in any economic activity.
(ii) Current Weekly Status (CWS): In CWS, the reference period is a week
to describe the activity status of a worker. The CWS employment refers to
those persons who are employed for at least an hour during the reference
week.
(iii) Current Daily Status (CDS): In CDS, the reference period is a day. It
measures the rate of utilisation of the labour force in terms of person
days.

6.7 NATURE OF EMPLOYMENT IN INDIA

The nature of employment can be studied with reference to distribution of work-
force (i) by gender, (ii) by states, (iii) by urban and rural areas, (ii) by type of
activity (main and marginal workers), and (v) by occupation. Magnitude of
employment in India can be measured with the help of a concept called Work
Participation Rate (WPR).
The WPR is defined as the percentage of total workforce to total population, i.e.,
𝑇𝑜𝑡𝑎𝑙 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑊𝑜𝑟𝑘𝑒𝑟𝑠
𝑊𝑃𝑅 100
𝑇𝑜𝑡𝑎𝑙 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛
6.7.1. Distribution of Work Force by Gender
The male participation rate at 51.90 per cent is much higher than the female
participation rate of 25.70 per cent. This is not surprising, given India's social
milieu. Even now, women, by and large, undertake productive work only under
economic compulsion and this is one reason why female participation rates are
higher for economically under-privileged communities such as peasants, artisans
and scheduled castes. However, as the Tenth Five Year document states,
increasing literacy and decreasing birth rates may result in more women seeking
economically productive work outside house.
6.7.2. Distribution of Work Force by States
Among the states, the WPR ranges from 30.88 in Punjab to 48.91 in Sikkim. If
the states and the Union Territories are considered together, the highest WPR is
111
Determinants of observed in Dadra and Nagar Haveli (53.25) and the lowest in Lakshdweep
Growth (26.43).
6.7.3. Distribution of Work Force by Urban and Rural Areas
The WPR is higher in the rural areas than the urban areas. The WPR in rural
areas is 42.0; in urban areas it is 32.2. This is true both of males and females, the
gap being considerably more in the case of females. In rural areas, WPR among
males is 52.43; in urban areas, it is 50.8. In rural areas, WPR among males is
urban areas, it is 11.5 only.
6.7.4. Distribution of Work Force by Main and Marginal Workers
Main workers are those who work for major part of the year (183 days or more).
Marginal workers are those who work for less than six months in a year. In 2001,
main workers constituted 30.5 per cent of total population. Marginal workers
constituted 8.7 per cent. Among males, 45.3 per cent are main workers and 6.6
per cent are marginal workers. Among females, main workers are 14.70 per cent
and marginal workers are 11 per cent.
6.7.5. Distribution of Work Force by Occupation
Distribution of work force by occupations is also known as the occupational
structure of population. For this purpose, different occupations are divided into
three categories, viz., (1) primary (agriculture and allied activities) sector, (2)
secondary (industry) sector, and (3) tertiary (services) sector.
In India, 60.4 per cent of the work force is engaged in agriculture, 23.8 per cent
in services, and only 15.8 per cent in industry. This type of occupational structure
in considered lopsided. There is heavy dependence on agriculture; about two-
thirds of the working population derives its subsistence from agriculture, non-
agricultural sector absorbing hardly one-third of the total working population.
This is mainly because of the fact that modern technology in India is supplied
mainly from the developed countries. It corresponds, by and large to their own
economic conditions and needs. This technology is essentially capital-intensive
and labour-saving. Its introduction tends to produce a much stronger effect on
production than on employment.

6.8 QUALITY OF EMPLOYMENT

Quality of employment in India, broadly speaking is low. The low quality of
employment can be seen in the low productivity. As per the latest available data,
in 1999-2000, the overall rate of unemployment in India was a low as 2.23 per
cent. The percentage of people living below the line of poverty was 26.1 per cent
This shows that of the total employed persons about 23.87 per cent fell under the
category of ‘working poor’.
Obviously, the major problems relate to that of the working poor as the
productivity of employment is very low. The low productivity of employment is
mainly because of low educational and skill levels of the workers. About 44.0 per
112
cent of all workers in 1999-2000 were illiterate and another 22.7 per cent had Human Resources
Infrastructure
schooling only up to primary level.

6.9 INFORMALISATION OF LABOUR

By informalisation of labour we mean a situation in which an employee's services
can be terminated by the employer at the latter's will. There is no security of
tenure, terms of employment lack any legal validity Employment is more in the
nature of casual and irregular employment. The tendency towards informalisation
of labour increased after economic reforms during the 1990s. The growing
informalisation of labour can be proved with the help of following factors:
(i) Rising proportion of unorganised sector workers in total work force.
Workers in an economy are classified in two sectors: (1) organised sector
workers, and (2) unorganised sector workers. Organised sector is
identified with modern market economy, and unorganised sector with the
traditional economy Workers in the organised sector have better wages
and salaries, job security, reasonably decent working conditions and
social protection against such risks as sickness, injurie, sociability and
death arising out of hazards and accidents at work, separations and old
age. Workers in the unorganised sector lack security of job and have no
protection against risks, have low earnings, often lower than the statutory
minimum wages and have no regularity.
Distribution of work force between organised and onorganised sectors in
shows the following facts: One, about 93 per cent of India’s ond
workforce is engaged in an unorganised sector. That leaves only 7 per
cent in the organised sector. Even this proportion has been coming down
further in recent years. Two, the number of workers engaged organised
sector, already relatively very has been further falling in post-reforms
period as would be seen from Table 6.1.
Table 6.1: Number of Workers in the Organised Sector
Your (1) Public Sector Private Sector Total (2) + (3) = 4
(2) (3)
1997 195.59 86.86 282.45
1998 194.18 87.48 281.66
1999 194.15 86.98 281.13
2000 193.14 86.46 279.60
2001 191.18 56.52 277.89
2002 187.73 84.32 272.06
2003 185.80 84.21 270.00
2014 180.07 84.82 264.58
2019 179.10 86.90 266.00
An increase in the share of unorganised sector employment obviously means an
overall deterioration in the quality of employment.

113
Determinants of (ii) Increase in the Proportion of Casual Labour. Another measure of
Growth growing informalisation of labour is an increase in the proportion of
casual labour in total work force.
For this purpose, we can classify the workers in three categories as
(1) self employed, (ii) regular salaried, and (iii) casual.
The proportion of each category in India is shown in Table 6.2:
Table 6.2: Distribution of Workers by Nature of Employment
(in per cent)
Nature of Employment
Year Self Employed Regular Casual
Salaried Worker
1977-78 58.9 13.9 27.2
1987-88 57.4 13.9 28.7
1983 56.0 14.4 29.6
1993-94 54.8 13.2 320
2018-19 52.9 13.9 33.2
We observe from Table 6.2 that
a) A majority of workers still work as self employed. A large majority
of them are engaged in agriculture or in unorganised sector.
b) A smaller proportion of workers are employed as regular salaried.
This class of workers has regular jobs with security, relatively better
earnings and social security. But their proportion is stagnant.
c) The category of casual workers has steadily increased. This class of
workers suffers from low earnings, irregularity and uncertainty of
work availability, poor condition of work and lack of social
protection and vulnerability to risks and hazards.
Thus, increasing informalisation and casualisation of work force represents
declining quality of labour in India.
6.9.1. Factors Responsible for Informalisation of Labour
Informalisation of labour is a characteristic feature of market economies, which
is dominated by forces of competition. Following factors account for it:
(i) Pressure to cut costs: Competition requires that each producer
should produce at minimum possible cost of production. In pursuit of
lower cost of production. producers opt for improved technology.
This technology provides for increasing substitution of labour for fer
for capital. Therefore, employers prefer to employ casual labour, so
that they can be retrenched at will.
(ii) Rigid Labour Laws: Labour laws do not permit retrenchment of
labour. In the controlled protected economy of the past, the producers
114 could afford extra labour and pass on the cost to the consumers. In the
 emerging competition this luxury is no longer available to them. Human Resources
Infrastructure
Therefore, they do not like to employ regular workers.
(iii) Need for Upgradation of Skills: Technology is undergoing a
dramatic fast change. Every next round of technology demands more
skills. It means that skill-base of workers has to be upgraded. This
again cuts back the regular employment.
(iv) No scope for hidden costs: A regular permanent employee gets not
only his salary but also a number of other benefits accrue to him.
These are hidden costs to the employer. Competition requires that
costs should be transparent. And hence the need to dispense with
regular workers.
(v) Demand-Supply Imbalance: That the employers could easily take
resort to informalisation is also explained by obtaining demand-
supply imbalance in the labour market. Supply of labour far exceeds
the demand for labour. This is because of the fact that adequate
employment opportunities could not be created in our economy.
(vi) Shortcomings of Planning: A few shortcomings in our technique of
planning can be identified that have worked as constraints on
employment expansion.
One, efforts to lay sufficient infrastructure in the country for balanced
economic development have been lacking.
Two, the plans could not stop the migration of the rural population
into cities by making rural areas more attractive and congenial by
enabling them to earn a better living off land and encouraging the
development of growth centres around villages
Three, the plans could not encourage the use of labour-intensive
techniques of agriculture and industrial production.
Last, the plans also have not done well in the spheres of irrigation,
wasteland reclamation, soil conservation, and development of dairies,
fisheries and poultry farming, flood control, drainage, anti-water-
logging, rural electrification and other construction activities which,
in turn, could have provided extensive employment opportunities to
all categories of workers including skilled and unskilled personnel.
In short, in the wake of liberalisation, privatisation and globalisation, the
pressures on labour have increased. No doubt, economic reforms have opened up
new opportunities and markets for investments and entrepreneurship, but unless
growth is rapid enough and has high employment elasticity, labour is on the
losing side. Therefore, it is important to work out and implement a sound
employment generation strategy.

115
Determinants of
6.10 SUGGESTIONS FOR EMPLOYMENT
Growth
GENERATION STRATEGY
Suitable strategies should be formulated and implemented for generating more
employment both in rural and urban areas of the economy.
6.10.1 Suggestions to Promote Employment in Urban Areas
(a) Reform of the educational system to make it vocational at the school stage,
further give it a vocational bias at the undergraduate stage, and restrict
admissions to really highly qualified persons at the postgraduate stages.
(b) Deliberate promotion of low capital intensity in industrial production except
in areas where technological considerations make it impossible to avoid high
capital intensity. Fiscal incentives and technological facilities will have to be
provided for encouraging low capital intensive methods of production that
will still be modern and viable in costs
(c) The vast infrastructure of research and development that we have built up in
the public sector is now not being used for the promotion of intermediate
technology and low capital intensive choice of techniques. The present
policy must be changed and deliberate attempts should be made to identify
and develop techniques of production that can be undertaken with low
capital-intensity
(d) In planning investment, whether in the private or public sector, long
gestation period should be avoided except where they are technologically
inescapable. Deliberate attempt should be made to promote investments that
involve a quick turnover of capital. This will ensure larger and more
continuous employment with a given volume of capital.
(e) In order to diminish the concentration of employment in the metropolitan
centres action will have to be taken to promote decentralisation and
dispersal of industrial activity. Mere policy declarations will not do; they
have to be accompanied by follow-up action.
(f) The new policy directives given to the nationalised banks to promote MSME
sector and encourage self-employment should be vigorously followed up.
6 10.2 Suggestions to Promote Employment in Rural Areas
In rural areas, economists are unanimous in their view that there is no other
remedy than a massive programme of investment in rural development. This also
requires upgradation of technology in production process in rural areas.
The measures for rural development can be listed as follows:
(i) Creation of local assets, particularly projects suitable for a quick
increase in agricultural production, such as small and medium irrigation

116
 and drainage works, the construction of storage facilities and feeder Human Resources
Infrastructure
roads and the development of local transport;
(ii) Land development and settlement;
(iii) Expansion of animal husbandry and diversification of agricultural
production;
(iv) Development of other productive activities such as forestry and fishing;
(v) Promotion of rural social activities such as education, housing and
health services;
(vi) Development of viable small-scale industries and handicrafts in rural
areas, such as the local processing of agricultural products and the
manufacture of simple consumer and producer goods needed in the
areas;
(vii) Promotion and rapid spread of rural electrification;
As already noted, development by itself may not bring about employment.
Some measures will have to be taken to increase employment potential of
development. This will require a frontal attack on the low productivity and the
low income status of large mass of the rural population like the marginal
farmers and small farmers. This goal can be achieved by:
(a) land reforms with ceiling on holdings and redistribution of surplus
land in such a manner as to increase the number of owner-cultivated
holdings,
(b) paying special and differential attention to the needs of marginal
and small farmers in terms of availability of credit, lower rates of
interest and facilities for obtaining easily technically-improved
agricultural inputs, and
(c) concerted efforts to find viable and year round employment in the
rural areas by an appropriate policy of rural industrialisation.
6.10.3. Other Measures
Employment opportunities both in the rural and urban areas can also be promoted
by a large national programme of public works for the creation of the national
network of infrastructural facilities especially in terms of transport and
communications that can widen the Indian market, facilitate mobility of goods
and people, and create opportunities for new as well as increased economic
activity in both urban and rural areas. This type of programme may cause
inflationary consequences in the short run. To offset consequences, simultaneous
attempts need be made to increase the supply of basic wage-goods and services
that will enable the economy to meet the pressure of the increased purchasing
power resulting from the public works programmes.
Finally, and to top it all, we may mention that we would be fighting a losing
battle unless efforts are made, along with efforts to create new employment
117
Determinants of opportunities, to check the demand for new jobs. This would require the adoption
Growth of an effective and meaningful population control policy. As long as the rate of
population growth does not slow down so that it enables new jobs.
Self-assessment Exercise C
1) Distinguish between the concepts of labour force and workforce.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
2) Give a brief account of occupational structure in India.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
3) Analyse the problems associated with casualisation of labour in India.
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

4) Suggest measures to improve employment situation in urban areas.

…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………
…………………………………………………………………………………

6.11 LET US SUM UP

In this unit we observed that the HRD has emerged as the central point of policy
decisions globally. We have also detailed the components of the HRD as also the
indicators of HRD. These help us to measure and compare the level of HRD in
different economies. We have also reviewed the status of skill formation in India.
We also discussed the structure of employment in India and associated problems.

6.12 KEY WORDS

• Human Capital: It refers to knowledge, skill and experience of a person
which are used in the production process.
• Human Capital Formation: It refers to the process of adding to stock of
human capital. Through investment in education, training and health of
human being, there can be human capital formation.
• Knowledge Economy: It refers to an economy where production and
consumption processes are based on intellectual capital or human capital.
118
6.13 TERMINAL QUESTIONS Human Resources
Infrastructure

1. Explain the concept of human capital. What role does it play in an

economy?
2. Give a brief account of the status of skill formation in India.
3. Assess the skill-gap condition in India. What measures do you suggest to
overcome these gaps?
4. What are the indicators of human resource development in India?

SELECT REFERENCES
Dhingra, I. C., Indian Economic Development (Sultan Chand, New Delhi, 2020).
Government of India, Economic Survey, recent issue

119
BLOCK 3 ISSUES IN INDIAN ECONOMY
You have learnt about Economic Development in Block 1 and Determinants of
Growth in Block 2. This block discusses in detail about the major themes of
poverty, its causes, difference between poverty and inequality, unemployment
nature, types and causes, causes and indicators of inequality in income
distribution and need for balanced regional development in India. This block has
four units.
Unit 7 deals with Poverty and inequality. The unit begins with the concepts
ofpoverty, its types (absolute & relative), measurement, difference
betweenpoverty and inequality is then explained,the needfor studying gender
equality and poverty with economic growth is highlighted, whether economic
growth reduces poverty and gender inequalityare discussed andin the end the
linkages between inequality and poverty are outlined.
Unit 8 deals inUnemployment in India. The unit begins with the concept of
unemployment and its types (rural and urban), measurement, causes and
consequences of unemployment in India are explained, remedial measures for
unemploymentare suggested and in the end the policy measures for employment
generation and labour reforms are highlighted.
Unit 9 deals with the Inequalities in Income Distribution. The unit begins with
the concept of inequality in income distribution, causes of income inequality are
discussed, income inequalities by using different methods are explained and in
the end policy measures taken by the government to reduce income inequality are
highlighted.
Unit 10 deals with Balanced Regional Growth. The unit begins with the
concept of regional imbalance in India, then measurement of regional imbalance
is given, the need for regional balance is highlighted, the factors responsible for
regional imbalance are identified, the impact of regional imbalance is described,
and in the end the policy initiatives by the government to reduce regional
imbalance along with the issues involved in achieving balanced regional growth
are outlined.
Issues in Indian
Economy UNIT 7 POVERTY AND INEQUALITY
7.0 Objectives
7.1 Introduction
7.2 Concepts of Poverty
7.2.1Absolute Poverty
7.2.2 Relative Poverty
7.2.3 Extent of Poverty in India

7.3 Measurement of Poverty in India

7.3.1Headcount ratio
7.3.2 Poverty Line
7.3.3 Multidimensional Poverty Index (MPI)

7.4 Causes of Poverty

7.5 Poverty and Inequality
7.6 Gender Equality, Poverty and Economic Growth
7.6.1 Poverty and Economic Growth
7.6.2 Gender Inequality and Economic Growth

7.7 Poverty Alleviation Strategy in India

7.8 Let Us Sum Up
7.9 Key Words
7.10 Terminal Questions

7.0 OBJECTIVES
After going through this unit, you should be able to:
• describe the concepts of poverty and inequality;
• distinguish between poverty and inequality;
• identify the need for studying gender equality and poverty with economic
growth;
• explain whether economic growth reduces poverty and gender inequality;
and
• describe the linkages between inequality and poverty.

7.1 INTRODUCTION
Human beings have always endeavoured to improve their quality of life. The
advancements made in the field of science and technology, particularly during
past two centuries have impacted human life in the most unusually way. This has
helped societies achieve stupendous economic progress categorically in the
countries of the North America and Europe among others. Lately, economies in
Asia and Africa have also experienced economic growth and development
102
benefitting their people in multiple ways. However, the economic progress has Poverty and
Inequality
not been quite equitable. Certain sections of society, mainly due to social
hierarchy, have been able to reap greater benefits than others, eventually leading
to economic inequalities. People, relatively less equipped with good education,
appropriate training and relevant skill have not been able to contribute
quantitatively and/ or qualitatively, and therefore, have remained economically
poor. Historical exploitation of certain sections of the society by the dominant
and privileged people has widened the gap between haves and have-nots and
thrown the less privileged into absolute poverty. M. K. Gandhi once said,
“Poverty is the worst form of violence.”
According to the World Bank, there were 736 million poor in the world in 2015.
Sub-Saharan Africa and South Asian countries house around three-fourth of the
total poor population in the world. About half (368 million) of the total poor in
the world live in just 5 countries – India (24 per cent), Nigeria (12 per cent),
Democratic Republic of Congo (7 per cent), Ethiopia (4 per cent) and Bangladesh
(3 per cent). With sustained efforts of the World Bank, the United Nations
Development Program (UNDP), national governments and numerous
development agencies, the extent of absolute poverty globally has been steadily
falling. However, the Covid-19 led pandemic is likely to impact this trend in
poverty reduction in the vulnerable countries. Therefore, poverty elimination has
remained a major challenge right before the developing countries.

7.2 CONCEPT OF POVERTY

An individual, for a healthy living, needs certain basic goods such as food, water
and shelter. Expansion of the existing cities and continuous increase in
population has made it difficult for some sections of society to fulfill their
fundamental needs of life. Poverty is a state or a condition in which an
individual, a family or a community fails to possess the required material wealth.
People living in such situation are called poor. Poverty can be defined as a
condition in which an individual or household lacks the financial resources to afford
certain minimum standard of living.
World Bank provides an international definition of poverty – for the year 2022 it
refers to an income of $1.90 dollar per day (in PPP terms). It means those
individuals, whose income is more than $1.90 per day are said to be living above
poverty line and those who earn less than one dollar a day are said to be living
below poverty line. According to the UNDP, “The way people experience
poverty goes beyond living on less than $1.90 a day. Poverty is not only about
lacking the means to make ends meet or pay the bills for basic services on time.
Poverty is multidimensional and encompasses much more than income.”
In recent years, there is a shift in the definition of poverty. The emphasis now is on
monitoring and addressing deficits in several dimensions; not just income. These
dimensions could be housing, education, health, environment and communication.
There is an increasing perception that poverty is multidimensional, although there
is a tendency to focus on human development outcomes such as health, 103
Issues in Indian education, and nutrition when looking beyond income measures. Thus, the prime
Economy
concern with the material dimensions of poverty alone has expanded to encompass a
more holistic model of the components of well-being, including various non-
material, psycho-social and environmental dimensions.
7.2.1 Absolute Poverty
Any person not in a position to fulfill his basic needs of life is said to be living in
absolute poverty. It is a condition of extreme poverty for an individual person or
a family. Absolute poverty is poverty below a set line of what is required to
access minimum needs for survival. This type of poverty is usually inherited by
children from their poor parents so it can be chronic by nature. Households living
in poverty experience problems such as malnutrition, child labour, lack of education,
child marriage and disease. Poor people are moderately built in their physique,
inadequately fed with nutritive food, and likely to have high infant mortality rate,
high maternal mortality rate and low average life. Poverty can be measured using
poverty line. So, a family may be called Above Poverty Line (APL) or Below
Poverty Line (BPL) family. Literacy rate, life expectancy at birth, maternal
mortality rate and infant mortality rate are very low in such families. Quality of
life of people is of sub-standard. People living in urban slums, hutments and
roadside makeshift arrangements are generally living in absolute poverty. Poor
countries from Asia, Africa and Latin America face the problem of absolute
poverty. Anti-poverty programmes are started by government from time to time
to eradicate this kind of poverty.
7.2.2 Relative Poverty
When distribution of wealth or national income is unevenly distributed among
different sections of society, some people are poorer compared to others. We
describe such situations as relative poverty. Thus relative poverty is a
comparative aspect of income distribution. Presence of relative poverty shows
economic inequality in the society. Inequality is measured by ‘Gini Coefficient’
and ‘Lorenzo Curve’. A higher value of the Gini coefficient implies greater
inequality. Literacy rate, life expectancy at birth, maternal mortality rate and
infant mortality rate may not be very low in such families. Relative poverty is
found everywhere, but it is an economic problem found more in the developed
countries. Quality of life is not equal for all. Some people live a better quality of
life than others. This problem can be corrected to some extent if the government
adopts fiscal measures including high tax rates on income and expenditure of rich
people.
7.2.3 Extent of Poverty in India
The United Nations estimated the number of poor in India to be 364 million in
2019, or 28 per cent of the population. According to a study of the Health
Ministry, Government of India, half of Indians above 45 years are either
undernourished or overweight. As mentioned earlier India has the highest number
of poor in the world. Around 68.8 per cent of the Indian population lives on less
104 than US$ 2 a day. Over 30 per cent even have less than US$ 1.25 per day
available – they are considered extremely poor. Poverty in India is deeply rooted Poverty and
Inequality
and widely present all over the country.
Poor are found principally working as agricultural labour in villages or as
workers in the unorganized sector in the towns and cities of India. The most
underprivileged sections of society, viz., Scheduled Castes (SCs) and Scheduled
Tribes (STs) are living in abject poverty. From the table, it is evident that the
percentage share of SC and ST people living below poverty line is much higher
than other sections of the society. Urban slums have become new places of
dwellings for the poor migrants from rural India. India is a country of mass
poverty, i.e., numerous people are homeless and jobless.
The first Millennium Development Goal (MDG) is to reduce extreme poverty.
Since the 2000s, India has made remarkable progress in reducing absolute
poverty. Between 2011 and 2015, more than 90 million people were lifted out of
extreme poverty. The economic slowdown triggered by the outbreak of Covid-19
pandemic is expected to have a significant impact on poor and vulnerable
households. The following section, describes the important reasons behind
poverty in India.
Self-Assessment Exercise A
1) Define the concept of poverty.
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
2) What is meant by inequality?
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
3) Distinguish between the concepts of absolute poverty and relative poverty.
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
4) Discuss the extent of poverty in India.
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
105
Issues in Indian
Economy 7.3 MEASUREMENT OF POVERTY IN INDIA
There are several methods of measurement of poverty. We discuss these methods
below.
7.3.1 Headcount Ratio
This is the simplest method of poverty measurement. We count the number of
poor persons in this method. Suppose in a locality, the population size is 1000.
Out of these, suppose 235 persons are poor. The percentage of poor in the
locality is
𝐻 100 23.5

Thus, we can say that 23.5 per cent people in the locality are poor. A major
limitation of this approach is that it does not take into account the intensity of
poverty, that is, how severe is poverty among people.
7.3.2 Poverty Line
In India poverty was defined initially in terms of energy requirement to enable a
person lead an active and healthy life. The energy norm during the 1950s was
2900 kilo calorie (Kcal) per day for rural areas and 2400 kilo calorie per day for
urban areas. Based on this norm, it was estimated that Rs. 20 per person per
month (1961-62 prices) was required for a person in rural area. The
corresponding figure for urban areas was Rs. 25 per person per month. These
figures defined the poverty line. Thus, if a person in rural areas earned less than
Rs. 20 per month (below Rs. 25 per month for urban areas), he was considered to
be below the poverty line.
Later, during the 1980s, the calorie requirement was reduced to 2400 Kcal per
day for rural areas and 2100 Kcal for urban areas. Due to inflation in the
economy, the poverty line figures were revised to Rs. 49 per capita per month for
rural areas and Rs. 57 per capita per month for urban areas. The poverty line was
estimated on the basis of consumption requirements. It did not include other
essential items required for an active and healthy life.
During 2004-05, apart from energy requirement, five non-food items were also
taken into consideration for estimation of poverty line. Accordingly, poverty line
was defined as Rs. 720 per capita per month for rural areas Rs. 840 per capita per
month for urban areas. Such estimates of poverty line continued for many years.
Percentage of population below poverty line was also estimated on the basis of
such poverty lines. The Planning Commission of India released the estimates of
persons below poverty line till 2011-12, after which the practice was
discontinued.
7.3.3 Multidimensional Poverty Index (MPI)
Over time it was perceived that poverty is strongly linked with many other
economic and social variables. A poor person is deprived of not only food, but
also of education, health, housing and durable assets. Thus poverty is
106
multidimensional in nature. In order to measure poverty a comprehensive index Poverty and
Inequality
is required, which will measure deprivation of people from consumption of
essential goods and services. Such thoughts gave rise to the concept of
Multidimensional Poverty Index (MPI).
MPI was first released by the Oxford Poverty and Human Development Initiative
(OPHI) and the United Nations Development Programme (UNDP) in 2010. Since
then the OPHI has been bringing out MPI which gives the poverty index for India
as a whole. Recently, in 2021, the NITI Aayog has brought out the baseline
report on multidimensional poverty index in India. This report presents the
multidimensional poverty index for the states and union territories of India.
As per the MPI, there are three important dimensions of poverty: (i) Health, (ii)
Education and (iii) Standard of Living. Under the category ‘health’, we consider
nutrition, child mortality and antenatal care. Under the category ‘education’ we
consider years of schooling and school attendance. For determination of the
standard of living, we consider seven criteria: (i) cooking fuel, (ii) sanitation, (iii)
drinking water, (iv) electricity, (v) housing, (vi) assets, and (vii) bank account.
According to the MPI report, the percentage of poor in certain states is very high
in 2021. For example: Bihar (51.91%), Jharkhand (42.16%), Uttar Pradesh
(37.79%) and Madhya Pradesh (36.65%). On the other hand, certain states have
relatively low levels of poverty. For example: Kerala (0.71%), Goa (3.76%),
Sikkim (3.82%), Tamil Nadu (4.89%) and Punjab (5.59%).

7.4 CAUSES OF POVERTY

Several factors are responsible for the prevalence of poverty and inequality in
India. We discuss some of these factors below.
(i) Weak Asset Base
An individual in India is poor because he has a weak asset base. He is born in a
family that hardly owns an ancestral profitable farm land and a big house or
possesses previous metals or a professional degree. The poor in India inherit
poverty and debt. Exactly in the same way, wealth of a family is passed on from
one generation to another. The disadvantaged groups receive very limited assets
in inheritance. Therefore, we observe rampant poverty among the disadvantaged
groups.
Table 7.1: Poverty Ratio among Social Groups (2011-12)
Category Rural (in per cent) Urban (in per cent)
SC 31.5 21.7
ST 45.3 24.1
OBC 22.6 15.4
Others 15.5 8.2
Total Population 25.7 13.7
Source: Planning Commission of India

107
Issues in Indian (ii) Social Factors
Economy
Indian society is hierarchical in nature. It is dominated by caste system,
discriminatory inheritance laws, and rigid traditions have directly or indirectly
aggravated the problem of poverty in the country. Caste-based occupational
reservation in India has discouraged people from learning skill sets and venture
into the labour market on the basis of efficiency. There is discrimination against
women in Indian society. Education of girl child is an important factor in this
context. Further, there is a need to change our mindset, as certain families do not
allow women to work outside.
(iii) High Population Growth
As per the Population Census of India, population in India was around 36 crores
in 1951 but increased to around 121 crores in 2011. India is the second most
populous country in the world after China. Population in India has increased over
two per cent per annum during the last half a decade. On an average, about 17
million people are added every year to the population of the country. In 2011,
population of India at 1210.8 millions, was almost equal to combined population
of the United States, Indonesia, Brazil, Pakistan, Bangladesh and Japan put
together. The population of India increased by more than 181 million during the
decade 2001-11. The estimated population of India in 2022 is 135 crores.
High population growth has increased the burden on the natural resources.
Population growth increases demographic pressure on land, resulting into
fragmentation of landholding, and ‘disguised unemployment’. It leads to reduced
agricultural productivity and fall in income of farmers. Marginal farmers,
particularly with large family size, use traditional methods of cultivation on their
fragmented land holdings. Indian cities and towns have neither been able to
provide enough jobs nor a decent living for the migrant workers. During 2001-
11, certain states registered low population growth (for example, Kerala, Andhra
Pradesh, Odisha, West Bengal, Punjab and Himachal Pradesh) while certain
states (such as Bihar, Chhattisgarh, Jharkhand, Rajasthan, Uttar Pradesh and
Madhya Pradesh) recorded high population growth rate.
(iv) Low Level Literacy
Illiteracy is a major cause of poverty. According to the United Nations Children’s
Fund (UNICEF), “About 25 per cent of children in India have no access to
education”. According to a study in the medical journal The Lancet, “44.5 per
cent of girls are still married in India before they are of legal age”. The illiterate
people – for not possessing relevant skill and education – are trapped in a vicious
cycle of poverty. The illiterate people end up with petty jobs, usually employed
in informal sector, and are paid poorly. As per Census 2011, literacy rate at all
India level was 72.98 per cent. There is a wide gap in the literacy rate for females
(64.63 per cent) and males (80.9 per cent). Education of the girl child again is the
need of the hour.
108
(v) Inflationary Pressure Poverty and
Inequality
High rate of inflation adversely affect the purchasing power of people. The
annual inflation rate in India has remained over 5 per cent. The lower economic
stratum of people is hit hard when prices of food grains, fuel and edible oil
exceed the rise in income levels. They find it difficult to get their minimum needs
fulfilled. For example, India, after Green Revolution, has become self-sufficient
and self-reliant in food grain production. The increase in food production
however has not increased the food availability for the poor in the country.
(vi) Unemployment
Indian economy has structural bottlenecks that hinder economic development.
This results in structural unemployment, seasonal unemployment as well as
disguised unemployment. Half of India’s population still depend on agriculture
and allied activities for livelihood. Employment opportunities are limited in
urban areas as well. Non-agricultural sector (industries and services) has not been
able to absorb the unemployed people.
(vii) Lack of Investment
India is a capital scare and labour abundant country. Lack of capital reduces the
extent of investment. During the early years after independence, the Government
used to invest heavily in key sectors including minerals and metals, transport and
communication, health and education, among others. Unfortunately, Foreign
Exchange Regulation Act (FERA), Monopolistic and Restrictive Trade Practices
(MRTP) Act, Industrial Licensing and high tax regime kept the private sector
from participating in the industrial development of the country. So, whatever
little investment was seen in the country, it prioritized select industrial and/urban
clusters. Restricted or limited availability of credit/capital for investment in
industries discouraged entrepreneurship in the country. The shortage of supply of
capital made it difficult for production and reduced employment opportunities in
the private sector particularly for the poor.
(viii) Regional Imbalance
There is regional imbalance in distribution of income and wealth in India. We
observe disparities across states in per capita income in India. Two major features
are observed so far as regional disparities is concerned. One, there is wide
disparity across states in per capita income. Sates such as Punjab, Haryana, Goa
and Karnataka have very high per capita income while states such as Bihar, Uttar
Pradesh, Jharkhand, Manipur and Madhya Pradesh have very low per capita
income. Second, the gap between rich and poor states is widening over time.
While rich states are getting richer, poor states are getting poorer.
The north-eastern states in India, popularly known as the Seven Sisters, despite
being endowed with abundant natural resources, do not contribute much to the
GDP of the country. States such as Chhattisgarh, Jharkhand, Odisha, Madhya
Pradesh and Rajasthan are rich in minerals and metals, but due to lack of

109
Issues in Indian conducive business environment, many people migrate to other states in search of
Economy
jobs.
(ix) Populist Measures
Political parties have learnt the skill of pursuing populist policy measures so as to
create vote banks. Provision of subsidies eats away a substantial portion of our
budgets. Free electricity to farmers and all households in certain states are major
heads of expenditure. In the process there is little resources left for investment in
capital formation. If productive capacity of the economy does not increase,
employment generation and output growth will be slower. Such populist
measures are not always meant to reduce poverty.
Self-assessment Exercise B
1) Describe the major causes of poverty in India.
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2) Why is inflation an important cause of poverty in India?
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3) Comment on the statement that high population growth and illiteracy are the
main causes of poverty in India.
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7.5 POVERTY AND INEQUALITY

Inequality needs to be distinguished from poverty. Inequality refers to the degree
of dispersion in the distribution of assets, income or consumption. Inequality
shows the classification of people into economically well off class, middle class
and poor class. It shows whether assets of the country are fairly distributed or
not. Poverty, on the other hand, refers to assets, income or consumption of those
at the bottom of the distribution. Poverty could be conceptualised in relative
terms or in absolute terms. Inequality indicates power balance in the society.
Since industrial revolution, there has been tremendous growth achieved by
countries across the world. With passage of time, the role of state has
significantly changed. The modern states –particularly those practicing
democracy – have become welfare states. However, there is widespread concern
110 that economic growth has not been fairly shared, and that the economic crisis has
only widened the gap between rich and poor. For instance, during the post- Poverty and
Inequality
independence period, the distribution of agricultural land is highly skewed in
favour of the so called upper castes of the Indian society while the farmers of the
SC and ST communities are either small and marginal farmers or landless
labourers. Concentration of economic power in India has been skewed and in
favour of the trading or business communities, interestingly these communities
are predominantly non-SC and non-ST castes. There exists relationship between
inequality and poverty described below.
Inequality and poverty are linked with each other.
a) In poor countries, there exists a wide difference between health and
education parameters of the rich and the poor. India’s pharmaceutical
industry is one of the largest in the world. However, due to their inability
to pay for medical treatment, the poor have very high infant mortality rate
and maternal mortality rate.
b) Gender-based discrimination is rampant and gender inequalities are much
deeper in poor countries compared to developed and rich countries. The
asset ownership among women in rural India is very low compared to
men.
c) There exist major differences in job quality, wage rate and extent of
economic security of workers in advanced countries and in their
counterparts in Asia, Africa and Latin America. Despite implementation
of important labour laws, exploitation of labour has continued leading to
persistent inequalities.
Poverty is related to non-availability of resources for a household. Poverty is seen
in people whose income and/or asset base is so low that it is difficult to maintain
certain quality of life. Inequality refers to disparities among people based on
income, wealth, education, health, nutrition, living space, and social indicators.
Poor people are unable to fulfill their basic needs such as food, health facilities,
education and shelter. Poverty leads to capability deprivation; that means poor
people are not capable of doing certain activities at par with others. Poor do not
have access to quality education, as a result of which they have low employment
opportunities. Poor people do not have access to health services, as a result of
which their productivity is low. Inequalities are ‘fundamentally about relational
disparities, denial of fair and equivalent enjoyment of rights, and the persistence
of arbitrary discrepancies in the worth, status, dignity and freedoms of different
people’ (UNICEF & UN Women, 2013). Inequality can exist in a variety of
different spheres such as income, wealth, education, health and nutrition.
Inequality is can be of two types: (i) vertical inequality, and (ii) horizontal
inequality. Vertical inequality refers to the inequality among individuals and
households (for example, inequality among households in income or
consumption). Horizontal inequality refers to inequality among groups of
individuals who share a common identity. Thus inequality is not due differences
in intelligence or skill among people. Horizontal inequality could be due social 111
Issues in Indian dimensions such as gender, disability, race, ethnicity, caste, religion or language.
Economy
As you may have observed, there is a strong linkage between poverty and caste in
India. Further, there are discriminations in society in the sense that some groups
of people not have access to certain facilities (for example, in rural areas). These
socially excluded groups often suffer from spatial inequalities as they tend to be
concentrated in disadvantaged locations.

7.6 GENDER EQUALITY, POVERTY AND

ECONOMIC GROWTH
Economic growth should ideally reduce gender inequalities and the extent of
extreme poverty. In India, too, the monumental progress made in all spheres of
life during post-economic reforms, have been accompanied by increased
participation of women in economic activities and reduction in the extent of the
most brutal forms of poverty. Gender inequalities are systematically greater in
poor countries than in rich countries. The reasons behind wider gender gaps are
more structural and/or systemic. For instance, the systems of patrilineality
(inheritance through male descendants) and patrilocality (married couples living
with or near the husband’s parents) play a central role in perpetuating gender
inequality in India’s male dominated society.
7.6.1 Poverty and Economic Growth
Economic growth is a result of the increase in investment leading to greater
employment opportunities and expansion of the GDP of the economy. Higher
economic growth benefits the society at large. It is important to note here that
economic growth has an impact on poverty and inequality. Higher economic
growth, however, may lead to reduction in the extent of poverty but it may not
necessarily reduce the extent of economic inequality. The reason is that faster
economic growth increases earnings of well-educated, well-trained people and
those who have better access to resources and opportunities. The poorer sections
of society however are not fortunate enough in this regard; their earnings may not
increase at the same pace the economy is growing. Therefore, the gap between
the rich and the poor is widening. In this regard, appropriate policy measures are
very important. In order to reduce inequality, a just and more equitable
redistribution of national income and factor rewards need to be a part of the
policy. If economic inequality persists, or accentuates over time, then there is
always a high probability of recurrence of poverty for the low income groups.
Globalization has transformed the way businesses operate. Opening up of the
Indian economy has led to increased exposure of the country to the rest of the
world. This has expanded the size of the market and led to higher level of output.
India now ranks among the fastest growing economies of the world.
You should note that higher economic growth is not the only objective for any
economic policy. Benefits of economic growth should percolate down to all
sections of society including the lower strata. In developing countries including
India, the poor strive hard to fulfil their minimum consumption needs of food and
112
non-food items. Therefore, the government has been continuously increasing its Poverty and
Inequality
expenditure on social sectors such as health, education, sanitation, etc.
7.6.2 Gender Equality and Economic Growth
Gender-based discrimination is defined as the difference in opportunities and
rewards available to people solely on the basis of gender. It is a social process by
which men and women are not treated equally. There can be numerous cases of
gender inequality practiced in India. For the same nature and quantum of work,
there is unequal payment of wages for men and women. Ownership of assets is
usually in the name of the male members of the family. A woman’s viewpoint is
not considered as important on critical issues in the family.
In many developed countries there is greater equality between man and woman.
Women in the industrially developed countries are mostly educationally
qualified, economically secure and socially empowered. The developed countries
rank high on the Gender Development Index (GDI). In developing countries, on
the other hand, women are not privileged enough. Despite higher economic
growth, gender inequality continues in Third World countries.
Women in India are discriminated both at home and outside. According to the
UNICEF, “India is the only large country where more girls die than boys and
school dropout rate is higher among girls compared to boys”. Crime against
women is rampant in India. A survey conducted by the Thomson Reuters
Foundation has ranked India as the world's most dangerous country for women,
ahead of Afghanistan, Syria and Saudi Arabia. Equal representation of women in
the state legislative assemblies and India Parliament is far from near. For
instance, there are 78 women members of parliament (14 per cent), the highest
since independence. As per the Human Development Report 2020, the gender
development index (GDI) value of India is 0.820, with the GDI value for females
at 0.573 and that for males at 0.699. This indicates the sharp contrast in
empowerment between man and woman. In this measure, India is behind
Bangladesh, with a GDI value of 0.904, while it stayed ahead of Pakistan (0.745).
The average GDI for the South Asian region stood at 0.824, while that for
medium HDI countries was 0.835, with India’s value being lower than both.
Despite rapid economic growth, the growth of microcredit programme and self-
help groups, and laudable efforts to increase women’s political participation,
gender disparities have remained deep and persistent in India. Gender inequality
prevails in all sectors of the economy such as education, health, politics, and
business among others. The UN Gender Inequality Index has ranked India below
several Sub-Saharan African countries. Women participation in non-agricultural
and white collar economic activities has increased in recent times. However, the
number of women in power hierarchy in business enterprises is far less than men.
India ranks 136th among 144 countries in women’s labour force participation rate
and the situation is worsening over time (Economic Survey 2017-18). For the
same work, males are paid higher wages compared to females particularly in the
unorganized sector. Despite recent economic advances, India’s gender balance
113
Issues in Indian for entrepreneurship remains among the lowest in the world. The labour market
Economy
participation of women in economic activity in India stood at 76.1 per cent for
males and at 20.5 per cent for females. The Human Development Report 2020
estimated gross national income per capita for males as $10,702 and for females
as $2,331.
Women empowerment and economic development are closely related. There is
two-way relationship between economic development and gender equality. While
economic development can play a major role in reducing gender inequality,
empowering women will lead to faster economic development. According some
studies, gender inequality in labour market earnings often implies power
asymmetries within the household, with men having more bargaining power than
women. Despite the sharp increase in investment, output and exports in India,
women in general and from the disadvantaged sections in particular, are the most
discriminated. India’s economic power would be greatly enhanced if women are
given proper healthcare, education, and economic opportunities.

7.7 POVERTY ALLEVIATION STRATEGY IN

INDIA
The government of India has made concerted efforts to reduce the extent of
poverty. In this initiative, we observe certain policy shifts over time. There have
been at least three policy shifts in the past.
(i) Trickle-Down Theory: During the 1950s and 1960s it was believed
that economic growth will take care of poverty and inequality. When
economic growth takes place, the benefits percolate downwards.
Income of people increase. Thus, there will be an increase in the
income of poor households also. With an increase in income, poor
households will be able to elevate themselves above the poverty line.
Thus the objective of the government was to achieve higher economic
growth.
The trickle-down theory however was not found to have a positive
effect on poor households. The benefit of economic growth was
cornered by the rich sections of society. Poor households continued to
remain poor, while economic inequality increased in the country (as
the rich became richer). Such developments compelled the
government to change its strategy regarding poverty alleviation.
(ii) Public Distribution System: The failure of the trickle-down approach
led the government to make special provisions for the poor
households. During the 1970s the ‘Public Distribution System (PDS)’
was strengthened. The PDS served two purposes – it procured food
grains from farmers during harvest season. During the harvest season
the price of agricultural commodities decreases sharply due to excess
supply. Government purchase of food grains helped in maintaining
114
 Poverty and
remunerative prices in the market. This ben3efitted the farmers. The Inequality
procured food grains were sold to poor households at subsidized
prices. Thus poor households could obtain essential commodities such
as rice, wheat, sugar and oil at a cheaper price. Procurement of food
grains continues these days also.
(iii) Direct Attack on Poverty: During the 1980s the government extended
cheaper credit to poor households. Not only the rate of interest was
very low on the loans extended to poor households, there was a
substantial amount of subsidy on repayment of the principal amount.
The objective of the programmes was to provide self-employment to
poor households. It was envisaged that poor households would carry
out small business, goat-rearing, milch cow, weaving, etc. with the
help of the credit given to them.
Self-employment programmes for poor households, however, did not
succeed as there was a lack of entrepreneurial skill among the poor.
The beneficiaries could not manage the activities. Income generated
from such activities was also very low, as a result of which the
beneficiaries could not repay the loan. This called for a new strategy
for poverty alleviation.
(iv) Wage Employment Programmes: With the failure of self-employment
programmes, the government continued with the employment
generation schemes during the 1990s. The focus was on creation of
infrastructure and community assets (such as road, houses, water
reservoir, etc.) which would generate additional wage employment for
people. Many small projects were completed under such schemes.
There were doubts on the quality of the assets created under such
schemes. There were also complaints of workers not getting their
wages.
The wage employment generation approach has continued under
different nomenclature. Employment generation under the Mahatma
Gandhi National Rural Employment Guarantee Act (MGNREGA) is
one such measure. In order to remove the irregularities in payments,
government has emphasized on financial inclusion and direct benefit
transfer to poor households. Under the MGNREGA, there is assured
wage employment up to 100 days in a year for each household.
(v) Social Security Measures: Apart from employment generation, the
government has made provisions of certain social security measures
that supplement the income of poor households. There is provision for
subsidized food, subsidized cooking gas, subsidized housing, pension
for the aged and widows, health insurance, etc. under various
schemes. 115
Issues in Indian Self-assessment Exercise C
Economy
1) Do you think, high economic growth can reduce poverty but not inequality?
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2) India has made remarkable economic progress but poverty continues to
prevail. Explain.
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3) Discuss the various measures taken by the government for alleviation of
poverty.
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4) Gender empowerment may help India achieve higher economic growth.
Comment.
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7.8 LET US SUM UP

The advancements made in the field of science and technology, particularly
during the past couple of centuries have impacted human life in the most
favourable manner. The economic progress made by mankind has not been quite
equitable. Certain sections of society, due to prevalence of unequal privileges
among individuals, have been able to economically benefit more than others.
Such unequal benefits eventually have led to poverty and inequalities. The
disadvantaged sections of society have remained economically poor.
Poverty is of two types: absolute poverty and relative poverty. A person not in a
position to fulfil his basic needs of life is said to be living in absolute poverty.
When distribution of wealth or national income is unevenly distributed among
116
households, we can say that there is relative poverty among the poorer Poverty and
Inequality
households. The United Nations estimated the number of poor in India to be 364
million in 2019, or 28 per cent of the population. Poverty in India is deeply
rooted and widespread.
There are many reasons behind poverty in India such as weak asset base, unequal
distribution of national income, high population growth, populist policy
measures, inflationary pressure, illiteracy, and lack of investments. Poverty is
related to non-availability of resources for an individual or a family. Inequality
refers to disparities and discrepancies among people based on income, wealth,
education, health, nutrition, space, politics and social identity among others.
Gender inequalities are systematically greater in poor countries than in rich
countries. The reasons behind wider gender gaps are more structural and/or
systemic.
The developed countries rank high on the Gender Development Index (GDI).
Women of the Global South –that included India- are not privileged enough.
Despite notable economic progress made by India in various fields, gender
inequality has not reduced as desired.
Concentration of economic power in India has been skewed and in favour of the
trading or business communities, interestingly these communities are
predominantly non-SC and non-ST castes.

7.9 KEY WORDS

Poverty: Poverty is the inability of a person to get the minimum consumption
requirements for life, health and efficiency. It can be absolute or relative in
nature.
Absolute Poverty: When poverty is measured in the context of per capita intake
of calories and minimum level of per capita consumption expenditure, it is
absolute poverty.
Relative Poverty: When we compare per capita income of different households
or regions, it indicates relative poverty.
Poverty Line: The line which indicates the level of purchasing power required to
satisfy the minimum needs of a person for life, health and efficiency, is called
poverty line. It divides population in terms of ‘poor’ and ‘not poor’.
Inclusive Growth: It means extending the benefits of growth to all sections of
society including small farmers, landless laborers, downtrodden people, etc.
Below the Poverty Line (BPL): Those people who do not have required
minimum purchasing power are considered BPL.
Basic Needs: An individual for a healthy living needs certain basic necessities of
life which include food, water and shelter.
Inequality: The state of not being equal, especially in status, rights and
opportunities. 117
Issues in Indian Gender Inequality: Gender inequality is defined as the prevalence of different
Economy
opportunities solely on basis of gender.
Developing Countries: All those countries that are industrially backward and
they rank low on the human development index (HDI), gender development
index (GDI) and other important parameters of well-being of people.
Economic Growth: It refers to the increase in the aggregate output of an
economy compared to the previous year.

7.10 TERMINAL QUESTIONS

Short questions:
1. Distinguish between the concepts of relative poverty and absolute
poverty.
2. Distinguish between relative poverty and absolute poverty.
3. Define the concept of inequality.
4. What is meant by gender inequality?
Essay type of questions:
1. What is meant by poverty line? Define the term ‘poverty’ in India.
2. Discuss the measures adopted by the government to reduce poverty in
India.
3. Discuss the causes of poverty in developing countries like India.
4. Describe the various measures taken by government for welfare of the
poor and socially disadvantaged groups.
5. Bring out the important causes of poverty.
6. Do you agree that higher economic growth can reduce the extent of
poverty? Substantiate your answer.
7. Describe the linkage between poverty and inequality.
8. Does economic growth always bring in gender equality? Discuss your
answer keeping India in mind.

FURTHER READING
The following textbooks and online resources can be referred for further in-
depth reading on the topics discussed in this unit.
Deaton and Kozel. The Great Indian Poverty Debate, Laxmi Publications, 1
January 2006
Martin Ravallion. The Debate on Globalization, Poverty, and Inequality: Why
Measurement Matters, Policy Research Working Papers, April, 2003.
Nilakantha Rath and V M Dandekar. Poverty in India, Economic and Political
Weekly, Vol. 6, Issue No. 2, 09 January, 1971
118
Amartya Sen. Poverty and Inequality, Stanford University Press, 2006 Poverty and
Inequality
Jonathan Haughton, Shahidur R. Khandker. Handbook on Poverty + Inequality,
World Bank Publications, 27 March, 2009
Abhijit Banerjee and Esther Duflo. Poor Economics: A Radical Rethinking of the
Way to Fight Global Poverty, 26 April 2011
Paul Collier. The Bottom Billion: Why the Poorest Countries are Failing and
What Can be Done About it, Oxford University Press, 31 August 2012
Gary S. Fields. Poverty, Inequality, and Development, Cambridge University
Press, October 2009,
P. Sainath. Everybody Loves a Good Drought: Stories from India’s Poorest
Districts, Penguin Books, 14 October 2000
Online references:
https://www.drishtiias.com/to-the-points/paper3/poverty-estimation-in-india
World Bank publication. Poverty and Shared Prosperity 2020: Reversals of
Fortune,https://www.worldbank.org/en/publication/poverty-and-shared-
prosperity
Amitabh Kundu and P. C. Mohanan. Employment and Inequality Outcomes in
India. https://www.oecd.org/employment/emp/42546020.pdf

Note: These questions/ exercise will help you understand the unit better. Try to
write answers of these questions, but do not submit your answers to the
University for assessment. These questions are for your practice only.

119
UNIT 8 UNEMPLOYMENT IN INDIA
8.0 Objectives
8.1 Introduction
8.2 Types of Unemployment
8.3 Nature and Extent of Unemployment in India
8.3.1 Rural Unemployment Scenario
8.3.2 Urban Unemployment Scenario
8.3.3 Measurement of Unemployment in India
8.3.4 Extent of Unemployment in India

8.4 Causes of Unemployment in India

8.5 Consequences of Unemployment in India
8.6 Policy Initiatives for Employment Generation in India
8.7 Let Us Sum Up
8.8 Key Words
8.9 Terminal Questions

8.0 OBJECTIVES
After studying this unit you should be able to:
● explain the concept of unemployment;
● describe the types of Unemployment;
● discuss the causes and consequences of unemployment in India;
● suggest remedial measures for unemployment; and
● highlight the policy measures for employment generation and labour reforms.

8.1 INTRODUCTION
Unemployment is a situation where a person is willing to work at the ongoing
wage rate, but does not find work. In other words, if a person is able to work and
willing to work, but does not get work at the prevailing wage rate, he is
considered as unemployed.
Classical economists held that there is always full employment in the economy.
Their viewpoint however was proved wrong during the ‘Great Depression’ of
1929-33. Famous economist J M Keynes explained the concept of depression and
associated it with unemployment in his book “The General Theory of
Employment Interest and Money”, which was published in 1936. Keynes also
suggested remedial measures for controlling depression as well as
unemployment. Hence the problem of unemployment gained importance only
after the Great Depression.
Unemployment is one of the major problems in India. Unemployment is not only
a social stigma for a person; it leads to wastage of human resources, poverty,
Issues in Indian inequality and ill-health. The nature of unemployment in India is different from
Economy
that in the developed countries. In developing countries unemployment exists
mainly due to the lack of capital. Capital deficiency does not permit various
economic sectors to expand and generate jobs.

8.2 TYPES OF UNEMPLOYMENT

It is relevant to distinguish between two concepts: ‘voluntary unemployment’ and
‘involuntary unemployment’. If a person does not want to work or wants wage
which is higher than the current market rate, he will be called ‘voluntarily
unemployed’. Such unemployment is not an economist’s concern and nothing
can be done about it. The other type of unemployment is ‘involuntary
unemployment’; the person is willing to work, but cannot find work at existing
wage rate. In economics, unemployment means involuntary unemployment
alone.
Apart from the two types of unemployment mentioned above (voluntary
unemployment and involuntary unemployment), there are some other forms of
unemployment.
(i) Cyclical Unemployment: Cyclical unemployment is caused by business
cycles and hence it is called cyclical unemployment. During the
depression phase of the business cycle, effective demand falls leading to
accumulation of inventories. Consequently, large scale retrenchment takes
place and unemployment is there. It is called deflationary unemployment
also. However, this sort of unemployment automatically disappears once
the depression phase of business cycle ends and economic recovery starts.
(ii) Frictional Unemployment: Frictional unemployment exists when job
opportunities are enough but labour is unemployed. This happens due to
frictions in the economy. There could be lack of information about job
availability, immobility of workers from one place to another, lack of
desired skill on the part of unemployed workers. There could be shortage
of raw materials, breakdown of machinery and power crisis due to which
there is under-utilization of production capacity. This type of
unemployment is temporary in nature.
(iii) Seasonal Unemployment: Seasonal unemployment, as the name
suggests, is a seasonal phenomenon. It is associated with activities carried
out in certain seasons only. Such unemployment is very common in
agriculture; there is a lean season after harvest. It can also be found in
seasonal industries like ice making, sugarcane crushing, etc.
(iv) Structural Unemployment: Structural unemployment is caused by
certain bottlenecks in the very structure of the economy. These
bottlenecks could be lack the capital, backward socio-economic
framework, too much dependency on agriculture, and very high
population growth.

102
 Sometimmes structuraal unemployment arises due to stru uctural changges in Unem
mployment in
India
the economy. Due to t structural changes, soome sectors grow fasterr than
others. Further,
F theere is a chhange in prroduction teechnology iin the
economyy also. For example: inntroduction of electric vehicles
v in India.
This willl lead to the demand for f an altogeether differeent type of repair
services for electric vehicles annd the existiing lot of mechanics
m w
will be
unemployyed unless th hey are re-skkilled.
(v) Disguiseed Unemplloyment: Disguised
D u
unemployme ent occurs when
laborers are employeed, but theirr contributionn to output is zero. It im
mplies
that thee marginal productivitty of laboour is zeroo. This typpe of
unemployyment is quuite commoon in agricuultural sectoor of most over-
populatedd poor counttries. Disguiised unemplooyment can be explainedd with
the help of
o Fig. 8.1.

Fig. no
n 8.1

Fig. 8.1:
8 Disguiseed Unemplooyment
In Fig. 8.1, we measuure labour on the x-axis and output on o the y-axis. The
curve OA AB is the total output cu urve. When we increasee the labour input,
there is an increasee in output. When laboour employeed is OL1, ooutput
produced d is OQ1. Yo ou should nootice that outtput increasees till labourr input
employedd is OL2. The T maxim mum output is OL2. When W labour input
employedd is greater than OL2, there is no increase in output. In Indian I
agricultuure, family laabour is widdely used. Thhey get engaged in worrk, but
their conntribution to output is neg
gligible.
In Fig. 8.1,
8 the segm ment L2L3 refers
r to dissguised unem
mployment. If we
withdraww L2L3 quanntity of laboour, output ddoes not deccline and reemains 103
Issuees in Indian unchaanged at O
OQ2. It shoows that L2L3 labour has zero marginal
Econnomy
produ
uctivity.

8
8.3 NATTURE AN
ND EXT
TENT OF
F UNEMP
PLOYM
MENT
IN INDIA
I
Inn developedd countries tthere is cycllical unemplloyment is very
v much prevalent
p
d to presen
due nce of busineess cycles. According
A too Keynes, th
he main causse of this
ty
ype of emplooyment is loow effective demand. Buut in India, as a in many other
o less
d
developed coountries, therre exists chroonic unemplloyment. Unnemploymennt in India
foor rural and urban areass is of differrent types. WWe present the
t typologyy of rural
annd urban uneemploymentt in India in Fig. 8.2.

Unemployment
in India

Rural
Unemployment Urban
Un
nnemployment

Seasonal Disguised Chronic Indu

ustrial Edu
ucated Under‐
Unemployment Unemployment Unemployyment Unempployment Unem
mployment EEmployment

F 8.2: Ty
Fig. ypes of Unem
mployment in Rural an
nd Urban In
ndia

8.3.1 Rural Unemploym

U ment Scenariio
Unemploymeent is caused by many factors succh as over population,
U p low skill
leevel, failure of planningg, defective education system, slow
w economicc growth,
annd lack of caapital.
Majority of India
M I lives in
i villages. The followiing are the three main forms of
u
unemploymen nt in rurall India: (aa) Seasonal unemploym ment (b) disguised
d
u
unemploymen nt (c) Chronnic unemployyment. We hhave discussed the charaacteristics
of unemploy yment in the previo ous section. We disccuss below w certain
ch
haracteristiccs of unemplloyment in In ndia.
a) Seaasonal Unemploymen nt: Agricultture is thee main soource of
emmployment in villages. As you knnow, agricuulture is a seasonal
occcupation. Aggricultural labourer
l andd farmers reemain relativvely free
durring certain months whhen cultivatioon is not gooing on. Duuring this
tim
me there are nno supplemeentary emplooyment oppoortunities.
b) Dissguised Un nemployment: Disguised unempployment iss widely
preevalent in ruural India. Disguised
D uneemploymentt takes placee as there
is no
n training oof the rural labour
l for non-agricultu
n ural occupatiions. The
groowing rural population
p k
keeps on deppending uponn the same lland area,
as frequently witnessed in i agricultuural joint faamilies. It has
h been
estimated thatt the extennt of disguuised unemp ployment inn Indian
agrriculture is too the extent of 22 per cent.
1044
 c) Chronic Unemployment: The workforce keeps on growing but Unemployment in
India
employment opportunities in rural areas remain limited. Consequently,,
the number of unemployed keeps in increasing. There is chronic
unemployment, especially among the landless agricultural workers.
8.3.2 Urban Unemployment Scenario
In addition to the residents of urban areas, many people migrate to urban areas in
search of jobs. Thus, the unemployment situation in urban areas is severe. Urban
unemployment has three prominent features: (i) There are thousands of educated
youth who are unemployed. This could be because of the flaws in our education
system. In many cases, the current education system does not impart requisite
skill required by industrial and services sectors. (ii) There is under-employment
in society in the sense that people do not get work for all days. Available jobs in
the industrial and services sector are not regular. (iii) Further, jobs available are
not according to the merit or qualification of job seekers. Many persons therefore
are under-paid.
8.3.3 Measurement of Unemployment in India
You may have come across two concepts: labour force and work force. ‘Labour
force’ includes all persons in the age group of 15 years and above who are
willing to work. Thus it includes both employed and unemployed persons. The
persons not included in the labour force are those who are retired, too ill to work,
keeping the house, or simply not looking for work. ‘Work force’ is somewhat
narrower – it includes the employed persons only. Thus the difference between
the labour force and the work force gives us the number of unemployed.
By employed persons we mean those who perform any paid work (thus
homemakers are not included) and those who have jobs. On the other hand, the
unemployed as a category includes people who are not employed but are actively
looking for work. While considering unemployment we do not take into account
those who are not in the labour force. We define unemployment rate as the
number of unemployed divided by the total labour force.
Measurement of unemployment has been a complex issue. All workers do not
have a regular salaried job; many workers search for jobs on a day to day basis.
Suppose, for example, someone worked for one day only in the last week. Should
we count him as employed?
In India, the National Statistical Office (NSO) (earlier known as National Sample
Survey Organisation - NSSO) has been conducting employment and
unemployment survey (EUS) every five years since 1972-73. The EUS measures
unemployment on the basis of four status: (i) the Usual Status (US); (ii) the Usual
Principal and Subsidiary Status (UPSS); (iii) the Current Weekly Status (CWS);
and (iv) the Current Daily Status (CDS). For the Usual Status (US) and the Usual
Principal and Subsidiary Status (UPSS), the reference period is one year. The
UPSS refers to the usual principal activity and the subsidiary activity status of a
105
Issues in Indian
Economy
person. The objective of UPSS is to assess the long term employment status of a
person. On the other hand, the objective of the CWS and is to assess employment
from a short term perspective. In the CWS approach, a person is considered
unemployed if (s)he did not get work even for one hour on any day in the past
one week.
The National Statistical office (NSO) of India started the Periodic Labour Force
Survey (PLFS) on a quarterly basis since April 2017. It considers current weekly
status (CWS) for estimation of unemployment rate. The PLFS gives data on
Labour Force Participation Rate, Worker Population Ratio, and Unemployment
Rate for different age groups. As of date, data is available for the period up to
January-March 2021.
8.3.4 Extent of Unemployment in India
There is a rise in the number of unemployed persons in India over the years,
despite rapid economic growth achieved by the country. It indicates a situation of
jobless growth, where production technology is becoming more and more capital-
intensive.
We present the number of unemployed persons and the number of jobs created
during various five year plans in Table 8.1. We observe from the table that during
the first five year plan the number of unemployed was 3.3 millions. The number
of new job seekers was 9 million, taking the total to 12.3 millions. During the
Plan, 7 million new jobs were created. As a result, the number of unemployed
increased by the end of the first five year plan to 5.3 million. The number of
unemployed continued increasing in the subsequent five year plans. It was
estimated that 9.2 million persons were unemployed at the beginning of Seventh
Plan. It was expected that this number would decline to 8.22 million by the end
of the seventh plan, but it did not decline. A similar feature continued in the
subsequent five year plans also.
Another set of data available from employment exchange records also point out a
similar trend – the number of unemployed in India has increased over the years.
Estimated number of unemployed persons as available from employment
exchange records is presented in Table 8.2. We observe that 17.84 million
persons were registered as unemployed in 1981, which increased to near 43.50
million in 2016-17. The number is rising very quickly due to jobless growth of
Indian economy. Its projection for 2017-18 was 17.80 million.

Table 8.1: Estimates /Extent of Employment and Unemployment in the Five

Year Plans (in Millions)
Plan/ First Second Third Fourth Fifth Sixth Seventh Eighth Ninth Tenth Elev
(1951- (1956- (1961- (1969- (1974- (1980- (1985- (1992- (1997 (2002- (2007
Particulars 56) 61) 66) 74) 79) 85) 90) 97) -02) 07)
106
 No. of unemployed at 3.3 5.3 7.1 12.6 14.0 12 9.2 23 18.0 34.85 Unemployment in
21.5
the beginning of Plan India

New job seekers 9.0 11.8 17.0 20.2 22.0 34 39.38 35 405.4 378.65 432.02
during the plan period

3.The total number of 12.3 17.1 24.1 33.0 36.0 46 48.58 58 423.4 413.50 453.52
unemployed (1+2)

4.Additional job 7.0 10.0 14.51 19.0 15.4 36.8 40.36 40 416.4 392.20 451.53
created during the
Plan

5. No. of unemployed 5.3 7.1 9.6 14.0 20.6 9.2 8.22 18 7.0 21.5 1.99
at the end of the Plan

Source: Economic Survey 2015-16 and Five Year Plan Documents

Table 8.2: Number of Unemployed as per Employment Exchange Records

(in Million)
Year Registered Unemployed

April 1981 17.84

April 1982 19.75

April 1983 14.83

April 1984 23.55

April 1985 26.27

April 1986 30.13

April 1987 30.36

Nov 1992 36.77

Aug 1993 36.49

Aug 1994 36.78

April 1997 30.00

April 1998 40.00

2016-17 43.50
Source: Tenth Five Year Plan document and various issues of Economic Survey.

Another source of data on unemployment among educated youth is the

employment exchange records. According these records also, there is an increase
in the number of unemployed in India over the years. We observe from Table 8.2
that 17.84 million persons were registered as unemployed in 1981, which
increased to about 43.50 million in 2016-17. The number of unemployed in India
has increased very fast over the years. Table 8.2 shows the unemployment and
unemployment figures for different years.

107
Issues in Indian Table 8.3: Employment and Unemployment Scenario in India
Economy
Variable Unit/ 1999- 2001-02 2006-07 2016-17
Year 2000 (P)

Labour Force Million 363.33 378.21 413.50 524.10

Employment Million 336.75 343.36 392.35 518.20

Unemployment per cent 7.32 9.21 5.11 5.6

No. of Million 26.58 34.85 21.5 5.8

Unemployed
Source: Tenth and Eleventh Five Year Plan Documents, and Economic Survey 2016-17

As mentioned earlier, the PLFS started in 2017-18 and quarterly data on

unemployment rate is available since then on a regular basis. As per the PLFS
data, unemployment rate in India in the age group 15 years and above was 8.8 per
cent in 2019-20 according to current weekly status (CWS) and 4.8 per cent
according to usual status.
Table 8.4: Unemployment Rates in Recent Years according to PLFS
(in per cent)
2019-20 2018-19 2017-18
Status male female person male female person male female person
Rural
Usual 4.5 2.6 4.0 5.6 3.5 5.0 5.8 3.8 5.3
status
CWS 8.7 5.5 7.9 8.7 7.3 8.4 8.8 7.7 8.5
Urban
Usual 6.4 8.9 7.0 7.1 9.9 7.7 7.7 10.8 7.8
status
CWS 10.6 12.4 11.0 8.9 12.1 9.5 8.8 12.8 9.6
All-India
Usual 5.1 4.2 4.8 6.0 5.2 5.8 6.2 5.7 6.1
status
CWS 9.3 7.3 8.8 8.8 8.7 8.8 8.8 9.1 8.9

Source: Periodic Labour Force Survey (Annual Report, July 2021), NSO

Self-Assessment Exercise A
1) Define the concept of unemployment.
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
2) Distinguish between the concepts of seasonal unemployment and disguised
unemployment.
………………………………………………………………………………
108 ………………………………………………………………………………
 ……………………………………………………………………………… Unemployment in
India
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
3) Distinguish between labor force and work force.
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………

4) Describe in brief the extent of unemployment in India.

………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………

8.4 CAUSES OF UNEMPLOYMENT

Now let us discuss the important causes of persisting unemployment in India.
(i) Rapid Growth of Population: Population of India has been growing
rapidly since 1951. Death rate declined due to availability of medicines
and healthcare but birth rate did not decline. Thus, population growth rate
accelerated after 1950. During the 1960-1990 population growth was
more than 2 per cent per annum. While population growth rate has
somewhat declined in recent years, it continues to be very high some
states of India. Accordingly, size of the labour force is increasing while
employment opportunities are not increasing at the same pace. So
unemployment is increasing over the years.
(ii) Low Economic Growth: Up to the fourth Five Year Plan (1951-74),
growth rate of the Indian economy was very low. Low economic growth
(see table 8.4) rate is mainly responsible for unemployment in India as job
opportunities did not expand adequately. In recent years, since 2015-16,
economic growth rate has slowed down.

Table 8.4: Economic Growth Rate in Various Plan Periods

Five Year Plan/Year Average Annual Rate of
Growth at 2004-05 Prices
109
Issues in Indian
Economy
First (1951-56) 3.6 per cent
Second (1956-61) 4.1 per cent
Third (1961-66) 2.5 per cent
Fourth (1969-74) 3.3 per cent
Fifth (1974-79) 5.0 per cent
Sixth (1980-85) 5.4 per cent
Seventh (1985-90) 5.8 per cent
Eighth (1992-97) 6.7 per cent
Ninth (2002-07) 6.6 per cent
Tenth (2007-12) 6.7 per cent
Eleventh (2007-12) 6.3 per cent
2012-13 4.9 per cent
2013-14 6.6 per cent
2014-15 7.3 per cent
2018-19 (P) 6.9 per cent
Source: Economic Survey 2015-16 and 2018-19.

(iii) Failure of Planning: Planning started in 1951. There is no doubt that

India has made progress during the plan period, yet all sections of
society could not gain from it. The rich became richer while the poor
became poorer. Thus economic growth was accompanied by
increasing inequality in the country. This was a major weakness of
our planning. In addition, not much attention was paid towards the
problem of unemployment in the beginning. Planning could not create
as many jobs as the number of job seekers.
(iv) Neglect of Agriculture: Majority of population in India depend on
agriculture. However, agriculture was not paid much attention during
various five year plans. Comparatively less expenditure was made on
this sector (see Table 8.5), as a result of which agriculture could not
develop fully. Neglect of agriculture too is a cause of rural
unemployment in India.
Table 8.5 shows that the share of agriculture in plan outlay has varied
between 18 per cent and 25 per cent (except the First Plan). This share
is much smaller than the share of the agricultural sector in national
income and employment.

Table 8.5: Share of Agriculture in Total Expenditure

110 Five Year Plan Percentage

 Share in Total Unemployment in
India
Expenditure
First (1951-56) 37.00
Second (1956-61) 20.90
Third (1961-66) 20.60
Fourth (1969-74) 23.30
Fifth (1974-79) 20.50
Sixth (1980-85) 25.40
Seventh (1985-90) 21.00
Eighth (1992-97) 22.15
Ninth (2002-07) 20.10
Tenth (2007-12) 19.80
Eleventh (2007-12) 18.50
Sources: Five Year Plan & Economic Survey, 2013-14.

(v) Neglect of Small and Cottage Industries: Small scale and cottage
industries are labour intensive. But these industries could not develop
in India appreciably. Technological upgradation and marketing
became a major problem for these industries. The five year plans laid
more stress on capital-intensive industries. Neglect of small scale
industries is therefore another cause of unemployment in India.
(vi) Slow Industrial Growth: Industrial growth rate has been very slow
in India due to many problems such as industrial disputes, strikes,
lockouts, industrial sickness, etc. These problems have increased
urban unemployment.
(vii) Shortage of Capital: Till recent time period, there has been a
shortage of capital in India. We know that the rate of capital formation
depends on the rate of saving. If saving rate is high, capital formation
rate will also be high. Without adequate capital formation, overall
expansion of the economy cannot take place. Thus capital inadequacy
leads to slower growth of jobs.
(viii) Defective Education System: Education system in India is not based
on employment. Every year millions of boys and girls come out of
colleges and universities but they are not absorbed in any suitable job.
Emphasis is laid on ‘general’ education rather than ‘vocational’ one.
Our education system has led to rapid increase in white collar
unemployment.
(ix) Lack of Mobility: Even these days, many Indians are superstitious.
Marginal farmers and laborers are so much attached to their land and
birth place that they do not want to leave it even if they do not have
111
Issues in Indian any work to do. Similarly, many skilled labour and educated youth do
Economy
not want to migrate to other regions. There are of course differences
in language and culture across states, which discourage mobility. As a
result, in some regions there is shortage of labour while in other
regions there is surplus. Shortage of farm labour in Punjab is a valid
example. Thus, lacks of mobility, cultural differences, customs and
tradition are also responsible for unemployment.
(x) Under-Utilization of Installed Capacity: Our productive capacity is
not utilized fully in many industries so there exists limited
employment opportunities. Various causes like lack of working
capital, skilled labour, raw material and infrastructural facilities
inhibit full utilization of capacity.
(xi) Modernization: In the modern time, many industries have adopted
capital intensive modern techniques. Consequently, unemployment
has increased as machines have replaced the labourers.
(xii) Other Factors: Apart from the factors mentioned above, there are
several others which worsens unemployment situation in India. Non-
availability of good quality infrastructure; shortage of essential inputs
such as electricity, raw materials, and credit; non-availability of
skilled labour and modern technology; etc.

8.5 CONSEQUENCES OF UNEMPLOYMENT

Unemployment has many adverse consequences.
(i) Poverty: Unemployment leads to loss income for a household, which in
turn leads the household to poverty. The number of unemployed in India is
very large. Problem of poverty due to unemployment has become a serious
problem.
(ii) Under-utilization of Human Resources: Due to lack of employment
opportunities, it has not been possible to fully use the available human
resources. Human beings are not in a position to contribute to the national
income. When human resources are not utilized properly, it results in loss
of national output.
(iii) Political Instability: The problem of unemployment has the potential of
creating political instability in the country. Unemployed youth may indulge
in activities that are detrimental to the development of a country.
(iv) Social Evil: Unemployment can lead to anti-social activities. It may lead to
social evils such as drugs, theft, gambling, etc. Government needs to be
very alert to check these social evils.
(v) Economic Exploitation: Due to large scale unemployment, the employers
try to exploit people by giving lower wages. Workers have to work for
longer hours; they are not paid according to their ability and the quantity of
work done.
112
Taking into account the adverse effects of unemployment, the government must Unemployment in
India
take steps towards employment generation.

8.6 POLICY INITIATIVES FOR EMPLOYMENT

GENERATION IN INDIA
Various policy measures have been taken by the government to reduce the
problem of unemployment. Some of the efforts made by the government in this
regard are given below.
1. Emphasis on Small Scale and Cottage Industries: To reduce the problem
of unemployment, emphasis has been laid on development of small scale and
village industries. Cottage and small scale industries are labour intensive,
which means that these employ large number of workers. Government has
given various incentives to set up these industries during five year plans
2. Check on Population Growth: Government has made efforts to check the
population growth. To achieve this objective, the government has emphasized
education of girl child, provision of health facilities, and creation of
awareness among people.
3. Establishment of Employment Exchanges: The government has established
employment exchanges for registration of people seeking employment and
dissemination of information regarding available vacancies. These days, the
Internet has played an important role in recruitment process. Every
employment exchange these has its online portal. Besides, in order to give
information about the vacancies to the general public, ‘Employment News.’,
a weekly paper, is published in different languages.
4. National Education Policy-2020: To tackle the problem of unemployment,
the National Education Policy-2020 has been formulated. Apart from other
issues, it emphasizes on vocational education.
5. Rapid Economic Development: Economic development in different sectors
creates new opportunities of employment. The government is trying to
accelerate the pace of growth by developing the different sectors so that new
employment opportunities can be created.
e) Rural Employment Guarantee Act: The Mahatma Gandhi National Rural
Employment Guarantee Act (MGNREGA) was launched in 2005. The Act
aims at providing at least 100 days of guaranteed wage employment in a
financial year to every rural household, with a stipulation of one-third
participation of women. In the process, the MGNREGA creates community
assets so that problems like chronic poverty, drought, deforestation, soil
erosion, etc. can be addressed. In budget 2019-20, Rs. 6000 crore were
allocated for MGNREGA. The number of beneficiaries under this programme
was 7.8 crores in 2019.
f) National Rural Livelihood Mission (NRLM): The NRLM is also called
Ajeevika. It was started in 2013-14 with an objective of organizing all rural
113
Issues in Indian poor households and nurturing them till they emerge out of poverty. Now,
Economy
NRLM is renamed as Deendayal Antayodaya Yojana. It provides
opportunities to poor households to have gainful self-employment and skilled
wage employment. Self-Help Groups (SHG) formed by women has been
successful in many cases to provide livelihood to households and raise their
income.
g) Micro Unit Development Refinance Agency Bank (MUDRA Bank): The
Government has set up the MUDRA Bank in April 2015. It meets credit
requirements of micro-enterprises and self-employed persons. In order to
increase output and employment, entrepreneurs can avail loan up to Rs.10
lakh at lower rate of interest.
Self-Assessment Exercise B
1) What are the main causes of unemployment in India?
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
2) Write a brief note on the consequences of unemployment in India.
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………

3) Mention at least four initiatives taken by the government to reduce the

problem of unemployment in India.
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………

8.7 LET US SUM UP

Unemployment is a serious problem for an economy. Unemployment could be
seasonal, chronic, disguised or structural. Unemployment is observed in both
rural and urban areas. As per the PLFS data, unemployment rate in India in the
age group 15 years and above was 8.8 per cent in 2019-20 according to current
weekly status (CWS) and 4.8 per cent according to usual status.
Unemployment has serious consequences for the households and for the
economy. Apart from poverty and psychological stress to the person concerned,
unemployment results in wastage of valuable resources for the country. The
government has initiated various policy measures to reduce unemployment in
114 India. Many developmental schemes are being implemented with this objective.
8.8 KEY WORDS Unemployment in
India

Unemployment: The situation in which a person is ready to work at prevailing

market wage rate but he does not get work. In simple words, when the number of
job seekers is more than number of jobs, it is termed as unemployment.
Full Employment: The situation when the number of job seekers is less than the
number of available jobs.
Under-employment: It refers to the situation when the person gets employment
not for full time or (s)he works at a job that is below her/his educational
qualification and ability.
Disguised Unemployment: It refers to a situation when the marginal
productivity of labour is zero.
Automation/Mechanization: It refers to the use of capital-intensive technology,
computers and machinery.
Dependency Ratio: It is the ratio of dependent population to the working
population. A high dependency ratio means less number of workers in the
society.
Rural Unemployment: It refers to the unemployment found in rural areas in the
form of disguised, seasonal or chronic unemployment.
Cyclical Unemployment: It refers to the unemployment caused by business
cycle during the phases of recession and depression.
Frictional Unemployment: It refers to a temporary phase of unemployment
when where workers shift between jobs. Job opportunities are enough but
workers are unemployed due to certain imperfections or frictions in the economy.

8.9 TERMINAL QUESTIONS

Short Answer Type Questions
1) What is meant by unemployment? Briefly explain any four types of
unemployment in India.
2) Describe four main reasons of unemployment in India.
3) Distinguish between seasonal unemployment disguised unemployment.
4) Give five suggestions to solve the unemployment problem in India.
5) Explain the nature of unemployment problem in developing countries.
6) Describe four consequences of unemployment in India.
7) What is meant by disguised unemployment? In what respects it affect
developing countries?
8) Briefly mention the estimates of employment and unemployment in India.
Long Answer Type Questions
1) Discuss nature, extent and types of unemployment in India. 115
Issues in Indian 2) What is unemployment? Discuss its causes and solutions in developing
Economy
countries.
3) What are main causes of unemployment in India? What measures do you
suggest to solve this problem?
4) Explain government policy measures to reduce unemployment problem in
India. Also critically evaluate these measures.
5) Discuss main types of unemployment in developing countries. Also give
suggestions to solve these types of unemployment.
6) State the present position of unemployment in India. Also explain main steps
taken by the government to solve this problem.
7) Describe the main features of MGNREGA. Also highlight such other
government schemes to reduce unemployment.

FURTHER READINGS
The following text books may be used for further in-depth study on the topics
dealt with in this unit.

Brown C.V, Unemployment and Inflation, Disha Publication, Delhi

Edwards, E.O. (Ed.). Employment in Developing Countries, Columbia

University Press, New York.

Hawkins K., Unemployment, Penguin Books, Second Edition.

Johnson Peter and Thomas Barry, Economic Perspective on Key Issues.

Sen Amartya, Employment, Technology and Development, Oxford University

press, London.

116
UNIT 9 INEQUALITY IN INCOME
DISTRIBUTION
Structure
9.0 Objectives
9.1 Introduction
9.2 Basic Concepts
9.2.1 Distribution of Income
9.2.2 Inequality
9.2.3 Inequality of Income

9.3 Causes of Inequality and Poverty

9.4 Measurement of Inequality
9.5 Policy measures to Reduce Inequality
9.6 Let Us Sum Up
9.7 Key Words
9.8 Terminal Questions

9.0 OBJECTIVES
After going through this unit, you should be able to:
● explain the concept of inequality in income distribution;
● describe the causes of income inequality;
● measure income inequalities by using different methods; and
● appreciate policy measures taken by the government to reduce income
inequality.

9.1 INTRODUCTION
The word inequality refers to some sort of injustice or unfairness. Inequality in
income distribution implies that some people are poorer compared to others.
Equality in income distribution is an ideal situation which is not seen anywhere.
Moderate inequality is not a problem for a country. Inequality turns out to be
problem, when it is too steep and it has many adverse consequences. In view of
this, it has been an objective of the government to reduce inequality in the
economy. The objective of Indian planning has always been to raise the standard
of living of the masses. This objective was given priority in all the five year plans
but somehow all these plans failed to reduce inequality.
The concept of income inequality is deeply connected with that of poverty and
social justice. Poverty and inequalities go hand-in-hand. Poverty is defined as a
condition in which an individual or household lacks the financial resources to
afford certain basic minimum standard of living. The poor households are not in
a position to meet the necessities of life. These necessities include food, clothing,
Issues in Indian
Economy
shelter, medical facilities, etc. Poverty is a curse and it brings misery to human
life. A poor man loses confidence and surrenders to the prevailing conditions and
problems. Due to poverty, a man cannot fulfill his basic needs and therefore mass
poverty disrupts social harmony and generates dissatisfaction.

9.2 BASIC CONCEPTS

Some important fundamentals concepts related with poverty and income
inequality are briefed below:-
9.2.1 Distribution of Income
Distribution of income refers to the sharing of wealth produced by a community
among the agents of production. Distribution can be personal and functional.
Personal Distribution refers to the distribution of national income among
different persons or individuals in the society. It shows the size and not the
source of income among different persons. Inequality in personal income
indicates personal distribution of income. If a majority of population is getting
very low income and a few are getting very high income, it is termed as
inequality in income. Functional Distribution, on the other hand, refers to
distribution of national income among different factors of production according
to their services or functions. It is concerned with the source of income rather
than the size of income. Income distribution can be explained by both micro and
macro theories of distribution.
9.2.2 Inequality
Inequality indicates the unequal distribution of resources in a country or region
and it can be regarded to income, wealth, region, rural, urban, social inequality.
The problem of inequality is concerned with the inequality of distribution of
individual income. In other words it means that income of a few individuals is
very high, while that of large numbers of a person is very low. This inequality
has been increasing over time.
All of us know that poverty is a curse but worse curse is poverty amidst plenty. A
large part of population cannot manage even two square meals while a small part
has so much that it is thrown away into garbage cans and drains. While the
majority of population does not have clothes to cover their bodies, a small
segment of population has their cupboards overflowing with colorful dresses.
Some do not have any shelter while others live in palatial buildings. Such is the
condition in India and this is called the problem of economic inequality. In the
interest of peace and rapid development, this inequality should be minimized as
early as possible.
9.2.3 Inequality of Income
Inequality of the distribution of income refers to that situation of an economy in
which the average income of small section of the country is much larger than the
average national income while the average income of large section is much
smaller than the average national income. It implies that income of some
2
individuals is very high while that of a large number of persons is very low. In Inequality in Income
Distribution
order to examine the distribution of income in India, various studies have been
conducted, e.g., study by a committee under the chairmanship of Prof P.C
Mahalnobis, National Council of Applied Economics Research, Reserve Bank of
India, and World Bank. Many other economists have also conducted inquiries in
respect of distribution of income. The World Bank also provides information on
distribution of household disposable income. According to the Human
Development Report 2007-08, the percentage share of national income held by
different income groups is as follows.
Table 9.1: Percentage Share in National Income of India

Peoples\ Year 1975-76 2004-05

Lowest 20% 7.0 8.1

highest 20% 49.4 45.3

Source: Human Development Report, 2007-08.

Table 9.1 shows the income distribution among different groups of households.
The lowest 20 per cent had 8.1 per cent of national income and the highest 20 per
cent had 45.3 per cent national income as per Human Development Report 2009.
Another estimate about income inequality shows top 10 per cent population of
India holds 31.1 per cent of national income while the bottom 10 per cent
population has only 3.6 per cent of total national income. This is clear indication
of prevailing inequalities in India.
In India along with inequality in the distribution of income, there also exists
inequality in the distribution of wealth. Inequality in the distribution of wealth
can be estimated on the basis of ownership of land holding and real estate.
According to National Sample Survey report in the year 2001, 70 per cent Indian
farmers are marginal farmers, i.e., they own less than 2 hectare of land.
According to National Council of Applied Economic Research (NCAER) in the
year 2001 upper most 10 per cent urban people own 57 per cent value of
residential real estate, while lower 10 per cent urban people own less than one per
cent value of residential real estate. Thus it shows the gross inequalities in the
distribution of income and wealth in India.

Different institutions and economists have tried to measure the inequality in the
distribution of personal income. Among them the efforts made by RBI and the
NCEAR are praise-worthy. Though these measures were taken at different points
of time using different methods, yet they all make it clear that there exists
considerable inequality in the distribution of personal income (see Table 9.2).

3
Issues in Indian
Economy
Table 9.2: Personal Income Distribution in India

Estimates Estimate by RBI Estimate by Iyenger NCAER estimates

(1953-54 to 1956-57) and Mukharji (1952-56) (1966)

Area/People Rural Urban Rural Urban Rural Urban

Highest 5% 17.0% 26.0% 14.0% 17.5% --- 31.0%

Highest 10% 25.0% 37.0% 24.0% 25.0% 33.6% 42.4%

Highest 50% 69.0% 75.0% --- --- 79.3% 83.4%

Lowest 20% 9.0% 7.0% 7.5% 8.5% 4.0% 4.0%

Though the data differ, the general inference we can draw is that distribution of
personal income is highly skewed in India. It also shows that inequality is more
pronounced in urban area than in the rural one.
Table 9.3: Estimates of Inequality in Income in India

Source. Ojha NCAER World World World NCAER

Period Bhatacharya (1964-65) Bank (1975- Bank Development (2009-10)
/People (1961-62 to 76) (1992-93) Report
1993-94) (2006)

Share of Top 35.0 33.5 33.6 28.4 28.5 53.2

10%
(Top
20%)

Share of 7.0 7.5 7.0 8.5 8.9 15.3

Bottom 20%
(Bottom
40%)

Table 9.3 shows the extent of income inequality in India during 1961-62 to 1993-
94, top 10 per cent of people in India got 35 per cent of the national income and
bottom 20 per cent got only 7 per cent. In the same way in 1975-76, top 10 per
cent people used to get 33.6 per cent of the income whereas bottom 20 per cent
got only 7 per cent. According to the World Development Report, in 1992-93 top
ten per cent population got 28.4 per cent of the national income whereas bottom
20 per cent got only 8.5 per cent. According to the World Development Report,
in 2006, top 10 per cent got 28.5 per cent of the national income while bottom 20
per cent received only 8.9 per cent of the national income.
The distribution of consumption expenditure given in Table 9.4 also shows that
there was very steep income inequality in India.
Table 9.4: Distribution of Family Consumption Expenditure
(Percentage Share in Total Consumption Expenditure)
4
 Inequality in Income
Area Rural Urban Distribution

People/Year 1958-59 1977-78 1958-59 1977-78

Lowest 30% 13.1 15.0 13.2 13.6

Middle 40% 34.3 33.1 31.7 32.4

Highest 30% 52.6 51.9 55.1 54.0

Source: Sixth Five Year Plan (1980-85)

From Table 9.4 we observe that during the period 1958-59 to 1977-78 the share
in total consumption expenditure of the lowest 30 per cent families has increased
a little, especially in rural areas. However, the basic structure remains the same
and inequality in family expenditure persists, almost as strongly as before.
Table 9.5: Rural-Urban Gap in Monthly Per Capital Expenditure
(MPCE at Constant Prices)

Area/Year Round Rural Urban

2011-12 68th 703.42 1353.82

2009-10 66th 599.06 1200.00

2004-05 61st 558.78 1052.36

Source: Various Survey Rounds of National Sample Surveys (NSS)

Table 9.6: Monthly Per Capita Expenditure at Current Prices

Area/Year Round Rural Urban

2011-12 68th 1278.94 2399.24

2009-10 66th 927.70 1785.21

2004-05 61st 558.78 1052.36

Source: Various Survey Rounds of NSS

We observe from the above tables that monthly per capita expenditures of rural
and urban areas are quite different, both in constant prices and current prices. The
per capita expenditure per month in urban areas is more as compared to that of
rural areas.
Multidimensional Poverty Index (MPI) 2010: This index indicates the share of
multi-dimensionally poor adjusted by the intensity of deprivation in terms of
living standard, health and education. The MPI shows huge income inequalities
and poverty in India. On the basis of data from 2000 to 2008, it indicates that 5
Issues in Indian
Economy
poverty ratio was 41.6 per cent and poverty index was 0.296 in India, calculated
as per purchasing power parity of $1.25 per day.
Global Hunger Index (GHI) 2020 also reveals high extent of poverty and
income inequalities in India. India ranked 94th out of 107 countries with a score
of 27.2 in the GHI index.

9.3 CAUSES OF INEQUALITY

Several factors are responsible for income inequality and poverty in India. Some
important causes are explained below.
(1) Rapid Growth of Population: Rapid growth of population is one of the
major causes of poverty and inequality in India. High population growth
is the root cause of all other problems. Population grew rapidly after
independence. Population in India which was 36 crores during the year
1951 increased to 68.4 crores in 1981 and further to 84.39 crores
according to 1991 census. According to 2011 census, the population of
India was 121.08 crores. Demand for consumption goods increases with
the rapid growth of population. In large families, per capita share of
consumption becomes pitiably low. What to say of comfort and luxuries,
big families find it difficult to manage two square meals. For the country
as a whole, extremely large part of resources is absorbed by production of
consumer goods. Only a limited amount of money is left for development
works, capital formation and future investment. This leads to slower
economic growth, which perpetuates poverty. So it will not be wrong to
say that the problem of poverty has become a major cause of the growth
of population. Ironically, the poor tend to have more children than the
higher income groups. That is why they have to suffer on this count also.
(2) Inadequate Employment Opportunities: There is a dearth of
employment opportunities in India. Even after 70 years of planning,
unemployment problem continues to be one of the major problems in
India. The rate of growth of population is more than the rate of growth of
employment. So it is evident that unemployment and hence poverty will
increase.
(3) Inadequate Growth Rate: Another cause of income inequality and
poverty in India is inadequate growth rate of the economy. During the
First Five Year Plan, growth rate of GDP was 3.5 per cent, while during
the Sixth Plan it was 5.4 per cent. It was estimated to be 5.0 during the
Seventh Plan. During 1951-91, the average growth rate has been just 3.9
per cent per year. Population growth on the other hand has taken place at
average annual rate of about 2.5 per cent. Low growth of the economy
vis-à-vis high population growth naturally leads to very slow increase in
per capita income and obstructs reduction in poverty.
(4) Rising Prices: Price rise is always beneficial to the rich and harmful to
the poor. In fact, inflation is often called a ‘burden’ on the poor. During
6
 the Plan Period the prices have increased rapidly. The main cause of price Inequality in Income
Distribution
rise is the adoption of deficit financing by the government. Besides it,
other causes like wrong policies of the government, increases in the oil
prices, black money and hoarding etc. are responsible for price rise. When
prices rise (and, as is customary), wages do not rise or rise less, the real
purchasing power of the already poor falls. Many more join the ranks of
those below poverty line and it results into more income inequalities.
Inflation based on Consumer Price Index in India in 2017-18 was 3.7 per
cent which increased to 7.0 per cent in December 2019.
(5) Neglect of Agriculture: Even in 2011-12, 48.9 per cent of the total
population was dependent on agriculture and allied activities. Economic
planning did not have a good effect on rural areas because of the neglect
of agriculture. It widened the gap between the rural and the urban areas.
Out of total expenditure of all plans only 12 to 15 per cent was spent on
agriculture, while it was 22 to 25 per cent on industries.
(6) Neglect of Small Scale and Cottage Industries: It was said that small
scale and cottage industries would be developed fast during the Plan
period but actually not much attention was paid to them. Under the 1956
Industrial Policy, the government laid emphasis on big industries. As a
result, small scale and cottage industries could not develop. Most of the
population lives in villages where only such industries can be set up. So
the neglect of small scale and cottage industries has caused poverty and
income inequality in India.
(7) Inequitable Distribution of Income and Wealth: The main objective of
planning in India is growth with social justice. It is essential that all small
businesses/ industries share the benefits of development equally. But it
has not happened. According to a survey, 20 per cent rich enjoy 53 per
cent of the total national income while 50 per cent bottom poor people get
only 19 per cent of the total national income. This inequality has
increased during the plan period instead of being reduced. In fact,
inability to minimize economic inequalities has worsened the poverty
situation.
(8) Shortage of Capital: The development of country depends on the capital.
Shortage of capital is the main hindrance in the way of economic
development. India faces severe shortage of capital. Industry does not
develop properly due to shortage of capital. Overall economic expansion
remained limited due to capital deficiency. Hence, output could not
expand considerably. This not only causes poverty but also prices-rise and
further bigger gap between the rich and the poor.
(9) Failure to Implement Land Reforms Effectively: Different State
governments have passed laws to remove poverty and inequality in
agriculture. But the pity is that these could not be implemented fully.

7
Issues in Indian
Economy
Many social and political factors are responsible for it. As a result,
poverty in rural areas could not be removed.
(10) Under Utilization of Natural Resources: Nature has been very kind to
India. In other words, India is full of natural resources but we have been
unable to make the best use of these resources because of the lack of
capital and technical knowledge etc. Sh. K T. Shah’s comment that ‘India
is a rich country but the Indians are poor’, proves it.
(11) Failure of Programmes designed to Remove Poverty and Inequality:
Government launched many programmes to remove poverty and
inequality. Some of the main programmes are:
a. Minimum Needs Programmes (MNP)
b. Integrated Rural Development Program (IRDP)
c. National Rural Employment Program (NREP)
d. 20 Points Economic Program etc.
But all these programmes could not succeed fully. Rather these programmes
benefited vested interests and officials.
(12) Conservative Social Structure: Our social structure is responsible for
the problem of poverty and inequality in India. Indian farmer is orthodox
by nature, he is not ready to change his methods and remove the
hindrances in his way. Fatalism has crippled us, especially the villages.
Most of us leave everything to fate and God. They also lack mobility
spirit of enterprises and scientific attributes. Hence unprogressive way of
thing and backward social setup also cause poverty and perpetuate it.
Social institutions like joint family system and inferior states to women
are also responsible for this.
There are a number of other factors including more than hundred years of
foreign rule of British domain and exploitation, low labour productivity,
weak infrastructure, backward and primitive technology, over dependence
on agricultural sector, inefficient use of capital and other productive
resources, unbalanced regional growth, defective planning strategy,
widespread illiteracy and defective education system. Lack of sincerity on
the part of the leaders and corruption are also reason behind the problems
of poverty and income inequality.
Check Your Progress A
1 What is Inequality ?
2 What is Multidimensional Poverty Index.
3 What is inadequate Growth Rate.
4 What is Conservative Social Structure.

8
9.4 MEAS
SUREME
ENT OF INEQUA
ALITY Inequalitty in Income
Distribution

Therre are variouus indicators measuring inequality.

i A
All these ind
dicators havee some
mathhematical orr intuitive appeal. Ineqquality meaasures can be b calculateed for
variaables such as
a income, consumption
c n, land holdiing, and other form of assets.
a
We describe
d beloow the impoortant indicattors of inequuality.
(i) Loreenz Curve: An Americcan economist, Dr. Lorrenz used grraphic
meassure for studdying inequuality in thee distribution of incom me and
wealtth. It is alsso called Cuumulative P Percentage Curve.
C Closeer the
Lorennz Curve too the line of equal diistribution or o line of pperfect
equallity, smaller is the size of
o income innequality. Sim milarly farthher the
Lorennz Curve froom the line ofo equals disstribution, larrger is the inncome
inequuality (see Fiig. 9.1).

Fig. 9.1:: Lorenz Cu

urve
In Fiig. 9.1 we depict
d two Lorenz curvves A and B. The deggree is
inequuality is high
her in the casse of B comppared to A.
(ii)
( Gini Coefficien nt of Ineq quality: Gini coefficieent is the most
comm monly used measure of inequality. IIt varies from m 0 to 1. Zeero (0)
referss to perfectt equality annd one (1) implies com mplete inequuality.
Whenn there is perfect equallity in incom me distributiion, everyonne has
equall amount off income. On n the other hhand, in the case of commplete
inequuality, one person has all the inccome whilee others havve no
incomme. A higheer value of thhe Gini coeffficient impllies higher degree
d
of ineequality in thhe country.
The Gini
G coefficiient is measuured on the bbasis of the Lorenz
L curve (See
Fig. 9.2).
9 The Loorenz curve shows
s the deeviation from
m perfect equuality.
The greater thee curvature, greater iss the inequuality. The Gini
coeffficient expresses inequallity in terms of a single number.
n

9
Issues in Indian
Economy

Fig. 9.2: Gini Coefficient

Gini coefficient is defined as follows:
௔௥௘௔ ஺
Gini coefficient =
௔௥௘௔ ሺ஺ା஻ሻ

9.5 POLICY MEASURES TO REDUCE

INEQUALITY
Removal of poverty and reduction of income inequalities are major problems of
India. Unless we are in a position to provide the necessities of life to all, our
political freedom is useless and any development is meaningless. As we have
seen, a multitude of factors – economic, social and political – are responsible for
it. The government has taken several policy measures to reduce inequality in the
country.
(i) Direct taxation: The government imposes income tax on individuals
and corporate sector. Taxes as you know are one-way transfer from
the tax payer to the government; there is no quid-pro-quo. The
government in its budget presentation every year announces the
exemption limit, tax rates, and income slabs on which income tax is
imposed. As you would have noticed, the income tax rate is
progressive such that an individual with higher income pays taxes at a
higher rate. There is an exemption limit so that persons with income
below that limit do not have to pay income tax. Similarly, income tax
is imposed on retained profits of the corporate houses.
(ii) Restrictions on monopoly practices: Monopoly power has a
tendency to restrict competition in the economy. Existence of 100
monopoly power can also restrict entry of new firms and set the prices
at a higher level. Thus the Competition Commission of India has set
guidelines for fair trade practices and investigates into cases where
unfairness is suspected.
(iii) Land reforms: The government has taken several measures to
regulate the ownership, operation, leasing, sales and inheritance of
landed property. Land is not just an input for production, it is held as
10 an asset which appreciates in value over time. The objective of land
 reforms has been to reduce inequality in land ownership and Inequality in Income
Distribution
associated problems.
(iv) Social security measures: The government has taken several steps to
provide a safety net to the poor. For the poor households there are
pension schemes, insurance benefits, bank account, etc. Also
subsidized food, housing, electricity, cooking gas, drinking water, etc.
are provided to persons below the poverty line.
(v) Employment generation: Provision of productive employment to a
person is the surest way of increasing his/her income. The government
has taken several measures to generate employment, transfer the
workforce from agricultural to non-agricultural sector, and provide a
secondary source of income to poor households. The government has
launched the MGNREGS (see Unit 7) to provide wage employment in
rural India. There are policy measures to impart skill to educated
youth and workers so that they can be employed. There is emphasis
on MSME sector, which is labour-intensive in production process.
Although these measures have provided some benefits to the poor, there is an
increase in inequality over time. In order to improve the living condition of the
poor, there is a need to increase the income and the standard of living of the poor
in India. The following suggestions can be made to reduce inequality and remove
poverty:
(1) Population Control: Some states in India still have a very high
population growth rate. Growing population is a major cause of poverty
in India. So it is necessary to reduce population growth rate in these
states. It is observed that education of girl child, age of marriage, and
adequate healthcare are important for reduction in birth rate.
(2) Creation of Employment Opportunities: Gainful employment is
essential for income generation for households. Thus it is essential for
policy makers to carry out projects that generate employment for the
poor income households. If the major chunk of the incremental income
of the country goes to the lower strata, inequality will decrease. Micro,
Small and Medium Enterprises (MSME) have huge potential for
generation of employment. Thus emphasis should be given on the
MSME sector.
(3) Increase in Production: Industrial and agricultural production should
be increased to remove poverty. Existing production capacity should be
utilized fully and new investments should be made. Proper coordination
should be there between large scale and small scale industries. Superior
seeds, manures, fertilized and modern methods of production should be
adopted for agricultural development. Necessary irrigation facilities
should be made available and social structure in rural areas should be
modified. All these measures can be helpful increasing agricultural and
industrial production. 11
Issues in Indian
Economy
(4) Check on Price Rise: Inflation affects the poor segment of the
population adversely. So price rise must be checked through proper
fiscal and monetary policies.
(5) Stepping up Capital Formation: Low rate of capital formation is a
major hindrance in the way of fast economic development. Capital
formation rate, therefore, must be increased it basically depends on the
saving rate; every possible efforts should be made to increase savings
and their mobilization.
A few other suggestions can also be made including major reforms in
education system, greater opportunities and facilities for self-employment,
reduction in regional imbalances, strengthening of industrial and agricultural
infrastructure and development of a new strategy of growth leading to
reduction in poverty and income inequalities.
Check Your Progress B
1 What is Lorenz Curve.
2 What do mean by Gini Coefficient of Inequality.
3 Write three suggestions to reduce inequality and remove poverty.

9.6 LET US SUM UP

Inequality in income distribution is a major problem in India. The main cause of
poverty and income inequality are rapid growth of population, unequal
distribution of income and wealth, slow growth of industries and agriculture, lack
of development of the MSME sector.
The measures to reduce income inequality include check on population growth,
control of inflation, faster economic growth, and effective implementation of
special poverty alleviation schemes. Government has adopted many programmes
to remove poverty and reduce inequality including incentives for efficiency, skill
development, emphasis on small scale and cottage industries, and specific
programmes for rural development. Effective implementation of such
programmes is very important.

9.7 KEY WORDS

Inequality: Inequality refers to unequal distribution of income, wealth, assets or
resources in a country.
Income Inequality: It refers to the unequal distribution of income across
sections of society. It indicates that income of some individuals is very high,
while that of the majority of persons is very low.
Socially Disadvantaged Groups: Also called socially deprived sections of
society such as Scheduled Castes, Scheduled Tribes, and Other Backward

12
Classes. The socially disadvantaged group remain deprived of health, education Inequality in Income
Distribution
and other facilities.
Regional Inequality: It means the differences in the economic development of
different regions.

9.8 TERMINAL QUESTIONS

Short Answer Type Questions
1) Discuss the extent of income inequality in India.
2) Discuss the extent of poverty and income inequality in India.
3) Describe the main causes of income inequality in India.
4) Discuss the important remedial measures for the problem of income
inequality in India.
5) Briefly explain extent and nature of income inequality in India.
Essay Type Questions
1) What is income inequality? Explain its extent and causes in India.
2) Explain the factors responsible for income inequality in India. Also state
main steps taken by government in this regard.
3) What is Poverty? Explain its causes and solutions.
4) Discuss measurers adopted by government to eradicate poverty and
reduce income inequality in India.
5) What is poverty line in India? State extent and nature of poverty. Also
highlight anti-poverty programmes for alleviating poverty in India.
6) Critically evaluate income inequality reduction and poverty alleviation
programmes in India.

FURTHER READINGS
The following text books may be used for further in-depth study on the topics
dealt with in this unit:

Atkinson, A.B., The Economy of Inequality, 2nd Edition, Clarndon Press, Oxford.

Cheney H., et al., Redistribution with Growth, Oxford University Press, London.

Fields G.S., Poverty, Inequality and Development, Cambridge University Press,

Cambridge.

Jain T.L., Poverty in India: An Economic Analysis, ESS Publication, New Delhi.

Jan Pen, Income Distribution, Harmonds-Worth, England.

Sen Amaratya, On Economic Inequality, Oxford University Press, London.

13
Issues in Indian Singer H. and Ansari J., Rich and Poor Countries, George Allen & Urwin
Economy
Limited, London.

Thail H., The Measurement of Inequality by Components of Income, Economic

Letters, 2:197-9.

14
UNIT 10 BALANCED REGIONAL GROWTH
10.0 Objectives
10.1 Introduction
10.2 Nature of Regional Imbalance in India
10.3 Measurement of Regional Imbalance
10.4 Need for Balanced Regional Development in India
10.5 Factors Responsible for Regional Imbalance
10.6 Impact of Regional Imbalance
10.7 Policy Initiatives by the Government to Reduce Regional Imbalance
10.8 Issues in Balanced Regional Development
10.9 Let Us Sum Up
10.10 Key Words
10.11 Terminal Questions

10.0 OBJECTIVES
Having gone through this unit you will be able to:
• highlight the nature of regional imbalance in India;
• measure regional imbalance;
• find out the need for regional balance;
• identify the factors responsible for regional imbalance;
• describe the impact of regional imbalance;
• describe the policy initiatives by the government to reduce regional imbalance;
and
• identify the issues involved in achieving balanced regional growth.

10.1 INTRODUCTION
Regional disparity is a ubiquitous phenomenon of the developing countries like
India. Balanced regional development is an ongoing challenge for the
government. Reducing regional inequalities remains a daunting politico-
administrative challenge. The inter-state and intra-state disparities are a major
source of concern for faster and more inclusive development at national level.
Development is not only area specific but also time specific. Development varies
from area to area. You should note that in every country some regions are more
developed than others. Further, growth rate in all the regions are not equal –
some region are growing at faster rate than others.
Since the 1950s, central government has paid attention to those regions which are
lagging behind in economic growth and development. Despite this, one of the
Issues in Indian features of development experience in India is the accentuation in regional
Economy
disparity in India. Disparities have strengthened over the years, instead of
weakening over time. Scholars have identified various factors that have
contributed to such disparities. The issue of regional imbalance came into a
sharper focus after the economic reforms of the 1990s. The less developed states
are falling behind the richer ones instead of catching up. In this unit, we look at
various aspects of regional imbalance in terms of its concept, nature, need, causes
and policy initiatives taken by the government.

10.2 NATURE OF REGIONAL IMBALANCE IN

INDIA
Balanced growth means equitable development in various sectors of the
economy. It means achieving a balance between economic and human
development where economic growth compliments human development.
Balanced Growth has two dimensions spatial (intra-state) and inter-regional
imbalance.
Developed regions provide number of attractions in terms of location, climate,
soil, hydrology, natural resource endowment, accessibility, etc. Besides these
natural advantages, such regions include the development of infrastructure, the
establishment of industries, transportation and communication network, nearness
to market, etc. Establishment of one industry paves the way for the development
of other industries by providing them with common facilities such as power,
transport, labour, etc. thus, showing agglomerative effect. Developed regions
also have number of social amenities.
Along with regional imbalance several terms have emerged such as, ‘backwash
effect’, ‘gap-widening’, ‘bridging the gap’, ‘disadvantaged regions’, ‘backward
area’, etc. Regional imbalance refers to the disequilibrium in economic
development and uneven economic achievement of various geographical regions.
It is reflected by the indicators such as per capita income, population living
below poverty line, population engaged in agriculture vis-à-vis engaged in
industries, literacy rate, educational attainment of people, availability of health
facilities, sanitation, housing, the ratio of urban-rural population, infrastructure
development of different states. Regional imbalance in development between
different States/ Areas/ Districts is common and exists in India. According to
Planning Commission (2013), “regional inequalities, both between States and
within States, present a serious development challenge to the Indian economy”.
An important aspect of regional disparities in India is the significant level of
disparities, which exists within different states, e.g., Vidarbha and Marathwada in
Maharashtra, Saurashtra in Gujarat, Northern Karnataka, etc. Specific reasons are
responsible for backwardness of regions within states. Backwardness of certain
regions in Gujarat, Madhya Pradesh, Bihar and Odisha can be associated with the
distinct style of living of the inhabitants who are mostly tribal and the neglect of
such regions by the policy makers.
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The following aspects of regional imbalance must be kept in mind: Balanced Regional
Growth
(i) Spatial: (a) Intra-regional disparities such as Eastern and Western
Uttar Pradesh. (b) Inter-regional imbalance: Co-existence of
relatively developed states (such as Gujarat, Maharashtra, Punjab
and Tamil Nadu) and economically backward states (such as
Bihar, Chhattisgarh, Madhya Pradesh, and Uttar Pradesh).
(ii) Social: There is class differentiation in dwellings according to
castes in a village. The dwellings of the people from lower caste
may be less developed than that of the higher caste.
(iii) Disequilibrium in resource endowment: Two regions may be
endowed differently with respect to factors of production. This
may culminate into development gaps.
(iv) Regional consciousness which generate a pattern of flow of
resources towards the developed region.
(v) The rural-urban imbalance is very common in India. Rural areas
are not developed in terms of availability of the basic, economic
and social infrastructure like transport, roads, electricity, water,
sanitation, education and health facilities, etc. It is because of the
absence of such facilities that rural areas lag behind urban areas in
terms of the basic indicators of development.
(vi) Regional disparities may be classified on the basis of natural
resources, man-made, inter-state or intra-state, whole or sectoral.
Planning Commission (2013) has observed that “with its wide diversities in
physiography, history, demography and sociology, India has been characterized
by regional disparities in socio-economic development not only between states
but also between districts of a state and between areas and social groups within
districts.”

10.3 MEASUREMENTOF REGIONAL INBALANCE

The measurement of regional disparities in the level of development is not an
easy task. The basic issues in this context are those of criteria, scale and
techniques of measurement. Janardhan and Rajendra (2017) have observed that
“there may be a model approach wherein some developed region is visualized as
a model of development and other region are assessed in terms of development of
this model. Indicators for this model are production, consumption, per capita
income, energy consumption, agricultural development, industrial development,
transport, social development, environmental degradation, etc.”
A number of efforts have been made to measure the extent of regional inequality.
In this context, several indicators can be used to measure regional disparities
across states. These are as follows:
(i) Gini coefficient of regional GDP per capita,
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Issues in Indian (ii) The share of the population living in low-income regions
Economy
(iii) Urban/rural divide and rural poverty
(iv) Differences for non-income factors like education, health and living
standards (which covers various aspects of living condition such as
electricity and sanitation)
(v) Differences in labour productivity
(vi) Multidimensional Poverty Index (MPI)
The Organization for Economic Cooperation and Development (OECD)
commonly uses the Gini coefficient of regional GDP per capita with equal
weights for each region/ state regardless of its population size. The coefficient
focuses on output rather than income and this does not include government
transfers and remittances from richer to poorer areas. Joumard, et al. (2017) point
out that “India’s regional disparities are large compared with the OECD average.
In 2013, output per capita in the poorest state (Bihar) was just 13 per cent the
level of Delhi, one of the richest territories. The share of the population living in
low-income regions in India is much higher, making poverty a more pressing
issue.”
The urban/rural divide accounts for a large share of India’s spatial income
inequality. In the early 2010s, the fastest growing states tend to be those with a
large urban population and the richest states are the most urbanised. Rural
poverty is both widespread and severe, largely reflecting the very low
agricultural productivity. Poverty in rural areas often results in forced migration
to cities, distress sales of land and, in extreme cases, suicides. Overall, the
absolute poverty rate in rural areas, at 26 per cent in 2011/12, was almost twice
the poverty rate in urban areas, despite a faster decline since the mid-
2000s.Differences for non-income dimensions are even larger between rural and
urban areas (Joumard, et al., 2017).
The Government of India (2013) has developed methodologies, including human
development criteria, to measure states’ development level and needs and
allocate central government transfers. The Oxford Multidimensional Poverty
Index (OMPI) suggests that deprivation in education, health and living standards
(which covers various aspects of living condition such as electricity and
sanitation) is even higher than in income (OPHI, 2015). Access to core public
services is also highly concentrated, with 69 per cent of the rural population
multi-dimensionally poor compared to 31 per cent in urban areas. The rural/urban
divide is particularly marked for electricity and sanitation. Access to health care
also varies significantly across states and between rural and urban areas (Joumard
et al., 2017).
Differences in labour productivity are by far the most important factor driving
differences in per capita output across states. Productivity in the three poorest
states (Bihar, Uttar Pradesh and Assam) was less than one third the level of
Haryana (Joumard et al., 2017).
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Omkar Goswami (2022) suggests two categories of variables to measure regional Balanced Regional
Growth
disparities: (i) Economic Indicators, and (ii) Social Indicators.
Economic indicators include GDP and per capita state domestic product (for the
year 2019-20, at current prices in rupees), households with electricity, households
with improved drinking water at source, households with improved sanitation
facility, and households using clean fuel for cooking. All these have been
expressed in percentage terms.
Social Indicators include the following variables:
(i) infant mortality rate per 1,000 live births,
(ii) sex ratio at birth, last five years,
(iii) females per 1,000 males, women aged 20-24 married before age
18 (in per cent),
(iv) women of 15-19 years who were mothers or pregnant (in per
cent),
(v) female population (above 6) who ever attended school (in per
cent),
(vi) women with 10 or more years of schooling (in per cent).
For each variable, comparison in value between the concerned state and the all-
India average. As such, for these variables, those that got high points were the
worse-off states. Lower the points, the better-off the state. Omkar Goswami
(2022) has highlighted that
“the comparison among the states bring some interesting facts. The worst
state is Bihar, which secured 9 points out of 11 which means, in 2019-21,
for nine out of the 11 variables chosen, Bihar fared worse than the
corresponding all-India average. Jharkhand and Odisha with 8 of the 11
variables being worse than all India average. After that comes Assam with
7 followed by a cluster of four states, for each of which six of the 11
variables were poorer than those of all India's: Uttar Pradesh, Madhya
Pradesh, Chhattisgarh and Tripura. If we look at “Rajasthan, West Bengal
and Meghalaya, five of the 11 indicators are worse than India's. For
Jammu and Kashmir, Andhra Pradesh, Arunachal Pradesh and Manipur,
the score is 4 out of 11. For Maharashtra and Telangana, it is 3, and for
Nagaland, 2. And for Punjab, Chandigarh, Himachal Pradesh, Haryana and
Uttarakhand in the north, it is just 1 out of 11, as it is for Gujarat and Goa
in the west, for Karnataka, Kerala and Tamil Nadu in the south, and for
Sikkim and Mizoram in the northeast.”
It is important to note that “West Bengal may be economically poor, it is superior
in social and health indicators.” However, Goswami (2022) highlights that “Bihar
fails in all six social indicators vis-a-vis India. Jharkhand and Odisha fail in five;
Tripura, Andhra Pradesh and Rajasthan fail in four; and UP, Madhya Pradesh,
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Issues in Indian Chhattisgarh, West Bengal, Assam and Telangana do not make it on three out of
Economy
six social counts.”
It is disheartening to find that not much improvement is visible between 2001 and
2019-20. Most districts in Bihar, Jharkhand, Odisha, Chhattisgarh, Madhya
Pradesh and Assam, and some in West Bengal and Tripura, were among the
worst in terms of household-level assets and access to amenities. So is the case
with social indicators in these states. Even in 2022, there are eight states which
are very bad in terms of assets, amenities and social indicators.
Goswami (2022) comes to the conclusion that “most states of the east are among
the worst in India on both economic and social indicators. In contrast, those in
the north (excluding Rajasthan), the west, much of the south and some of the
north-east are far better off. It is interesting to find that development has driven
the northern, western and southern states and has left the centre, the east and the
north-east far behind over the two decades of present century.”
In this context, while discussing the grant of special category to states for transfer
of funds, the Rajan Committee (2013) has opined that “need of states should be
based on a simple index of under-development.” The index proposed by Rajan
Committee (2013) is an average of the following ten sub-components:
(i) monthly per capita consumption expenditure,
(ii) education,
(iii) health,
(iv) house-hold amenities,
(v) poverty rate,
(vi) female literacy,
(vii) percent of SC-ST population,
(viii) urbanization rate,
(ix) financial inclusion, and
(x) connectivity.
The Committee has emphasised that “less developed states rank higher on the
index, and would get larger allocations based on the need criteria” (Rajan, 2013).
Self-Assessment Exercise A
1) What is meant by regional inequality?
………………………………………………………………………………
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2) Describe the nature of regional imbalance in India.
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 ……………………………………………………………………………… Balanced Regional
Growth
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3) Explain how regional imbalance can be measured.
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4) Describe the criteria suggested by the Rajan Committee for grant of funds to
states.
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10.4 NEED FOR BALANCED REGIONAL

DEVELOPMENT IN INDIA
It is important to note that balanced regional development does not mean equal
development of the regions in the state. It simply implies the fullest realization of
a region’s potential so that the benefits of overall economic growth are shared by
the inhabitants of the region. Given the economic condition, the objective of the
government should be to move towards a more egalitarian society, coupled with
balanced development of different regions. Despite taking a number of steps to
reduce the regional disparities, sizeable differences in development still exist
between states and between districts within a state.
It is well to remember that there have been demands for separate States in India
since independence. Creation of some of the States in the past in the wake of
popular agitation was based on perceived neglect of certain backward regions in
some of the bigger states. Examples could be creation of Andhra Pradesh and
Gujarat in the 1950s, and creation of Punjab, Haryana and Himachal Pradesh in
the 1960s. Similarly, there is a demand for a separate Vidharbha State in
Maharashtra. Recently, in 2014, a separate state of Telangana was created from
Andhra Pradesh. Earlier, Chhattisgarh from Madhya Pradesh, Jharkhand from
Bihar and Uttaranchal from Uttar Pradesh were created. These demands for
separate states were mainly due to the lack of economic development in the
regions.
Planning Commission (2008) is also of the opinion that “the gains of the growth
witnessed have not reached all parts of the country and all sections of the people
in an equitable manner. Widening income differentials between more developed
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Issues in Indian and relatively poorer States is a matter of serious concern.” Growth and
Economy
development must exhibit regional balance. India is a union of 28 states and 8
union territories which differ in terms of their productive potential and the type of
industry they can support. The realization of their potential holds the key to
increasing the competitiveness of the nation as a whole.
The sustainability of the growth rate and the goal to achieve its development
target will be difficult to meet unless India develops as an integrated whole of
regional competency. Some regions are lacking in natural resources even then
they are ensuring their development through technological development. So there
is a need for stability in the development process of the country by adopting the
process of balanced regional development of the country.
A balanced regional development is necessary for the following reasons:
a. Inequality breeds economic inefficiencies and limits productivity. Thus
regional balance is required to accelerate the overall growth rate of
GDP.
b. It will minimise backwash effects. Backwash effect refers to movement
of wealth from poorer regions to richer region.
c. It will lead to development of regions which are below national average.
d. It will provide certain minimum standard of living to inhabitants of the
backward states.
e. It will help in maintaining political stability and tackling the problem of
left wing extremists and insurgency to have a strong India. Thus it will
lead to social harmony.
Keeping in view the importance of balanced regional development, we now look
into the factors that should be emphasised. Majumder (2005) has highlighted the
following variables for balanced regional development:
(i) Agricultural development,
(ii) Industrial development,
(iii) Human development related to social indicators of literacy,
mortality, etc.
(iv) Infrastructure which is composed of physical, financial and social
infrastructure. Physical infrastructure consists of Agro-specific
infrastructure (irrigation and agricultural credit), transport &
communication infrastructure (road, railways, and communication
networks), and power infrastructure. Financial infrastructure consists
mainly of banking services while social infrastructure consists of
availability of educational and health facilities. Each of these
components of development and infrastructure themselves consists of
several variables / indications.

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10.5 FACTORS RESPONSIBLE FOR REGIONAL Balanced Regional
Growth
IMBALANCE
The level of development of a state largely depends on a complex set of cultural,
historical, natural and sociological factors. Regional inequalities in the levels of
development are the result of the disparities in the distribution of physical
resources, diverse culture, and technological achievements. Technology is a vital
input of development strategies as there is a positive correlation between the
level of technological improvement and the level of economic development.
Regional disparities in the level of development are the product of collective
effect of all these factors. Further, factors like distance to the nearest urban
agglomeration, differences in urbanization, availability of electricity and certain
state-specific characteristics play a crucial role in explaining divergence across
regions.
In India, regional inequality is the product of the following factors:
1. Geographical Factors
a. Some regions are endowed with natural resources such as
minerals, water, fertile land, proximity to the ocean, and
accessibility to waterways. Such regions are more developed
than geographically disadvantaged regions of hilly terrain,
desert, infertile land, etc. As for example, North-Eastern states
have remained mostly backward due to their inaccessibility and
other inherent difficulties.
b. Coastal states have geographical advantage as they have a port
to do business abroad. These are more developed compared to
many non-coastal states.
2. Manmade / Historical Factors
a. Historical factors also play an important role in regional
disparity. Development during colonial rule has contributed to
regional inequities. The British rulers preferred to develop
those regions of the country which had potential for
manufacturing and trading activities. At that time, they did not
had any industrial policy focusing on overall development.
3. Social Factors
a. Illiteracy and lack of education in the less developed regions
has high fertility rate and thus growing population.
b. Non-availability of required social services.
c. Social peace and harmony are conducive for development.
That is why the region having a peaceful society is more
developed.

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Issues in Indian 4. Economic Factors
Economy
a. Inadequate infrastructure like transport system in poorer
states.
b. Incapacity of the states to harness rich demographic dividend
due to less developed job market.
c. There is disparity in availability of power supply among
states.
5. Political Factors
a. Faulty development strategies in the post-independence era.
b. Inter-state disparities in development have increased post
economic reforms period.
c. Some regional governments implemented development policy
more effectively as compared to other regions, hence they are
more developed.
d. Red-tapism, corruption and administrative inefficiency. Added
to this is the lack of political will to fulfil regional needs.
e. Neglect of some regions and preference of other regions in
terms of new investments and infrastructure facilities. It is
apparent that new investment in the private sector has a
tendency to prefer those regions having basic infrastructural
facilities.
f. Unhealthy business environment because of extremist
activities, law and order problem, etc. have obstructed the flow
of investments into backward regions besides making flight of
capital from backward states.

10.6 IMPACT OF REGIONAL IMBALANCE

Regional disparity in development has the following consequences:
(i) Violent conflicts occur because of uneven regional development
which leads to several agitations intra-state or inter-states.
(ii) Insurgency in the north-east and the left wing extremism in large
parts of the central and eastern states of India.
(iii) Unplanned and haphazard migration from backward areas to the
developed areas in search of livelihood. For example, migration
from rural to urban areas, as the latter provides better quality of
life and job opportunities.
(iv) Economic deprivation and inequality in access to resources.

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 (v) Concentration of industrial development at one place leads to air Balanced Regional
Growth
and sound pollution, shortage of housing and water, problem of
congestion, etc.
(vi) Pressure on existing infrastructure in metropolitan cities.
The states with low level of socio-economic development have become more
vulnerable to the adverse effect of liberalisation. Bihar, Madhya Pradesh,
Rajasthan and Uttar Pradesh are still lagging behind in terms of per capita income
and social indicators.
Poverty and under-employment are especially acute in areas with heavy pressure
of population and in those with scanty development of natural resources. Thus,
regional imbalance is a threat to the goal of inclusive growth and reduction of
poverty. Such imbalances have dampened the speed of further economic reforms,
and pose an obstacle to India’s future economic growth. They affect character of
social life, the nature of the political process, and the priorities of the state.
Self-Assessment Exercise B
2) Mention four factors responsible for regional imbalance in India.
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2) Describe the nature of regional imbalance in India.
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3) Explain how regional imbalance can be measured.
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4) Explain why regional balance is important for a country.
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10.7 POLICY INITIATIVES BY THE GOVERNMENT

TO REDUCE REGIONAL IMBALANCE
A number of questions arise at this point. What criteria a government should
consider to evaluate regional imbalance? What type of policy a government
111
Issues in Indian should adopt to bring in balanced regional development? It is not easy to answer
Economy
these questions. Active state intervention however has been envisaged to reduce
the disparities. During the past 70 years of planned development in India, many
efforts have been made to bring backward regions at par with the advanced
regions. Some of these steps are given below.
(i) Priority has been given to programmes in areas such as agriculture,
community development and irrigation, local development works, etc.
These sectors have a strong linkage with the locality and helps in
development of the area.
(ii) Ensuring provision of economic infrastructure such as power, water
supply, transport and communications, training institutions, etc. in
backward areas. Availability of infrastructure in the area would provide
incentives for establishment of industries and provide employment
opportunities to the local people.
(iii) Launching of programmes for the expansion of micro, small and medium
enterprises (MSMEs). Industrial estates have been set up in all states and
increasingly they are to be located in the smaller towns and rural areas.
(iv) In the case of location of new enterprises, particularly public enterprises,
consideration has been given to the need for developing all the regions of
the country. Many higher education institutions have also been
established in backward regions.
(v) According to the erstwhile Planning Commission (2013) the regional
aspects of development were dealt with in the following manner:
(a) In the plans of the states emphasis was given to programmes which
had a direct bearing on the welfare of the people in different parts of
the country.
(b) Special programmes were undertaken in specific regions areas where
development had either received a temporary setback, or was being
held back by certain basic deficiencies.
(c) Steps were taken to secure more dispersed development of industry
which, in turn, created conditions for development in several related
fields.
(d) In general, efforts were made to enlarge the possibilities of
development in areas which have in the past been relatively backward.
The mechanism employed to achieve regional balance in development was the
transfer of resources from the Centre to the states. These transfers, which are
more heavily directed to populous and poorer states, have been channelled
through the Finance Commission and the Planning Commission. Some of these
transfers are as follows:
a) The Gadgil Formula was evolved in 1969 for determining the
allocation of central assistance for state plans. The formula took
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 due cognizance of the need for balanced regional development. Balanced Regional
Growth
Special weightage has been given to backward states in allocation
of resources.
b) The concept of Special Category States was introduced by the
Fifth Finance Commission (1969) for providing special assistance
to disadvantaged states with a low resource base, difficult terrain,
low population density, inadequate infrastructure and non-viable
state finances.
c) The Planning Commission adopted an area-specific approach in
its planning strategy and introduced multiple centrally sponsored
programmes.
d) The Tribal Development Programme, the Hill Area Development
Programme, and the Western Ghats Development Programme
were initiated, catering to geographically homogeneous and
backward regions. However, such area-specific approaches for
growing divergences in development patterns have not been
successful.
The Rajan Committee (2013) proposed a general method for allocating funds
from the Centre to the states based both on a state’s development needs as well as
its development performance. The Committee proposed allocations based on the
index, but with allocations increasing more than linearly to the most
underdeveloped states. The scheme of allocation accommodates differences in
needs, even while recognizing that the truly needy states should be given
disproportionately more funds. Over the years there has been an improvement in
some areas in reducing regional disparities. However, because of the fact that
several states are not able to access the fruits of development equitably, the
overall stress in the national polity has been increasing (Planning Commission,
2013).

10.8 ISSUES IN BALANCED REGIONAL

DEVELOPMENT
Not only are regional disparities pronounced, they have even increased since the
1990s (Ahluwalia 2000). Economic growth since economic liberalisation has
enhanced divergence rather than fostering convergence.
The objective of balanced regional development has consistently featured as an
important agenda of development plans. India’s geographical diversity and
different levels of development across regions imply that targeted action would
be required in less prosperous regions to ensure a minimum acceptable level of
prosperity. This requires a common set of national policies which must be
complemented by policies and programmes targeted at specific regions.
The NITI Aayog (2017) in its agenda proposed policy changes and programmes
for action during 2017-18 to 2019-20. This document highlighted regional
disparity as a critical development issue and offered ambitious proposals for 113
Issues in Indian policy changes within a short period. The geographical characteristics of the
Economy
country require region-specific policies and programmes. With these factors in
view, the NITI Aayog (2017) focused on targeted actions in the following four
regions in India:
a. North Eastern Region (NER)
b. Coastal Areas and Islands
c. North Himalayan States
d. Desert & Drought Prone Areas
Development policies should enable backward regions to overcome the
disadvantages they face and make available at least some minimum standard of
services for their citizens (Planning Commission, 2008). Kurian (2005) has
stressed that “reduction of regional disparities should be looked upon as a
national objective. The strength of a building depends on the strength of its
weakest pillar. In a similar way the strength of the Indian economy depends on
the strength of the economy of Bihar. Similarly, the bottom line of India’s human
development will depend on the incomes and socio-demographic indicators of
development in northern and eastern India”.
Kurien (2005) is of the view that “the solution mainly rests with the local
leadership. Unless the local leadership – political, bureaucratic and intellectual –
resolve to usher in development based on sharing the gains on egalitarian basis
with the masses, results will be hard to come by. Resources are not the real
constraint. It is the way resources are spent. Unless the work culture in public
services changes, funds alone will not solve the problems. It is imperative that
Centre and the leadership of the backward States should evolve institutional
arrangements to ensure that funds transferred result in the best use in terms of
development”.
Fostering competition amongst states through the business reforms action plan is
expected to improve regional balance. Inter-state competition in improving
governance and the ease of doing business will be of help towards balanced
regional growth. But enticing private investment will need further action on
simplifying regulatory architecture, reducing the litigation and alternative dispute
settlement mechanisms, and easing factors of production, where action rests with
the state. This could also catalyse private investment and innovative public-
private partnerships (Shankar, 2017).
These backward regions should make efforts themselves to improve their
economic and social condition. However, these can be achieved only by taking
concrete action on the ground. If India has to do well, the States as a whole must
do well. Many State Governments are also taking action to redress the problem of
regional imbalances. The role of the Centre in promoting equity among States
and regions has assumed added importance in the post liberalization era.
The main issues of achieving regional balance relate to
114
 (i) Reducing divergence and fostering convergence across regions. Balanced Regional
Growth
(ii) Keeping in view the geographical diversity of the country, there is a
need to have targeted action plan for less developed regions to
ensure that a minimum acceptable level of prosperity is brought to
these regions.
(iii) To make action plan effective, there is a need to have a common set
of national policies which would complement policies and
programmes targeted at specific regions.
(iv) There is a case for having region-specific programmes to provide a
given minimum level of amenities to less developed regions at the
earliest because growth and prosperity must exhibit regional
balance.
(v) Need for investments in backward areas.
(vi) Ensuring good governance in backward states.
CYP 3: Check your progress (to be checked)
Q1. Is policy needed to reduce regional imbalance? Give two arguments.
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_________________________________________________
_________________________________________________
Q2. What important policy measures have been taken by the government
to achieve regional balance? Mention four measures.
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_________________________________________________
_________________________________________________
_________________________________________________

Q3. Which kind of policy measures are important? Write five sentences.
_________________________________________________
_________________________________________________
_________________________________________________
_________________________________________________
_________________________________________________
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Issues in Indian
Economy
Q4. Point out reasons for policies not being very effective. Indicate
important ones.
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_________________________________________________
_________________________________________________
_________________________________________________
_________________________________________________

Q5. What suggestions will you give for achieving regional balance?
Write four of them.
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_________________________________________________
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10.9 LET US SUM UP

Regional imbalance is a common phenomenon in India. The co-existence of
relatively developed and economically depressed states and even regions within
each state is known as regional imbalance. Regional Imbalances implies that
there are differences in the level of economic development across regions.
Regional imbalances may be inter-state or intra-state. Some parts of the country
are highly developed and some parts are severely affected by lack of resources
and facilities. Some regions are quite rich in natural resources but they are poor
because they are unable to utilize the resources. A group of factors are
responsible for regional disparity such as historical, geographical, political,
location-specific, social, etc. Income Inequalities is another important problem.
Regional imbalance is a threat to the goal of inclusive growth and reduction of
poverty. Impact of regional disparities may be discerned in the form of
unplanned migration, social tension, conflict with local people, unutilized vs.
over-utilized resources, left wing extremism, political uncertainty, etc.
The issue of achieving regional balance has been an integral component of
development policy. Various steps have been taken to address the issue of
regional imbalance through the mechanism of Finance Commission and Planning
Commission.
Despite having pro-backward areas policy and programmes, considerable
economic and social inequalities exist across states. After economic
liberalisation, the disparity across states has increased. Intra-state disparity has
116
also increased over time. There is a strong need for strengthening good Balanced Regional
Growth
governance in the backward areas. Towards this end, it is necessary that the local
bodies in the backward areas are empowered and strengthened to reduce the
regional imbalances in the country. Investing in education, connecting areas and
regions (through roads, rail, air and information technology), improving urban
management, empowering the poor, and introducing social safety nets are some
of main areas where concerted action is needed.

10.10 KEY WORDS

Gini Coefficient: The Gini coefficient is a measure of inequality. It is often used
as a measure of inequality across households or individuals, which can be
extended to measure inequality across regions or states or countries. The Gini
coefficient takes on values between 0 and 1, with zero interpreted as perfect
equality. The Gini coefficient assigns an equal weight to each region regardless
of its size. Differences in the values of the coefficient across countries may
partly reflect the differences in the size of regions in each country.
OMPI: the Oxford Multidimensional Poverty Index is an international measure
of acute poverty covering over 100 developing countries. Recently India has
started measuring poverty across states by using MPI (see Unit 7). The OMPI
complements traditional income-based poverty measures by capturing the
deprivations that each person faces at the same time with respect to education,
health and living standards.
Inter-State Council: This is not a permanent constitutional body, which can be
created at any time. It was set up in 1990 through a presidential ordinance for the
first time as per the recommendations of the Sarkaria Commission under the
Ministry of Home affairs. The secretarial functions of the Zonal Councils have
been reassigned to the Inter-State Council Secretariat from 1st April 2011. Inter-
State Council works as an instrument for cooperation, coordination and the
evolution of common policies. The interstate council is proposed to meet thrice a
year. But in 26 years, it has met only 11 times. The latest meeting was held after
a gap of 10 years in Delhi in July 2016.
NITI Aayog: The National Institution for Transforming India, better known as
NITI Aayog, is constituted to replace the Planning Commission, which had been
instituted in 1950., NITI Aayog, was formed via a resolution of the Union
Cabinet on January 1, 2015.
This is the premier policy think tank of the Government of India, providing
directional and policy inputs, apart from designing strategic and long-term
policies and programmes for the Government of India. It also serves relevant
technical advice to the Centre, States, and Union Territories. The Governing
Council of NITI Aayog is chaired by the Prime Minister and comprises Chief
Ministers of all the States and Union Territories with legislatures and Lt.
Governors of the Union Territories.

117
Issues in Indian
Economy 10.11 TERMINAL QUESTIONS
Q1. What do you mean by balanced regional growth? Is regional inequality in
India actually a problem of economic geography? Discuss.
Q2. Analyse the causes of regional imbalance in India? Which cause(s) you
consider to be of importance in the present condition?
Q3. Describe the impact of regional imbalance in the economy. Classify the
impact into social, economic and political.
Q4. Explain the policy steps taken by the government since 1960 and with
what effect?
Q5. How do you suggest the policy makers for an effective plan for achieving
balanced regional growth in the country? Narrate your plan in some
detail.

SOME USEFUL BOOKS / REFERENCES

Ahluwalia, M. (2000), “State Level Performance under Economic Reforms in
India” (Paper presented at the Centre for Research on Economic
Development and Policy Reform Conference on Indian Economic
Prospects: Advancing Policy Reform, May 2000; Stanford
University)
http://planningcommission.nic.in/aboutus/speech/spemsa/msa007.pdf

Goswami, Omkar (2022, January 26). A Tale of two Indias: The regional skew in

Government of India (2013), Report of the Committee for evolving a composite

development index of states.

Janardhan, Gadekar Deepak & Rajendra, Sonawane Vijay (2017, May). Regional
Disparities of Socio- Economic Development in Ahmednagar
District, Maharashtra (India). International Journal of Recent
Research and Applied Studies Volume 4, Issue 5(5).

Majumder, Rajarshi (2005) Infrastructure and regional development:

Interlinkages in India. Indian Economic Review, Vol. XXXX, No. 2,
pp. 167-184

Niti Aayog: India (2017): Three Year Action Agenda (2017-18 and 2019-20)

Planning Commission (2013). Twelfth five year plan (2012 - 2017) Vol. I. Sage
Publications India Pvt Ltd, New Delhi.

118
BLOCK 4 SECTORAL DEVELOPMENT-I;
AGRICULTURE SECTOR IN INDIA
You have learnt about Economic Development in Block 1 and Determinants of Growth in Block
2 and in Block 3 about issues in Indian Economy. This fourth block covers importance of agriculture,
problem of productivity and growth pattern in detail. This block has three units.
Unit 11 deals in Importance of Agriculture. The unit begins with sectoral contribution to the Economy,
some empirical evidence about agriculture and economic development are described, role of Agriculture
in Economic Development of a country is highlighted, and the unit ends with the importance of
agriculture in India’s national economy.
Unit 12 deals in Problem of Productivity. The unit begins with productivity in India’s agriculture,its
general causes, institutional causes andtechnological factors, thenmeasures to raise productivity in Indian
agriculture are given,how to reduce pressure of population on land is discussed, concept of agriculture
research and extension, agriculture marketing,ever green technology are explained in the end.
Unit 13 deals in Growth Pattern. The unit begins with history and development of India’s agriculture
during the first half of the 20th centuryBritish period andpost-independenceperiod ranging from ‘The Pre
- Green Revolution Period’ to ‘The Beginning of Green Revolution’ to ‘The Maturing of Green
Revolution’ to ‘Economic Liberalization and Deceleration of Agricultural Growth’ to‘The Period of
Recovery’ to the‘The National Democratic Alliance- II (NDA-II) Rule’ and in the end challengesthe
Indian agriculture facesalong with the policy suggestions are given.
UNIT: 11 IMPORTANCE OF AGRICULTURE AND ECONOMIC DEVELOPMENT

Structure

11.0 Objectives
11.1 Introduction
11.2 Sectoral Contribution to the Economy
11.3 Agriculture and Economic Development: Some Empirical Evidences
11.4 Role of Agriculture in Economic Development of a Country
11.5 Importance of Agriculture in India’s National Economy
11.6 Let Us Sum Up
11.7 Key Words
11.8 Answers to Check Your Progress
11.9 Terminal Questions

11.0 OBJECTIVES

After reading this unit, you should be able to

• explain contribution of different sectors to Indian economy;
• describe how agriculture and economic development are interwoven;
• discuss how does agriculture provide employment;
• explain how does agriculture make available food to the expanding population;
• describe how does agriculture supply raw material to the industries; and
• discuss how does agriculture contribute to the elimination of poverty.

11.1 INTRODUCTION

“Everything else can wait, but not Agriculture”, the first prime minister of India, Pt. Nehru said
while addressing a group of farmers in late 1950s. Agriculture is the oldest organized occupation
in the world. It is as old as the human civilization when the human being started utilization of
land for his/her survival and sustainability. Over the time, a dynamic change took place in
agriculture and its operations. In this unit, you will learn about the sectoral contribution to the
economy, agriculture and economic development, role of agriculture in economic development
of a country and importance of agriculture in India’s national economy. Till the onset of the
industrial revolution in Western Europe, agriculture was the main source of livelihood and
employment and agriculture was basically subsistence in nature. Even today in most of the
developing countries, agriculture sector is the dominant source of employment and livelihood.

The importance of agriculture in the national GDP and employment depends very much upon the
level of economic development in that country. It is the agriculture sector, which in the initial
stages of development owns much of resources, be it income, labour or capital. Any economy
can be divided into three broad sectors, namely primary sector, secondary sector and tertiary
sector. Primary sector incorporates agriculture and allied activities, secondary sector all types of
manufacturing and tertiary sector contains the services sector. The structure of an economy
changes as economic development takes place in the economy. The economists have termed
these changes in the economy over a period time as ‘Structural Transformation of an Economy’.
Agriculture continues to be the mainstay of Indian economy even after 70 years of independence
since agriculture contributes 16.5 per cent of the GDP (Economic Survey, 2019-20) and about 42
per cent of the working population is engaged in agriculture (National Statistics office,2020).

11.2 SECTORAL CONTRIBUTION OF THE ECONOMY

Indian economy can also be divided into three sectors, namely, agriculture and allied activities,
industry and services. Agriculture sector includes agriculture (Agriculture proper and Livestock),
forestry and Logging, fishing and related activities. Industry includes mining and quarrying,
manufacturing (Registered and Unregistered), electricity, gas, water supply, and construction.
Services sector includes 'Trade, hotels, transport, communication and services related to
broadcasting', 'Financial, real estate and profession services, 'Public Administration, defense and
other services.

At the time of independence of the country, the agriculture sector was the predominant sector of
the economy, both in terms of its contribution to the gross domestic product (GDP) and in
providing employment to the country’s labour force. Table 1 depicts the lopsided picture of the
Indian economy on the eve of independence when the agriculture sector dominated the economy
in terms of contribution to national income and to provision of employment to the labour force.
One half of the national income and three fourth of jobs originated from the agriculture sector.

Table 1: Structure of Indian Economy on the Eve of Independence

Sectors Income Employment
Agriculture 49.1 72.3
Mines, Manufacturing, Small Enterprises 17.1 10.7
Services, Trade, Transport and Communications
and other Services 34.2 18
Source: Bettlehem Charges, India Independent

The industrial sector contributed 17 per cent of the national income and about 10.7 per cent of
the workforce was working in industries. The industrial activities where technical progress is the
most important source of growth were employing just one tenth of the workforce. The most of
the industries were consumer good based while the capital goods industries were typically
missing from the scenes. The tertiary sector comprising the services was adding one third of the
national income while employing about one fifth of the workforce.

It can be noted from Table 1 that India’s economy on the eve of Independence was
predominantly rural and agrarian in nature with more than 85 per cent of the population living in
villages and most of them were dependent on agriculture for their livelihood. In spite of a large
proportion of workers employed in agriculture (70%), the country was not self sufficient in food
and raw materials for the industry. The average food grain availability was deficient in quantity
and quality and country faced recurring famines.

Since then a systemic and significant decline in the share of agriculture sector in the nation’s
GDP was observed. The share of employment did not catch up with GDP resulting in a huge
difference in the earning of the agriculture sector and non-agriculture sector.
Table 2: Composition of Gross Domestic Product since independence (in per cent)

Agriculture and
Allied
Year Activities(GDP) Industries(GDP) Services(GDP)
1950-51 51.81 14.16 33.25
1980-81 35.39 24.29 39.92
2000-01 24.5 25.22 50.27
2010-11 17.74 27.76 54.5
2016-17 15.11 31.12 53.77
2019-20 18 27 55
2020-21 20 26 54
Source: Economic Survey, GOI., (various years)

Table 3: Contribution of Different Sector in Employment

Sectors 1999-2000 (%) 2004-05 (%) 2009-10(%) 2015-16(%) 2019-20(%)

Agriculture 59.9 56.6 53.2 45 42.2
Industries 16.4 18.7 21.5 25 25
Services 23.7 24.7 25.3 30 32.8
Total 100 100 100 100 100
Source: Data.gov.in

As shown in Table 2, the contribution of the agriculture sector to the GDP has come down from
more than fifty per cent in 1950-51 to 35 per cent in 1980-81and to 15 per cent in 2016-17. We
observe a consistent decline in the contribution of agriculture to the national income and its place
has been taken over by the industrial and service sectors, particularly the service sector which
now shares more than 50 per cent of the national income. Whereas the importance of agriculture
as a source of employment is being marked by a small decrease over time and latest government
source says that 44 per cent of the workforce is engaged in the agriculture for the employment.
Thus, we can say that a partial transformation of the economy has taken place since
independence wherein the share of agriculture in the gross value added (GVA) has marked
significant reduction while the agriculture as the dominant source of employment remains intact.
Most of the studies related to the western developed countries and East Asian countries verify
the stage wise system pattern adopted by these countries.
11.3 AGRICULTURE AND ECONOMIC DEVELOPMENT: SOME EMPIRICAL
EVIDENCES

Agriculture is the most important sector of the economy and it is the development of agriculture
sector which precedes the development of the other sectors of the economy. In the initial stages
of the economic development, agriculture sector commands most of the resources. A significant
proportion of national output came from agriculture and most of the labour force found
employment in agriculture. Agriculture dominates low income countries, 70% of whose
population depends on it; amongst the vast majority of the world’s poor, agriculture is still the
main source of income, just as farming is their chief occupation (World Bank,1982). In India,
agriculture was the main source of national income and occupation at the time of independence.
Agriculture and allied activities contributed nearly 50 per cent to India’s national income and
around 72 per cent of total working population was engaged in agriculture. Agriculture
contributes to both income growth and poverty reduction in developing countries. Agriculture
sector generates income and employment in rural areas and provides food at reasonable prices in
urban areas. The sector matters greatly in low-income countries where about 60 per cent of the
labour force is employed in agriculture. It accounts for 25 per cent of GDP (but only 9 per cent in
middle-income and 1 per cent in high-income countries). Agriculture provides food, income and
jobs and hence can be an engine of growth in agriculture-based developing countries and an
effective tool to reduce poverty in transforming countries. Agriculture contributes factor, labour
and market to the other sectors in the initial stages of the development.

Kuznet (1968) has identified three important contributions which agriculture makes to the
economic growth of an economy, viz. factor contribution, product contribution and market
contribution. According to the World Development Report (1982), in Europe, Japan and United
States, for example, a dynamic agriculture accompanied, and in some instances led, process of
industrialization and growth (World Bank,1971). In contemporary development theory, the
agricultural and rural sectors of the less developed countries are believed to be the key sectors in
attaining desired development and growth objectives (Reynolds, 1975; Todaro, 1989).
Development of agriculture is crucial for the development of people directly engaged in
agriculture and those in non-agriculture sectors. The development of agriculture stimulates the
development of other sectors through linkages, both backward and forward. It was Hirschman
(1958) who introduced the concept of ‘sectoral linkages’ in his theory of ‘unbalanced growth’.
He argued that the growth of the sector with larger linkages will increase growth faster, through
linkages other than the alternative means. At the same time, he mentioned that agriculture cannot
be leading sector because of its weak backward linkages, whereas Kalecki (1960) and Kuznet
(1968) emphasized that agriculture development is the sine qua non for industrialization.
Joanson and Mellor (1961) and Mellor (1976) discussed the importance of agriculture on non-
agriculture sector. The researchers have not only acknowledged the dominant role of agriculture
in economic development of less developed countries, but have seen technological change as a
key dynamic force for transforming conventional agriculture. Traditional agriculture is seen as a
source of food and raw material for the economy and its people. It is also seen as a source of
income and employment. While the above-mentioned contributions of agriculture are a common
knowledge what is not so common is a twofold contribution of agriculture and its people. One of
these is that this sector provides a demand base for the rest of the economy, which has multiplier
effects for the development of secondary and tertiary sectors at the local, regional and national
level. And second is that the development of agriculture is conducive to reducing the poverty
ratio. Agriculture also contributes to the economy by providing savings and foreign exchange.

The empirical studies regarding the economic development and agriculture come from the study
of Kuznet (1966) who observed that as economies develop, the importance of agriculture in
employment and income diminishes. Timmer (2002) using a panel of 65 developing countries
over 1960 – 1985 found a positive correlation between growth in agricultural, GDP and its
lagged values and non-agricultural GDP growth. Self and Grabowksi (2007) established a
positive relation between different measures of agricultural productivity and average growth of
real GDP per capita over 1960 – 1995 for a cross-section of countries. De Janvry and Sadoulet
(2009) studied in China over 1980 – 2001 and found that a 1 per cent agricultural growth had an
effect on aggregate growth of 0.45 per cent, whereas the indirect effect through the non-
agricultural sector represents half this effect. In his study, ‘Agricultural growth and Industrial
performance in India’, Rangarajan (1982) maintained that one per cent growth in agricultural
production brought about a resultant increase by about 0.5 per cent in industrial production and
by more than 0.7 per cent in national income. So, development of the agricultural sector is
essential for achieving a faster rate of economic growth. Chand and others (2012) calculated that
a one per cent increase in agriculture GDP contributes about 0.25 per cent to overall GDP growth
in India. It means if agriculture attains the four per cent annual growth rate, it would contribute
additional two per cent to India’s national output. Whereas the World Bank report (2008) from
cross country evidence suggests that growth in agriculture GDP is at least twice as effective as
the other sectors in reducing poverty.
The World Development Report (2008) has classified the operation of agriculture in three
distinct worlds- the developing countries, the transforming countries and the urbanized countries.
The agriculture sector plays different roles in the above mentioned countries accordingly. In
agriculture-based economies, agriculture contributes on average 32 per cent to overall economic
growth and the majority of the poor live in rural areas, whereas in transforming countries,
agriculture contributes on average 7 per cent to overall growth but poverty is still mostly rural. In
urbanized countries, agriculture accounts for only 5 per cent of economic growth and urban
poverty is higher than poverty in the rural areas.

Agriculture dominates low-income developing countries, where 60-70 per cent of the population
depends on agriculture for their sustenance. Its growth in large part dictates the growth of their
GDP. The chunk of the population spends 60 to 70 per cent of its income on food. As the
development proceeds, role of agriculture diminishes, eventually accounting for the smaller
share in both output and employment. For the developing countries, growth in agriculture will
further speed up the process of industrialization in these countries. A clear positive relationship
between the agriculture and economic development emerges from different experiences of the
developing countries.

In the agriculture based poor countries, which include Sub Saharan Africa, agriculture and its
allied activities are essential to growth and to reducing mass poverty and food insecurity. These
sub-Saharan countries are dominated by the small size farm holdings, so increasing the small
holder farming’s productivity is a prerequisite for the agriculture development in these countries.
It is not so that small holders are less productive or less motivated than the large farm holders.
Given the right incentive and institutional framework, small farmers are equally responsive and
productive.
In transforming countries, which include most of the South and East Asia and Middle East and
North Africa, ever increasing rural–urban income inequality and continuing extreme rural
poverty are primary sources of social and political tensions. These countries have been relying
on agriculture protection and subsidies which in fact is not sustainable nor can it solve the
problems of income disparities. The right approach to the income disparities in these countries
requires a comprehensive approach-shifting to high value agriculture, decentralizing nonfarm
economic activities in rural areas, and providing assistance to help move people out of
agriculture. All these require a bold and a committed political decision and innovative policy
initiative.
In urbanized countries, which include most of Latin America and much of Europe and Central
Asia, agriculture can help reduce the remaining rural poverty if small holders become direct
suppliers in modern food markets. In this way, good jobs are created in agriculture and agro
industry, and markets for environmental services are introduced.
Check Your Progress A
1. What was the contribution of agriculture to income and employment on the eve of
independence?
2. How did the contribution of agriculture to GDP change from 1950 to 2021?
3. Name three contributions of agriculture to the economic growth.
4. Which of the following statements are True or False?
i) Agriculture is the oldest organized occupation in the world.
ii) Economic development leads to ‘Structural Transformation of an Economy’.
iii) India’s economy on the eve of Independence was predominantly urban.
iv) Agriculture also contributes to the economy by providing savings and foreign
exchange.
v) The agriculture sector plays same role in the developing countries, the
transforming countries and the urbanized countries. False

11.4 ROLE OF AGRICULTURE IN ECONOMIC DEVELOPMENT OF A COUNTRY

Agriculture is strategically very important for the development of other sectors of the economy.
The development of secondary sector and also tertiary sector of most of the developed countries
relied on agriculture sector in the initial stages of economic development. It was the agriculture
sector that preceded the development of industrial sector in the modern day in England and
America. Even the most prosperous nation of Asia, Japan owes the development of economy to
the development of agriculture. Agriculture sector stimulates the development of other sectors
through multiple ways. Simon Kuznet classifies the three types of contributions which
agriculture makes for the economic growth of a country as:
(1) The factor contribution
(2) The product contribution
(3) The market contribution
Let us learn them in detail.
1) The factor contribution: When agriculture starts developing, it releases the factors/resources
productive in nature to the other sectors of the economy. The release of these useful, productive
resources to the non-agriculture sector of the economy is called Factor Contribution of
agriculture. The factor contribution can further be divided into:
a) Provision of Capital
b) Provision of labour
a) Provision of Capital: In the initial stages of development, all the important desirable factors
of productions like labour, capital, entrepreneurship and income are in the agriculture sector.
Development of other sectors require the funds to invest in the non-agriculture sector. It is
agriculture which generates the necessary funds for the other sectors and the transfer of capital to
the non-agriculture sector can be voluntary or compulsory. It is voluntary when the landlords,
farmers and the agriculturists themselves invest in the non-agriculture sector. The historical
evidences show that the farmers of England and Japan were prominent to save and invest in the
industrial projects in their respective countries. When the government levies taxes on the
movement of agricultural products and income and generates revenue, such generation of
revenue is known as compulsory transfer of the funds from the agriculture to other sectors. Land
tax, which was imposed by the government of Japan at the end of the 19th century, formed 80 %
of the total revenue of the government. Further, the growth in the agriculture sector itself brings
down the prices of agricultural commodities which helps in increasing the real income of the
consumers and reduces the cost of industrial input resulting in more profit for the industries. In
densely populated countries like India, a bulk of the population is engaged in agriculture without
any real contribution to the marginal product. Prof. Nurkse has called them “disguised
unemployed” and if we withdraw a part of the population from the agriculture sector, it would
help us to raise the marginal product. Thus, if this excess or disguised unemployed labour can be
utilized to produce the social overhead capital like roads, canals, it would help in the
development of the non-agriculture sector.
b) Provision of labour: In the initial stages of development, most of the labour force is engaged
in the agriculture sector. The release of labour from the agriculture sector to other sectors of the
economy is another important contribution of agriculture towards the development of the non-
agriculture sector. We have seen that the importance of agriculture as the largest employer
decreases in the course of time as the economy develops. Today, most of the developed countries
like America, England and Japan even the Australia and New Zealand employ only 3 to 5 per
cent of the workforce in the agriculture sector. In the beginning of the development, the farm
population is one of the important sources of the labour supply and at the same time, the
movement of farm labour to another sector is not always easy. The transfer of labour from the
agriculture to non-agriculture sector may not be a problem in an over populated country since
labour is already surplus in these countries. The transfer would actually increase the productivity
of the remaining labour. But the transfer of labour from the agriculture sector to non-agriculture
sector may create a problem in sparsely populated countries. In such countries, there is no
disguised unemployment and a transfer may actually reduce the agricultural production. So, in a
less populated country, the movement of labour from the agriculture sector to non-agriculture
sector must be preceded by the increase in overall agricultural productivity. Kuznet has added
another economic dimension to the movement of labour from the agricultural sector to non-
agriculture sector. He iterates that transfer of labour means the transfer of capital invested in the
agricultural labour.
2) Product contribution:
a) Provision of wage goods: When other sectors of the economy develop, people move from the
primary sector to other sectors of the economy for better employment. The demand for the food
grain will increase resulting from increasing income for the other sector employees. At the same
time the demand for the food grain also increases because the income of those engaged in
 agriculture also increases. This happens because of the increase in prices of agricultural
commodities they produce. Thus, provision of wage goods is the most important contribution of
the agriculture sector to the other sectors. With the development of the economy the dependence
on the agriculture for the labour, capital and industrial raw materials are reduced. But the
dependence on raw material will remain intact unless the scientific innovation makes it possible
for provision of synthetic food.
b) Provision of industrial raw materials: Another important contribution to the non agriculture
sector and especially to the development of the industrial sector is provision of raw materials to
the industries. Historical evidence suggests that agro - based industries were first to develop in
the advanced economies. Agro - based industries were easier and economical to develop since
they are flexible in the sense that the labour can be adjusted without investing much on training
and the capital required to invest is in limited supply in the initial stages of development.
3) Market Contribution
This contribution covers following activities:
a) Market for the products of other sectors: Agriculture sectors provide not only the inputs
important for the development of the non-agriculture sector, but also the market for the other
sectors growing production. As we have seen that in the initial stage, most of the income is
generated in the agriculture sector so the demand for most of the goods and services also comes
from the agriculture sector. In countries like India, where a considerable part of the population
depends on agriculture, the demand for the industrial and service products very much depends
on the growth of the agriculture sector.
(b) Flow of agricultural product to other sectors of the economy: As agriculture develops and its
production becomes more market oriented, many other institutions generally non-agriculture in
nature, come into existence. They include services like packaging, processing, and distribution.
Agriculture development provides the necessary inputs and consumer goods while promoting the
development of the industrial sector. In return, the developed industrial sector helps the
development of agriculture sector through modern technology and an expanded market for the
agricultural products.
(c) Development of international trade: The agricultural surplus products can move into the
international markets after meeting the domestic market needs. In this way, agriculture connects
the domestic market with the international market through the surplus. This international
 movement of agriculture products helps the country in question to earn valuable foreign
exchange and brings the capital most needed for the investment.
You have learnt the sectoral contribution of the economy, agriculture and economic development
and role of agriculture in economic development of a country. Let us now learn the importance
of agribulture in India’s national economy.

11.5 IMPORTANCE OF AGRICULTURE IN INDIA’S NATIONAL ECONOMY

As we stated earlier, agriculture is the mainstay of India’s economy. Its importance to the
national economy can be gauged from the following facts:
1. Agriculture as a source of employment: As reproduced in Table 3, agriculture is the
largest employer in India. The proportion of the workforce employed in agriculture has come
down in the course of time, but it is still the single largest employer in the country. About 42 per
cent of the workforce is engaged in agriculture in India according to the latest government
figures.
In the western developed countries like the United States of America and United Kingdom, a
meager 2 to 3 per cent of the working population is employed in agriculture. Even Australia and
New Zealand which have a well developed agriculture employ a miniscule part, less than 10 per
cent of its working population in agriculture.
2. Contribution to national income: When India got independence in 1947, agriculture
contributed more than fifty per cent of India’s national income. Since then, there has been a
consistent net decline in the agriculture’s contribution to national income which is depicted in
Table 2. The share of agriculture in GDP increased to 19.9 per cent in 2020-21 from 17.8 per cent
in 2019-20. Following 2003-04, the share has remained between 17 and 19 per cent.“The growth
in GVA (gross value added) of agriculture and allied sectors has been fluctuating over time.
However, during 2020-21, while the GVA for the entire economy contracted by 7.2 per cent,
growth in GVA for agriculture maintained a positive growth of 3.4 per cent,” according to the
Economic survey,2020-21. The share of agriculture in the national income is regularly used as an
indicator of economic development.
The the share of agriculture in the national income of the developed countries has become very
low and the sector contributes only between 2 to 3 per cent of their national income. It suggests
that as a country develops, the significance of agriculture as a source of employment and income
declines.
3. Supply of food to the expanding population:India is the second largest populated
country in the world and according to the United Nations Population Fund (UNPF), India will
surpass China as the most populated country in the world. Agriculture in India is facing the twin
challenges of supplying food grain to a large and growing population. Further, the demand for
food will increase in the course of time with increase in income. In other words, income elasticity
of demand for food in a developing country is high. According to Ramesh Chand (member NITI
Aayog), domestic demand for food grain is expected to increase from 207 million tonnes in 2004 -
05 to 235.4 million tonnes by the end of eleventh five year plan and further to 280.6 million
tonnes by the end of 2020-21.

Thus, combined with the growth in per capita income and urbanization, the demand for food
grain and specially the high value crops will increase in future. That would be another challenge to
meet for India’s agriculture given the shrinking land size and climatic variability.

4. Provision of raw materials to industries: Agriculture provides raw materials to various

industries of national importance. Sugar industry, jute industry, cotton textile industry are
examples of some such industries which completely rely on agriculture for their inputs. Further,
the entire range of food processing industries is similarly dependent on agriculture for supply of
raw materials. So, development of agriculture is sine qua non for development of the industries
dependent on agriculture. Agriculture is the main support for India’s transport system, since
railways and roadways secure bulk of their business from the movement of agricultural goods.
India’s internal trade is mostly in agricultural products.
5. Poverty eradication: Agricultural growth has a direct impact on the poverty eradication
and has special powers in reducing poverty across all country types. According to a World Bank
Study (2008), the GDP growth originating in the agriculture sector is at least twice as effective in
reducing poverty as GDP growth originating outside agriculture. In China, the growth in
agriculture GDP was 3.5 times more effective in reducing the poverty; for Latin America, it was
2.7 times more. In India and China, according to the World Bank, following the green revolution
and market liberalization, rapid growth in the agriculture sector was seen which resulted in a
drastic reduction in the proportion of the population living under the poverty line.
6. Importance in global trade: When India got independence in 1947, in spite of the bulk
of the population working in agriculture sector, the country was not self sufficient in agriculture
production. The country heavily relied on the imports to feed its growing population. The
condition changed soon after the success of the green revolution. The country has now become
self sufficient in food grains and exports them as well. According to a WTO report (2021), India
became one of the top 10 exporters of the agricultural products in 2019 with a considerable share
in export of rice, cotton, meat and soya bean. India’s share in global agri export was 3.7% in 2019
and India has overtaken Thailand as the largest exporter of rice in 2019. India is also the third-
largest cotton exporter (7.6%), and the fourth-largest importer (10%) in 2019. In the largest traded
agri product, soya beans, India (0.1%) has a meager share, but was ranked ninth in the world. In
the “meat and edible meat" category, India was ranked eighth in the world with a 4% share in
global trade. The above facts state the story of India’s successful transition from ‘ship to mouth’
situation to top ten agricultural exporters in the world.
Check Your Progress B
1. Name three types of contributions of agriculture to the economic growth.
2. Name three Indian industries to which agriculture provides raw material.
3. Explain the concept of green revolution.
4. Which of the following statements are True or False?
i) Agriculture generates the necessary funds for the other sectors.
ii) Agro-based industries were first to develop in the advanced economies.
iii) Agricultural growth has a direct impact on the poverty eradication.
iv) In 1947, India was self-sufficient in agriculture production.
v) India became one of the top 10 exporters of the agricultural products in 2019.

11.6 LET US SUM UP

“Everything else can wait, but not Agriculture”, the first prime minister of India, Pt. Nehru said
while addressing a group of farmers. India’s economy on the eve of Independence was
predominantly rural and agrarian in nature with more than 85 per cent of the population living in
villages and most of them were dependent on agriculture for their livelihood. In spite of a large
proportion of workers employed in agriculture (70%) and the country was not self sufficient in
food and raw materials for the industry. Since then a systemic and significant decline in the share
of agriculture sector in the nation’s GDP was observed. Its place has been taken over by the
industrial and service sectors, particularly the service sector which now shares more than 50 per
cent of the national income.
Kuznet (1968) has identified three important contributions which agriculture makes to the
economic growth of an economy, viz. factor contribution, product contribution and market
contribution. Agriculture dominates low-income developing countries, where 60-70 per cent of
the population depends on agriculture for their sustenance. Its growth in large part dictates the
growth of their GDP. Agriculture is the largest employer in India. The proportion of the workforce
employed in agriculture has come down in the course of time, but its still the single largest
employer in the country. About 42 per cent of the workforce is engaged in agriculture in India
according to the latest government figures. The share of agriculture in GDP increased to 19.9 per
cent in 2020-21 from 17.8 per cent in 2019-20. Agriculture in India is facing the twin challenges
of supplying food grain to a large and growing population and at the same time, the demand for
food will increase in the course of time with increase in income.
Agriculture provides raw materials to various industries of national importance. Sugar industry,
jute industry, cotton textile industry are examples of some such industries which completely rely
on agriculture for their inputs. Agricultural growth has a direct impact on the poverty eradication
and has special powers in reducing poverty across all country types. According to a World Bank
Study (Year?), the GDP growth originating in the agriculture sector is at least twice as effective in
reducing poverty as GDP growth originating outside agriculture. According to a WTO report
(2021), India became one of the top 10 exporters of the agricultural products in 2019 with a
considerable share in export of rice, cotton, meat and soya bean. The above facts state the story of
India’s successful transition from ‘ship to mouth’ situation to top ten agricultural exporters in the
world.

11.7 KEY WORDS

Agriculture: The occupation concerned with cultivating land, raising crops, and feeding,
breeding, and raising livestock.
 Economic Development: The increase in the production, distribution, and use of income,
wealth, and commodities.
Disguised Unemployment: Concealed fact about the actual percentage of people not having
appropriate means of earning livelihood.
Primary sector: The area of priorotised necessity.

11.8 ANSWERS TO CHECK YOUR PROGRESS

A 4 i) True, ii) True, iii) False, iv) True, v) True
B 4 i) True, ii) True, iii) True, iv) False, v) True

11.9 TERMINAL QUESTIONS

1) Discuss the importance of agriculture in India’s economy. Describe its contribution to the
national economy.
2) How does agriculture play a dominant role in the development of an economy? Explain.
3) What do you mean by structural transformation of an economy? Does Indian economy
follow complete structural transformation? Discuss with examples.
4) What are the important contributions that agriculture makes according to Simon Kuznet?

FURTHER READINGS
Ramesh Chand, “Demand for Foodgrains”, Economic and Political Weekly, December 29,2007.
Kapila Uma, Economic Development and Policy in India, Academic Foundation, New Delhi,
2009-10.
Soni, R.N, Leading issues in Agriculture economics
Witt,L.(1965), “Role of Agriculture in economic development,: A Review” journal of Farm
Economics, Feburary, 1965.
Kuznet, S.(1965), Economic Growth and structure, Oxford and IBH Publishing Co., New Delhi.
Government of India; Economic Survey-various issues.
UNIT 12: PRODUCTIVITY IN INDIAN AGRICULTURE

Structure
12.0 Objectives
12.1 Introduction
12.2 Productivity in India’s Agriculture
12.2.1 General Causes
12.2.2 Institutional Causes
2.2.3 Technological Factors
12.3 Measures to Raise Productivity in Indian Agriculture
12.3.1 Reduction in the Pressure of Population on Land
12.3.2 Agriculture Research and Extension
12.3.3 Agriculture Marketing
12.3.4 Ever Green Technology
12.4 Let Us Sum Up
12.5 Key Words
12.6 Answers to Check Your Progress
12.7 Terminal Questions

12.0 OBJECTIVES
After reading this unit, you should be able to

• describe major food crops in India

• explain India’s position in world agriculture

• describe different reasons of low agricultural productivity in India

• explain measures for raising agricultural productivity in Indian agriculture

12.1 INTRODUCTION
With a population of 1.30 billion, India is the world's second most populous country. It is the
seventh largest country in the world with an area of 3.288 million sq kms. It has a long coastline
of over 7,500 kms. With the highest mountain range in the world, the Himalayas to its north, the
Thar desert to its west, the Gangetic delta to its east and the Deccan Plateau in the south, the
country is home to vast agro-ecological diversity. India is the world's largest producer of milk,
pulses and jute, and ranks as the second largest producer of rice, wheat, sugarcane, groundnut,
vegetables, fruit and cotton. It is also one of the leading producers of spices, fish, poultry,
livestock and plantation crops.

While agriculture’s share in India’s economy has declined to 20% in 2021, it was once
consistently declined to 15 % in 2010-11 then improved to current level, due to the high growth
rates of the industrial and services sectors. The sector’s importance in India’s economic and
social fabric goes well beyond this indicator. First, nearly three-quarters of India’s families
depend on rural incomes. Second, the majority of India’s poor (some 770 million people or about
70 percent) are found in rural areas. Third, India’s food security depends on producing cereal
crops, as well as increasing its production of fruit, vegetables and milk to meet the demands of a
growing population with rising incomes. To do so, a productive, competitive, diversified and
sustainable agricultural sector will need to emerge at an accelerated pace1.

Agriculture, with its allied sectors, is the largest source of livelihoods in India. Seventy percent
of its rural households still depend primarily on agriculture for their livelihood, with 87 percent
of farmers being small and marginal. In 2020-21, total food grain production was estimated at
305.44 million tonnes (MT) (Advance Estimate). India is the largest producer (25% of global
production), consumer (27% of world consumption) and importer (14%) of pulses in the world.
India's annual milk production was 165 MT (2017-18), making India the largest producer of
milk, jute and pulses, and with the world's largest cattle population 303 million in 2020.India's
cattle inventory amounted to over 303 million in 2020. While the global cattle population stood
at over 987 million, India had the highest cattle population, followed by Brazil, the United
States, and China that year. It is the second-largest producer of rice, wheat, sugarcane, cotton and
groundnuts, as well as the second-largest fruit and vegetable producer, accounting for 10.9% and
8.6% of the world fruit and vegetable production respectively2.

As per “Third Advance Estimates” for 2020-21, total Food grain production in the country is
estimated at record 305.44 million tonnes, which is higher by 7.94 million tonnes than the
production of food grain of 297.50 million tonnes achieved during 2019-20. Further, the
production during 2020-21 is higher by 26.66 million tonnes than the previous five years’ (2015-
16 to 2019-20) average production of food grain.

1
World Bank,2019.
Table 1 Production of Major food crops in India (in million tonnes)
2020-21
Crop Season 2005-06 2010-11 2015-16 (Advance
Estimate)
Kharif 78.27 80.65 91.41 104.30
Rice Rabi 13.52 15.33 13.00 17.16
Total 91.79 95.98 104.41 121.46
Wheat Rabi 69.35 86.87 92.29 108.75
Kharif 12.16 16.64 16.05 20.95
Maize Rabi 2.55 5.09 6.51 9.29
Total 14.71 21.73 22.57 30.24
Kharif 105.01 113.73 119.56 139.87
Cereals Rabi 90.21 112.52 115.66 140.00
Total 195.22 226.25 235.22 279.87
Tur Kharif 2.74 2.86 2.56 4.14
Gram Rabi 5.60 8.22 7.06 12.61
Kharif 0.90 1.40 1.25 1.56
Urad Rabi 0.35 0.36 0.70 0.82
Total 1.25 1.76 1.95 2.38
Kharif 0.69 1.53 1.00 1.99
Moong Rabi 0.26 0.27 0.59 0.65
Total 0.95 1.80 1.59 2.64
Kharif 4.86 7.12 5.53 8.49
Total Pulses Rabi 8.52 11.12 10.79 17.09
Total 13.38 18.24 16.32 25.58
Kharif 109.87 120.85 125.09 148.36
Total Foodgrains Rabi 98.73 123.64 126.45 157.08
Total 208.60 244.49 251.54 305.44
Total Oilseeds Kharif 167.67 219.22 166.98 245.52
Rabi 112.11 105.57 85.53 120.13
Total 279.78 324.79 252.51 365.65
Sugarcane Total 2811.72 3423.82 3484.48 3927.97

Cotton # Total 184.99 330.00 300.05 364.92

Source: Ministry of agriculture and farmers' welfare.
# Lakh bales of 170kgs each.
The Table 2 shows the production of agriculture commodities in India from the triennium 2005-
06 to triennium 2020-21. The production of all the crops depicted in the table shows a
progressive increase in the output over the years. According to the ministry’s calculation, total
production of rice during 2020-21 is estimated at a record 121.46 million tonnes. It is higher by
9.01 million tonnes than the last five years average production of 112.44 million tonnes.
Production of wheat during 2020-21 is estimated at a record 108.75 million tonnes. It is higher
by 8.32 million tonnes than the average wheat production of 100.42 million tonnes.
Total pulses production during 2020-21 is estimated at 25.58 million tonnes which is higher by
3.64 million tonnes than the last five years’ average production of 21.93 million tonnes.
Total oilseeds production in the country during 2020-21 is estimated at a record 36.57 million
tonnes which is higher by 3.35 million tonnes than the production of 33.22 million tonnes during
2019-20. Further, the production of oilseeds during 2020-21 is higher by 6.02 million tonnes
than the average oilseeds production. Total production of sugarcane in the country during 2020-
21 is estimated at 392.80 million tonnes. The production of sugarcane during 2020-21 is higher
by 30.73 million tonnes than the average sugarcane production of 362.07 million tonnes.
Production of cotton is estimated at 36.49 million bales (of 170 kg each) is higher by 4.59
million bales than the average cotton production.

Table 2: India's Position in World Agriculture During 2016

Item India World % India's Next to

Share Rank
Russian
Federation,
1. Total Area ( Million
328.73 13490.08 2.44 Seventh Canada, U.S.A.,
Hectares)
China, Brazil,
Australia
Arable Land 156.46 1423.79 10.99 First
3. Crop Production ( Million
Tonnes)
( A): Total Cereals 297.85 2909.2 10.24 Third China, U.S.A.

Wheat 92.29 749.01 12.32 Second China

Rice( Paddy) 163.7 756.16 21.65 Second China

(B): Total Pulses 18.15 83.46 21.75 First

(C): Oilseeds

Groundnut( in shell) 7.46 44.91 16.62 Second China

 (D) Commercial Crops

Sugarcane 348.45 1861.18 18.72 Second Brazil

Tea 1.25 5.91 21.14 Second China

Jute 1.90 3.31 57.31 First

Tobacco Unmanufactured 0.78 6.40 12.23 Second China

4. Fruit & Vegetables

Production ( Million Tonnes)
(A): Vegetables Primary & 123.63 1229.51 10.06 Second China
Melons
(B): Fruits Primary 88.47 710.5 12.45 Second China
(excluding Melons)
(C): Potatoes 43.42 374.25 11.6 Second China

(D): Onion( Dry) 20.93 94.94 22.05 Second China

5. Livestock ( Million Heads)

(A): Cattle 186.04 1488.96 12.49 Second Brazil
(B): Buffaloes 112.57 199.39 56.46 First

(E): Goats 134.13 1025.64 13.08 Second China

6. Animal Products (Million

Tonnes)
(A): Milk Total 165.33 809.8 20.42 First

Source: Pocket Book of Agricultural Statistics, 2018

12.2 PRODUCTIVITY IN INDIA’S AGRICULTURE

India is primarily an agricultural country, as the sector provides livelihood to more than 50% of
the population and contributes nearly one fifth of the country’s GDP. However, India lags behind
many other countries as far as agricultural productivity is concerned. The reasons are several.
The agricultural productivity can be measured in two ways; a) productivity per hectare, and b)
productivity per labour. If we compare the productivity of the India’s agriculture with the rest of
the world, India lags behind not only the developed western countries but the developing
 countries as well. Some of the major causes behind the low productivity of Indian agriculture are
discussed below:

India’s yield per hectare for rice and wheat is low if we compare with the BRICS countries. If
India’s yield rates for the two crops are at China’s levels, it can double our yields or halve the
land used for the purpose. At present, India produces 106.19 million tonnes of rice a year from
44 million hectares of land. That is a yield rate of 2.4 tonnes per hectare, placing India at 27th
place out of 47 countries. China and Brazil have yield rates of 4.7 t/ha and 3.6 t/ha, respectively.
If Indian agricultural productivity was at these rates, we could produce 205.52 million tonnes and
160.01 million tonnes of rice, respectively. Egypt leads the world in rice yields—at Egypt’s yield
rate, India could almost triple its rice output. As far as wheat is concerned, India has a higher
yield rate than for rice, but it still lags a large part of the world. India’s yield rate of 3.15 tonnes
per hectare for wheat places it 19th out of 41 countries. Here, India does better than Brazil’s
yield rate of 2.73 tonnes per hectare, but lags behind South Africa (3.4 t/ha) and China (4.9 t/ha).
If India’s wheat productivity is at these countries’ levels, it would be producing 101.22 million
tonnes and 147.53 million tonnes of wheat, respectively. New Zealand has the highest
productivity of wheat in the world. If India produces wheat at the rate at which New Zealand
does, then it can produce 2.5 times more than what it produces. This is not to say that Indian
agricultural productivity in wheat and rice has not improved over the years. Yield rates in wheat
have grown at a compounded annual growth rate of 1.8% from 1983 to 2013 and in rice by
1.71% over the same period. These are not particularly slow growth rates. The improvement in
yield rates for rice would place it at number 13 in the world while that in wheat would peg it at
14th rank3.

12.2.1 General Causes

a) Demographic Factors: As we know India is second most populated country in the world and at
the present rate of growth of population the country will very soon overtake China as the most
populated country. With the increasing pressure of the population on land, the average
landholding in the country is consistently decreasing and the size of average land holding
declined from 2.1 hectares in 1970-71 to 1.15 hectares in 2010-11 to 1.08 hectares in 2015-
16.Small and marginal farmers with less than two hectares of land account for bulk of all farmers
in India, but own about half of the crop area, according to provisional numbers from the 10th
Agriculture Census 2015-16. The survey showed that while Indian farms became more
fragmented between 2010-11 and 2015-16, holdings continue to be inequitably distributed. The
increasing pressure of population on land is partly responsible for the subdivision and
fragmentation of holdings resulting in low productivity. We expect that in the course of time, the
economic growth in the country will open new job opportunities in the non agricultural sectors.
In India this has not happened and the employment in the manufacturing sector for the last three
decades is stagnant, employing less than one fifth of the workforce. Thus, the increasing pressure

3
The Mint, 9th September,2014
 of the population is directly falling to the agriculture sector resulting in consistent decline in the
size of the holding and low productivity.
b) Social Environment: The social environment of the villages is regarded as one of the major
hindrances to the development of Indian agriculture. It has been observed that in general the
Indian farmers are illiterate, superstitious, conservative and do not respond to the new and
modern agricultural techniques. Again the working conditions as well as the health conditions
are very poor and it has lessened the productive capacity of the farmers.

12.2.2 Institutional Causes

a) Land Tenure System: Zamindari system has been an important factor responsible for the low
productivity of Indian agriculture, the form of land tenure system which India inherited from the
colonial powers. The zamindari system was highly exploitative in character and ruined the
capacity, willingness and enthusiasm of the cultivators to increase the production and
productivity. In this system the cultivator is not the owner of land. Zamindar is the owner of
land and he can evict the tenant at any time. So the cultivator does not take interest in the
development of land and Zaminder does not take an interest in the development of cultivation.
Though the zamindari system was abolished after independence, yet the position of the cultivator
has not improved. Legislation passed after the independence of the country for the abolition of
intermediaries did not break the stronghold of the zamindars and it only changed the
nomenclature from the “zamindars” to big landlords. Moreover, the land reforms carried out in
the country in the post reform period did not make any significant changes in the stronghold of
the zamindars in the rural areas and except few states like West Bengal, Kerala and Jammu
Kashmir, the reforms failed miserably. Regulation of rent, security of tenure, ownership rights of
tenants did not make much aspired changes in the tenant’s life, they are still at the mercy of big
landlords.
b) Uneconomic Holding: As discussed in demographic factors, according to National Sample
Survey (NSS), since the first agriculture census over 45 years ago, the number of farms in India
has more than doubled from 71 million in 1970-71 to 145 million in 2015-16. The average farm
size more than halved from 2.28 hectares (ha) to 1.08ha.Between 1970-71 and 2010-11, the
number of farms increased by 194%, almost exactly in line with the rural population, which
increased by 189%. In India as per latest NSS report, small and marginal farmers with less than
two hectares of land account for 86.2% of all farmers in India, but own just 47.3% of the crop
area. At the same time, semi-medium and medium land holding farmers owning between 2-10
hectares of land account for 13.2% of all farmers, but own 43.6% of the crop area. During this
period the proportion of small and marginal farmers grew from 84.9% to 86.2%, while the total
number of operational holdings grew from 138 million to 146 million. The total area under
farming, however, fell from 159.6 million hectares in 2010-11 to 157.14 million hectares in
2015-16.Between 2010-11 and 2015-16, the number of small and marginal farms rose by about 9
million. Further, these 126 million farmers together owned about 74.4 million hectares of land —
or an average holding of just 0.6 hectares each—not enough to produce surpluses. Thus, a
 booming small and marginal farmers and consistent decline in the farm size makes Indian
agriculture uneconomic and less productive.

c) Inadequate Marketing and Credit Facilities:

i) Inadequate/Improper Warehouses: There is a near absence of proper warehousing facilities in

the villages. This compels the farmers to store their produce in pits and mud vessels. Such
unscientific methods of storage lead to considerable losses of produce by wastage. Absence of
adequate storage in villages forces farmers to sell the crops in one go that creates an abundant
supply yielding low and un-remunerative prices to the producers. The large producers may have
the capacity to arrange required storage facilities. The small producers do not have storage
facilities. While the setting up of central and state warehousing facilities has improved the
situation to some extent, there is every need to expand the facilities much more on this front.

ii) Lack of Grading and Standardization: The practice of selling graded items which can fetch
better return is missing among the small farmers. The common practice is to sell them in heaps
of one lot with items of different qualities mixed up. The low returns received as a result of this
practice do not induce the farmers to adopt better methods and practices for producing quality
products.

iii) Inadequate Transport Facilities: Good road connectivity to transport the produce to Mandi
(the places where produce are sold in bulk) with adequate motorized transport facilities is a must.
The practice in India, particularly for small farmers, is to transport their goods in bullock carts.
The feasibility to transport items to far off places is greatly constrained by this means of
transportation.

iv) Presence of Large Number of Intermediaries: As we have seen above, the length of
marketing channel is not small or optimum to realise maximum returns to the producers. The
situation is particularly adverse due to number of intermediaries or middle men operating in the
names of village traders, kutcha/pucca arhtiyaas, brokers, wholesalers, retailers, money lenders,
etc. A number of middle men in the marketing of agri produce leads to a situation where in both
the producers and consumers are at receiving end and a good part of margin goes to the middle
man. Empirical evidences suggest that the marketing margin varies for different commodities
and farmers receives only 30 to 25 percent of the consumer price.

v) Inadequate Market Information: Very often, farmers do not get the right information about
prices in the markets. Taking advantage of this ignorance on the part of farmers, middlemen take
undue benefit of the situation. The situation is changing with the government making use of
media like radio, newspapers, etc. to announce and disseminate information on prices in markets.
However, there are problems of time lag and the consequent less reliable information reaching
the sellers. This leads to traders often paying less than the prices quoted by the government in the
news media.
vi) Inadequate Credit facilities: The farmers need credit for various purposes like purchase of
seeds, fertilizers, irrigation, etc. In India the scope of formal institutional lending has been
limited and curtailed in post liberalization period. At the same time, many formalities are
associated with formal credit institutions so farmers rely on the informal sources like money
lender and Mahajan who not only charge exorbitant interest rate but they also indulge in many
malpractices. This exorbitant interest and unscrupulous practices adopted by informal credit
sources are a major reason behind the farmer suicide in India. According to P.Sainath, a veteran
journalist, in India every four hours a farmer kills himself. Timely provision of credit is must for
the efficient and sustainable agriculture.

12.2.3 Technological Factors

The following technological factors are also responsible for low agricultural productivity in
Indian agriculture:

(a) Traditional Methods of Cultivation: The farmers in India have been adopting orthodox and
inefficient methods and techniques of cultivation. As they are tradition bound and poor, thus they
could not adopt modern, efficient methods adopted by western countries of the world. These
farmers were relying on centuries old wooden plough and other implements. It is only in recent
years that the Indian farmers have started to adopt improved implements like steel ploughs, seed
drills, harrows, hoes etc. to a limited extent only. Thus, Indian agriculture is dualistic in nature
wherein the developed regions of the country, Punjab, Haryana and Western Uttar Pradesh apply
the most sophisticated technology used by their counter parts in the western developed
countries. On the other hand in most of the country’s hinterland farmers are using the traditional
methods used by their fore father resulting in low productivity. Thus, Indian agriculture is
traditional and therefore, productivity is low.

(b) Lack of High Yielding Seeds: Indian farmers are still using seeds which are not of good
quality. In the post green revolution period, the use of high yielding varieties of seeds increased
substantially resulting in a considerable increase in the productivity. But the use of high yielding
varieties of seeds is limited to irrigated areas of the country. Still a large number of farmers use
low quality seeds resulting in low productivity.

(c) Lack of Fertilizer: Fertilizer consumption measures the quantity of plant nutrients used per
unit of arable land. Fertilizer products cover nitrogenous, potash, and phosphate fertilizers
(including ground rock phosphate). Traditional nutrients--animal and plant manures--are not
included.

Indian farmers are not applying sufficient quantity of fertilizers on their lands. Constant
cultivation of land causes deterioration of the fertility of soil. For the revitalization of soil
fertility and to use fallow land for cultivation, application of various types of fertilizer is
indispensable. The use of fertilizers in India increased after mid 1970’s, but is still confined to
few agriculturally advanced regions of the country. As of 2018, fertilizer consumption in Hong
Kong was 3,573.9 kilograms per hectare. The top 5 countries also include Malaysia, Bahrain,
New Zealand, and Ireland. India with 175 kg per hectares was ranked 45th according to the world
bank data. Thus, the fertilizers used per hectare is very low compared to the world standards.

(d) Inadequate Irrigation Facilities: Water is the most critical input for enhancing agricultural
productivity, and therefore expansion of irrigation has been a key strategy in the development of
agriculture in the country. The ultimate irrigation potential of India has been estimated to be
139.5 mha, comprising 58.5 mha from major and medium schemes, 15 mha from minor
irrigation schemes and 66 mha from groundwater exploitation. India’s irrigation potential has
increased from 22.6 mha in 1951 to about 90 mha at the end of 1995.An adequate and assured
water supply at the appropriate time is essential for increasing the yield of the crops. In India,
agriculture largely depends on the rainfall, which is mostly uncertain and unseasonable. Before
independence, only 19 per cent of the total land was irrigated in India. But in-spite of vigorous
programme of major and minor irrigation projects undertaken since 1951, currently about 45
percent of country’s cropped area is irrigated. This shows that 55 percent of cropped area is still
dependent on the rains. Rainfall is becoming erratic in India owing to the climate change and
variability in precipitation in the last twenty years has increased. This has resulted in droughts in
some parts of the country and excess rainfall and flood in other parts of the country. The
Country’s full irrigation potential is not wholly utilised because of defective management and
water cost is constantly increasing, thus, making farming difficult and costly for small farmers.

(e) Lack of pesticides: Farmers in India lose a considerable part of their produce to pests and
insects which eats the plants. According to a study by the Associated Chambers of Commerce
and Industry of India in 2015, annual crop losses due to pests and diseases amount to Rs.50,000
crore ($500 billion), which is significant in a country where at least 200 million Indians go to bed
hungry every night. About 30-35% of the annual crop yield in India gets wasted because of pests,
according to a research by Indian Council of Agriculture Research (ICAR) paper in 2017.The
use of pesticides and insecticides is still limited to a few areas and larger farms. Thus, over a
wider area, crops suffer much damage due to pests and insects resulting in lower output and low
productivity.

(f) Lack of Agricultural Research: Public spending on agriculture is one of the key policy
instruments of the government to promote growth and alleviate poverty in rural areas. Amongst
the various types of government spending, Agricultural Research and Education (R&E) is found
to be one of the most critical for promoting farm yields, which contributes towards augmenting
yield and thus income of the peasantry. According to Ashok Gulati, a renowned Agricultural
Economist, India spends about 0.7 per cent of its GDPA (2014-15) on aggregate agriculture
research, including education, extension and training (AgRE&XT) as against the recommended
level of 2 per cent of agri-GDP by the world Bank. Further, According to the Economic Survey
2017-18, the total R&D expenditure in India as a percentage of GDP has been stagnant at 0.6 to
0.7 per cent in the last two decades — much lower than the US (2.8 per cent), China (2.1 per
cent), South Korea (4.3 per cent) and Israel (4.2 per cent). Comparing India and China’s
spending on agricultural research and development, “Agriculture Science and Technology
Indicators (ASTI)” data reveal that India currently spends 0.30 per cent of agriculture GDP on
agricultural research, which is just half the share invested by China (0.62 per cent).
Thus, Productivity of most of the crops in the country is low and there is considerable scope to
raise it. Except wheat, productivity of most other crops in the country is below the world average
and much lower than agriculturally advance countries. Even, within the country there are large
variations in yield across states. A large variation in yield across states is due to variation in the
factors discussed above, even the variations are found in the states with the similar irrigation
coverage, productivity show significant variations due to poor level or low adoption of improved
technology.

Check Your Progress A

1. What are the main cereal crops in India?

2. List the main reasons for the low agricultural productivity in India.

3. What do you mean by technological reasons of low productivity?

4. Which of the following statements are ‘True’ or ‘False’?

i) Agriculture, with its allied sectors, is the largest source of livelihoods in India

ii) In wheat production, India’s rank in world is first.

iii) India’s yield per hectare for rice and wheat is low if we compare with the BRICS
countries.

iv) There are very good warehousing facilities in the villages in India. False

v) Indian farmers are not applying sufficient quantity of fertilizers on their lands

12.3 MEASURES TO RAISE PRODUCTIVITY IN INDIAN AGRICULTURE

There are two sources to increase agricultural output, i.e., area and productivity. Due to rising
demand for land for non agricultural uses and already high share of arable land in the total
geographical area of the country, further expansion in the area under cultivation is not feasible.
Rather, there is a decline of about 10 lakh hectares, as agricultural land has been diverted to non-
agricultural uses since the year 2004-05. Therefore, agricultural output has to be increased
through improvement in productivity per unit of land (Nitti Aayog,2017).

12.3.1 Reduction in the Pressure of Population on Land: Indian agriculture employs the
largest share of the workforce – about 42 percent in 2019 – though its share in the overall gross
domestic product (GDP) is only 20 percent in 2020. India is still largely a rural economy with 66
percent of the country’s population living in rural areas (World Bank, 2019). The proportion of
the workforce employed in the agriculture in India is very high from any standard. Thus, there is
utmost need to withdraw a part of the workforce from agriculture and provide them alternative
employment outside agriculture, which would help reduce the pressure on agriculture and
consequently improve the productivity. Over the last four decades, the absolute number of
workers in India has increased from 180.7 million in 1971 to 481.7 million in 2011, indicating an
addition of close to 6 million workers to the workforce every year (Census of India, various
issues). Moreover, the absolute number of workforce employed in the agriculture sector has
increased from 125.7 million to 263.1 million during the same period, though in terms of
percentage, this share has declined from 66.5 percent in 1981 to 42.3 per cent in
2019(Gulati,2019). According to Gulati, raising labour productivity will require raising land
productivity by (a) pumping in more capital; (b) creating employment opportunities in off-farm
jobs such as food processing, cold storages, construction sector; (c) skill formation; and (d)
‘diversification’ towards high value agricultural activities such as dairy farming, poultry rearing,
horticulture and fisheries.

12.3.2. Agriculture Research and Extension: As we have seen the expenditure made by the
Government of India for agricultural research and extension is very low as compared to other
countries. An increase in the expenditure on agriculture knowledge and innovation systems is an
important factor in the improvement of productivity of the agricultural sector in India. In a study
conducted by Gulati and Terway (2018) on the impact of investment and subsidies on
agricultural GDP growth and poverty reduction, it was estimated that for every rupee invested in
agricultural research and education (R&E), agriculture GDP increases by INR 11.2. Moreover,
for every million rupees spent on agricultural R&E, 328 people are brought out of poverty. The
study confirms the return from per rupee spent on agriculture research is highest. It shows that
every rupee spent on agricultural research and development yields better returns (11.2),
compared to returns on every rupee spent on fertilizer subsidy (0.88), power subsidy (0.79),
education (0.97) or on roads (1.10).In India, over the years, the ratio of expenditure on
agricultural knowledge and innovation systems as a percentage of agricultural gross value added
(GVA) improved from 0.38 percent in 2000/01, touched 0.64 percent in 2010/11 but fell back to
0.35 percent in 2018/19.Therefore, in order to improve the sector’s total factor productivity,
India needs to invest more in agricultural R&E (Gulati and Gupta, 2019).

12.3.3 Agricultural Marketing: Agricultural Marketing is riddled with the middlemen who
sucks the benefits accruing to the farmers and end consumers. Some of the reforms in the
marketing suggested by experts are discussed below4, which are essential for improving the
productivity in the agriculture sector.

a) Uniform Mandi fees: These fees now range from 0.5% to 5% on the value of sale, while
varying across states and commodities. It is proposed that a uniform Mandi fee of 0.25% or
0.50% be levied nationwide for foodgrain, oilseeds and fruits & vegetables. The consequent
losses to APMCs may be compensated by the Centre and state governments, as in the case of the
Goods and Services Tax.

4
“Reform 2.0: focus must shift from agricultural production to marketing”, Indian Express, 27thjune, 2019.
b) Abolish Mandi fees on inter-state trade: Charging Mandi on produce brought to a state
from other states (where it would already have been levied) amounts to double taxation, besides
violating the idea of a single national market. The practical difficulty is to verify whether the
commodity has actually come from another state, as traders sometimes use this route to pass on
their unaccounted stocks. A way out is to make e-way bills mandatory for all inter-state trade and
Mandi fee exemptions be given only against these.

c) Eliminate Arthtiya-based trading: All trades in APMCs should be through open

auctioning, involving multiple bidders for each lot. Such trades should be directly between
buyers and sellers, with no middlemen charging commission. The arthtiya can participate only as
a trader. The farmer should have total freedom to sell his produce at the farmgate, haat, APMC
yard, private markets, deemed markets (warehouses/cold storages) or e-trading platforms.

d) Storage and banking facilities near APMCs: At Mandis the lowest prices are during
the 3-4 post-harvest months and highest in the immediate pre-harvest period. Farmers undertake
maximum sales just after harvest, as they need to purchase inputs for the next sowing season.
Such distress sales can be avoided if facilities for bagging and storage, along with loans against
warehouse receipts, are available to meet immediate cash requirements. These should exist in the
vicinity of APMCs. When farmers have the choice to sell or store their crop, it will force traders
to pay the actual value of produce based on quality.

e) Promote Farmers Producers Orgainisation (FPOs) in marketing: Producer

organisations/companies should be encouraged to take up direct marketing of their members’
produce to large buyers and processors. Besides, they can be given mandi to trade in APMCs.
There are some FPOs that do such trading; it has been found to result in more competition and
better prices at APMCs.

f) Relax/abolish Essential Commodities Act: Increased production, liberalised imports

and food inflation well under control, restrictions on stocking, movement and export of farm
produce have become redundant. The dismantling of such controls under ECA and other
regulations would expand trade and lead to better realisations for cultivators.

g) Common e-NAM trading licence: Electronic National Agriculture Market (e-NAM)

online trading platform has helped connect 585 APMCs across India. The ground reality,
however, is that much of trading in e-NAM is still being done by traders within the same mandis.
The reason is the individual licencing system adopted by each APMC. What is needed is a
common licence valid across all e-NAM APMCs. This can be issued with a rider that the trader
will deposit upfront the margin money/funds in any APMC where he wishes to undertake
physical buying on any given day. An e-wallet or plug-and-play facility of this kind will multiply
the number of buyers and meet the e-NAM’s primary objective of promoting better price
discovery.

12.3.4 Ever Green Technology: The chemicals induced technology known as green revolution
has made India self sufficient in food grains. The application of new technology in mid 1960’s
not only eliminated India’s dependence on imports for feeding the ever increasing population,
but also increased the productivity of the crops by leaps and bounds. The productivity of rice and
wheat recorded high growth owing to the application of new technology. The major problems
associated with Green Revolution are related to environmental factors like depletion and
pollution of groundwater, soil erosion and loss of biodiversity. The chemical technology was not
carbon neutral, the excessive use of chemicals; fertilizers and pesticides resulted in a number of
environmental problems. As a result gain in productivity achieved through the new technology
has reached a plateau. More than that chemical based technology is not sustainable knowing
agriculture is one of the largest users of water in India and the largest polluter of the environment
worldwide. Owing to the resource and technology constraints in India, the chemical technology
cannot be the solution to increase the productivity and meet nutrition security in India. Hence
scientists and the government of India have come up with the concept of ‘evergreen revolution’;
which implies productivity improvement in perpetuity without social and environment harm. The
evergreen revolution involves the integration of ecological principles in technology development
and dissemination.
The Green Revolution transformed the image of India from being a ‘begging bowl’ to ‘bread
basket’. However, to rectify flaws and loopholes of the Green Revolution, the country needs to
make it evergreen. Though India is now self-sufficient in many aspects of food production, it still
relies on imports for crops such as pulses and oilseeds, where production has not kept pace with
demand.
Dr.M.S.Swaminathan, who coined the term “Evergreen Revolution” to highlight the pathway of
increasing production and productivity in a manner such that short and long term goals of food
production are not mutually antagonistic. The logic is to produce more from less--less land, less
pesticide, less water and it must be an evergreen revolution to get sustainable agriculture.
Introducing Indian farmers to innovative information and communication technologies (ICT) can
enhance farm productivity. ICT initiatives can tackle key challenges in the agricultural value-
chain through networking on weather alerts, the sowing period, and the prices of produce.
According to the ICAR in the dry areas, dry lands produce half the country’s cereals, 77 per cent
of its oilseeds and 85 per cent of its pulses. Implementation of new and efficient irrigation
methods, better watershed management and maintenance of vegetation cover in catchment areas
and development of drought-tolerant crop varieties is required to optimise water utilisation.
GM food crops are also critical for enabling the success of evergreen revolution. These crops
have been proven to significantly improve yield through high levels of disease and pest
resistance, improved weed management, abiotic stress tolerance and nutrient-use efficient crops.
For example approval and promotion of Bt.Mustard helps us to reduce the edible oil imports and
improve Indian economy as well as provide nutrition.
With increase in population, there is a dire need to increase food grain production at a rapid pace.
The challenge lies in producing more with less resources. Only increased productivity which is
ecologically sustainable can ensure higher production of Foodgrains. Food security involves an
increase in food grain production and distribution which is accessible and affordable. Stagnation
of food grain production is the biggest concern of recent time. Evergreen revolution is the need
of the hour.

Check Your Progress B

1. How has the workforce in agriculture in India changed during the last three decades?
2. Name three measures of agriculture marketing which can help in raising agricultural
productivity.
3. What is ‘Ever Green Technology’?
 4. Which of the following statements are ‘True’ or ‘False’?

i)There has been a decline of about 10 lakh hectares as agricultural land since the year
2004-05.

ii) The farmer should have total freedom to sell his produce at any place of his choice.
iii) The Green Revolution transformed the image of India from being a ‘begging bowl’ to
‘bread basket’.
iv) India has invested sufficient funds in the agricultural research.
v) Only increased productivity which is ecologically sustainable can ensure higher
production of foodgrains.

12.4 LET US SUM UP

India is primarily an agricultural country, as the sector provides livelihood to more than 50% of
the population and contributes nearly one fifth of the country’s GDP. However, India lags behind
many other countries as far as agricultural productivity is concerned. India’s yield per hectare for
rice and wheat is low if we compare with the BRICS countries. If India’s yield rates for the two
crops are at China’s levels, it can double our yields or halve the land used for the purpose. At
present, India produces 106.19 million tonnes of rice a year from 44 million hectares of land.
That is a yield rate of 2.4 tonnes per hectare, placing India at 27th place out of 47 countries.
There are several reasons for this, which include demographic factors, Social Environment, Land
Tenure System, Inadequate/Improper Warehouses, Uneconomic Holding, Inadequate Transport
Facilities, Presence of Large Number of Intermediaries, Inadequate Market Information,
Inadequate Credit facilities and several Technological Factors.

Therefore, agricultural output has to be increased through improvement in productivity per unit
of land (Nitti Aayog,2017). Several desirable measures have been suggested, such as Reduction in the
Pressure of Population on Land, Agriculture Research and Extension, Agricultural Marketing,
Uniform Mandi fees, Abolish Mandi fees on inter-state trade, Eliminate Arthtiya-based trading,
Storage and banking facilities near APMCs, Promote Farmers Producers Orgainisation (FPOs) in
marketing, and Ever Green Technology, etc.

12.5 KEY WORDS

BRICS countries: Group of Brazil, Russia, India, China and South Africa.

Ever Green revolution: The productivity improvement of foodgrains in perpetuity without

social and environment harm. The evergreen revolution involves the integration of ecological
principles in technology development and dissemination.
Green Revolution: Application of new technology based on increased use fertilizers, pesticides
and planned rotation of crops led to remarkable increase in agricultural productivity and made
India self sufficient in food grains. It was called ‘Green Revolution’.

Mandis: The market/place where trading of agricultural products is carried out.

e-NAM: Electronic National Agriculture Market is a platform where online trading of the
agricultural products can be done.

Social Environment: Different customs, traditions, etc. in a society.

Zamindari system: During the British rule in India, Zamindars were recognized as the owner of
the lands and were given the rights to collect the rent from the peasants. While the zamindars
became the owners of the land, the actual farmers became tenants. It was abolished after
Independence.

12.6 ANSWERS TO CHECK YOUR PROGRESS

A 4 i) True, ii) False, iii) True, iv) True, v) True
B 4 i) True, ii) True, iii) True, iv) False, v) True

12.7 TERMINAL QUESTIONS

1.What are the factors responsible for the low productivity of agriculture in India?
2. Describe various methods being implemented for improving agricultural productivity.
3. “The Green Revolution was a watershed in Indian agriculture” Elaborate.
4. What is the difference between the “Green Revolution” and “Ever Green Revolution”?
5. How middlemen can be eliminated in the trade of agricultural products?

FURTHER READINGS

1) Kapila, Uma, Economic Development and Policy in India, Academic Foundation (2009-10)
Edition, New Delhi.
2) “Reform 2.0: focus must shift from agricultural production to marketing”, Indian Express,
27th June, 2019.
3) NITI Aayog. 2018. Demand and Supply Projections Towards 2030: The Working Group
Report. New Delhi, NITI Aayog, Government of India.
4) World Bank. 2019. World Development Indicators. Washington, DC., The World Bank
https://databank.worldbank.org/source/world-development-indicators.

5) Gulati,Ashok and Juneja,2021, “Transforming Indian Agriculture”. Nitti Ayog, New Delhi.
UNIT 13 GROWTH PATTERN IN INDIA'S AGRICULTURE
Structure
13.0 Objectives
13.1 Introduction
13.2 India’s Agriculture during the first half of the 20th century –British period
13.3 India’s Agriculture in Post Independence Period
13.3.1 1950-51 to 1964-65: The Pre-Green Revolution Period.
13.3.2 1967-68 to 1979 -80: The Beginning of Green Revolution.
13.3.3 1980-81 to 1990-91: The Maturing of Green Revolution.
13.3.4 1990-91 to 2003-04:Economic Liberalization and Deceleration of Agricultural
Growth.
13.3.5 2004-05 to 2014-15: The Period of Recovery.
13.3.6 2014-15 to 2019-20: The National Democratic Alliance- II (NDA-II) Rule.
13.4 Challenges of Indian Agriculture
13.5 Policy Suggestions
13.6 Let Us Sum Up
13.7 Key Words
13.8 Answers to Check Your Progress
13.9 Terminal Questions

13.0 OBJECTIVES

After reading this unit, you should be able to

• compare the agricultural growth pattern of the post-independence era with that of the pre-
independence;

• explain challenges faced by Indian agriculture;

• outline the suggestions made by the experts.

13.1 INTRODUCTION
India’s agriculture has moved from very low, subsistent, ship-to-mouth situation to self-
dependent in the food grains and also a net exporter of the agricultural commodities in the recent
years. Today, India is the largest exporter of rice in the world. The main objective of this chapter
is to review the performance of Indian agriculture since independence. A brief analysis of the
performance of India’s agriculture in the first half of the 20th century is attempted in the first part
and a detailed in-depth analysis of the country’s agriculture post-independence is done in the
subsequent section. The policy recommendations to make the growth consistent and sustainable
have been made in the last section. India’s agricultural growth trajectory during the British
period, especially the first half of the 19th century, is very important for understanding the
growth in the rest of the post-independence period.

13.2 INDIAN AGRICULTURE DURING THE FIRST HALF OF THE

20TH CENTURY - BRITISH PERIOD

According to all the credible estimates, India’s growth performance during the first half of the
nineteenth century was not an impressive one. According to Sivasubraamonian, the growth rate
of the primary sector during the 1900-01 to 1946-47 was only 0.46% per annum (pa) which is
very low from any standard. The growth rate of the secondary sector and the tertiary sector
during the same period was higher than the primary sector. The economy did not show any
credible structural change and three-fourth of the work force was employed in the agriculture
throughout the 20th century. That is the reason why economists called the performance of the
Indian economy in the first half of the twentieth century as “Static Economy in Progress”.

Table 1. Growth Rates of GDP and per capita Income at 1993-94 Prices

Years GDP GDP Agr. Secondary Tertiary Per capita

Income

1900-47 1.05 0.46 1.82 1.66 0.22

1950-65 3.94 2.54 6.88 4.76 1.86

1967-80 3.44 2.04 4.23 4.54 1.23

1981-91 5.62 3.08 7.10 6.72 3.50

1992-04 6.10 2.38 6.29 8.22 4.21

1950-04 4.33 2.54 5.54 5.54 2.12

Source: Sivasubramonian, 2000 and National Accounts Statistics,2004.

The growth rate of agricultural produce was miniscule. According to George Blyn’s estimate
prepared on the basis of 18 major crops during 1901-04 to 1940-44, agricultural output recorded
a growth rate of 0.262 pa at the 1925-29 prices. Similarly, as per Sivasubramonian’s extended
study of the princely states of India covering 25 instead of 18 crops using the 1938-39 prices
used by Blyn, the growth rate of total agricultural output was 0.41% pa during 1900-01 to 1946-
47. While foodgrains grew at 0.15% p.a., the growth of non-foodgrains was 0.77% pa. The
growth rate of population during that interval was slightly higher than the growth rate of the food
grains; hence the per capita availability of food grains declined during that time interval.

Table 2. Change in the Structure of GDP and Workers

% Share in GDP % Share in Workers

1900-01 to 1909-10 1940-41 to 1946-47 1900 1946
Sectors
Primary Sector 63.1 51.9 74.7 74.8
Secondary Sector 12 14.4 10.7 10
Tertiary Sector 24.9 33.7 14.4 15.1
Source: Sivasubramonian S. pp.469 & 477.

Further, the precarious condition of the economy in general and agriculture sector in particular
can be gauged from the structure of gross domestic product (GDP) and employment as depicted
in Table 2. At the advent of independence, the primary sector, mainly consisting of agriculture,
generated more than half of the national income and employed three-fourth of the work force. No
visible transformation in the economy during the first half of the 19th century has been observed,
resulting the economy one of the lowest per capita consumption and income in the world.The
first half of the 19th century in India can be better categorized as the period of near stagnation.

Table 3. Growth Rates: Pre-Independence Period in Per Cent Per Annum*

Area Yield Output
All Crops 0.4 Neg. 0.4
Foodgrains 0.3 -0.2 0.1
Non Foodgrain 0.4 0.09 1.3
*Pre-Independence Period: 1891 to 1946.
Source: Pre-independence period growth rates are exponential rates of growth based on the data from
George Blyn, "Agricultural Trends in India 1891-1974: Output, Availability and Productivity", University
of Pennsylvania Press, 1966.
Table 3 presents the growth rates of area, per hectare yield and aggregate output in the
agriculture sector in the pre-independence period. There is an obvious indication of stagnancy of
overall agricultural output, especially of foodgrains in the studied period. Yield improvements
are difficult to discern and the foodgrain yields appear to have had a negative trend. Historical
studies of agrarian change in the pre-Independence period clearly bring out the stagnancy-
inducing characteristics of the socio-economic and technological environment prevailing then.

13.3 INDIA’S AGRICULTURE IN POST-INDEPENDENCE PERIOD

India, at the time of independence, inherited one of the most backward agriculture. In spite of
having an overwhelming population dependent on the agriculture, the country was not self-
sufficient in the food grain production. The country had to depend heavily on imports to feed its
large and ever growing population. The agricultural economist Dr Ashok Gulati termed this
phenomena as “ ship-to-mouth”. The study of agriculture growth in India can be divided into five
phases, first four are named by another prominent agriculture economist, Prof. G.S.Bhalla, while
the period from the 2004-05 to 2014-15 has been named as period of recovery by Dr. Ramesh
Chand, member, NITI Aayog.

a) 1950-51 to 1964-65: The Pre-Green Revolution Period.

b) 1967 to 1979 -80: The Beginning of Green Revolution.
c) 1980-81 to 1990-91: The Maturing of Green Revolution.
d) 1990-91 to 2003 -04: Economic Liberalization and Deceleration of Agricultural Growth.
e) 2004-05 to 2014-15:The Period of Recovery
f) 2014-15 to 2019-20: The National Democratic Alliance- II (NDA-II) Rule.

Table 4. Growth Rate of GDP and Per Capita Income at 1993-94 prices

Years GDP Agriculture Secondary Tertiary Per capita

Income

1900-47 1.05 0.46 1.82 1.66 0.22

1950-65 3.94 2.54 6.88 4.76 1.86

1967-80 3.44 2.04 4.23 4.54 1.23

1981-91 5.62 3.08 7.10 6.72 3.50

1992-04 6.10 2.38 6.29 8.22 4.21

2004/05 - 7.7 3.72 8.44 8.96 -

2014/15

Source: Growth up to 1994-05 to 2003/04 has been taken from Sivasubramonian, 2000 and
NAS,2004.

13.3.1 1949-50 to 1964-65: The Pre-Green Revolution Period: During this period, the major
thrust soon after independence was on institutional and agrarian reforms. India passed a
significant body of land reform legislation. According to Prof. Kaushik Basu, a leading
economist, the most obvious argument in favour of land reform is equity. In a land-scarce
country with a significant section of the rural population below the poverty line, the case for
ensuring that everyone has access to some minimum amount of land seems compelling from this
point of view. The two basic objectives of the land reforms were:
1) To remove the intermediaries or impediments that were widespread owing to the kind of land
tenure system which the country inherited from colonial rulers.
2) To eliminate the kind of exploitation of the landless and small farmers through the
distribution of land in their favor.
During this phase, some other steps needed for the development of agriculture were also taken.
These were: the construction of new roads, provision of additional irrigation facilities through
multipurpose projects, provision of additional credit facilities and production of more fertilizers
in the country. Community development programme (CDP) was started to involve people in the
process of agricultural and rural development. Many agricultural research institutions and
agricultural universities and college were set up during this period in the country. Consequently,
foodgrain output increased from 51 million tonnes in 1951-52 to 68 million tonnes in 1955-56
and it was 82 million tones in 1960-61. Intensive Agriculture Districts Program (IADP) was
launched in 1961. In the begining, IADP programme was initiated in three districts and it was
extended in stages to thirteen other districts in later period.To motivate the farmers to adopt
better technology, the Government had started the incentive price policy in 1964. The
Agriculture Price Commission was institutionalized to advise the government on the fixation of
support prices of agricultural crops. As a result of initiatives like IADP, the agricultural output
increased to 89 million tonnes in 1964-65 which was significantly higher than the 82 million
tonnes produced in 1960-61.
Table 5. Growth rates of Production, Area under Cultivation and Productivity (per cent
per annum)

Plan Period Production Area Productivity

First Plan (1951-56) 4.1 2.6 1.4
Second Plan (1956-61) 3.1 1.3 1.8
 Third Plan (1961-65) 3.3 0.6 2.7
Source: Soni, R.N., Leading Issues in Agricultural Economics, pp 416.

Table 5 depicts the compound growth rates for agriculture production, area and productivity of
the all crops taken together from 1951 to 1965.The productivity growth had been increasing in
every successive plan and significantly in the intensive plan period. At the same time, the growth
rate of the area under the crops was more than the yield growth except in the intensive period.
During the first period, 1949 - 50 to 1964-65 total crop output in India recorded a trend growth
rate of 3.15% pa. This growth rate was fairly high compared to the pre-independence period and
was achieved mainly as a result of increase in irrigation and net sown area. The growth rate of
yield was rather low during this period. As per Ramesh Chand, first five year plan allocated a
substantial outlay to the agriculture sector, followed by tenancy reforms, institutional changes
and completion of major irrigation projects. He further mentions that the priority and importance
that agriculture sector received in the first plan was not sustained and growth of sub sector
decelerated in the beginning of 1960’s resulting in shortages of food. The large quantity of
foodgrains was imported. Another important characteristic of growth in this period was that
growth of output was relatively more and this was contributed by the new area brought under
cultivation. The growth of output in this period was contributed 50 per cent by the area whereas
the yield supplemented another 38 per cent to the output growth shown in the Table 6.

13.3.2 1967 to 1979 -80: The Beginning of Green Revolution

In the mid sixties, a new agriculture strategy was adopted which laid stress on the application of
new draft high yielding varieties (HYV) of seeds. As a policy support measure in January 1965,
the Agriculture Prices Commission was set up to recommend MSP. This was followed by the
Food Corporation of India (FCI) to take charge of the logistics of procuring major agricultural
commodities. These seeds were innovated by the American scientist Norman Borlaug. The
introduction of Borlaug’s new seed- fertilizer technology during the mid–sixties resulted in a
spectacular jump in the yield levels of wheat, rice and later oilseeds and cotton. The growth rate
of total crop output during 1967- 68 to 1979-80 decelerated to 2.19 % pa compared with a
growth rate of 3.15 % pa during the earlier period.The growth rate of food grain output also
decreased to 2.15% pa during this period, compared with 2.82% pa earlier. The limited impact of
new technology as per Bhalla was due to:
1) New technology was limited to wheat in the initial period, and had a low weight in cereals
during the 1960s. In spite of wheat output being doubled by 1970-71, it only constituted about
22% of total food grain output in that year.
2) The geographical coverage of HYV was also confined to the north- western states of Punjab,
Haryana and western U.P. So, its overall impact on the growth of food grain output was limited.
Further, this decline in the growth of agricultural GDP happened because of the after effect of
the 1965-66 and 1966-67 drought and also the result of the after effects of wars. There were two
oil crises and conflict with the neighbours and a drastic reduction in foreign aid that resulted in a
big decline in public and overall investment (Bhalla, 2007). Further, an important point to notice
in this period is that the major contribution to the output growth was coming from the growth of
yield rather than area. The wheat production registered a compound growth rate of 5.03 per cent
per annum during this period. The yield’s contribution to the growth in this period was 58.45 per
cent, while the area contributed 23.29 per cent. Other than Punjab, Haryana and western part of
Uttar Pradesh, state of West Bengal also benefitted from the wheat revolution. The southern
states comprising of Tamil Naidu, Kerala and Karnatka also recorded medium to high growth
rate.Thus, we can conclude that growth in this period was prominently assisted by the yield, and
the influence of new technology was limited to few crops and limited regions in the country.

13.3.3 1980-81 to 1990-91: The Maturing of Green Revolution

This period witnessed the wider dissemination of new technology into new areas and extension
to new crops resulting in very impressive growth of the agricultural output from 2.19 % achieved
in the earlier period to 3.19%. The new technology made inroads into new regions of the country
which otherwise was confined to the northwestern states, Panjab, Haryana and western Uttar
Pradesh. The new technology was extended to wheat, rice, maize and a few other commercial
crops like cotton, sugarcane and oilseeds. During this period, all the major crops registered
higher growth rate in yield. rice marked production and yield growth rate of 3.62 per cent and
3.19 per cent, respectively. Wheat yield also registered impressive growth of 3.57 per cent.
Growth in yield of pulses and coarse cereals was commendable. The production of food grains
observed a high growth rate of 2.73 per cent, mainly assisted by high growth rate of yield of 2.97
per cent. The technology mission on oilseeds was started in the mid 1980s to boost the
production and productivity of oilseeds and the mission succeeded in raising the production and
productivity which registered a growth rate of 5.46 per cent and 2.95 per cent. Potato, coconut
and cotton all showed high growth rates in production and yield and cotton registered a high
growth of 3.50 per cent and 5.19 per cent1respectively.More than that, the notable feature of this
period was that growth in output was contributed more by the increase in yield rather than the
increase in area as enumerated in the Table 6. The yield contributed the 80 per cent of the growth
in output and the area supplemented less than 5 per cent to output growth. This period was very
significant in the agriculture development of the country. In this period, not only the new
technology spread to the other regions especially of the rainfed areas but also many new crops
also benefitted from new technology. The agricultural growth of the eastern states of the country
particularly West Bengal during this period was remarkable and also rainfed states like Rajasthan
and Madhya Pradesh performed spectacularly on account of shifting of the areas from coarse
cereal to oil seeds. This period also witnessed the narrowing down of regional inequality in
output growth and yield level.

1
Individual crop growth rate has been derived from the Kannansand work and they are coumpound growth rate
1999‐00 prices.
Table 6 Per Cent Contribution of Area and Yield Growth to Output Growth

Years Area Contribution Yield Contribution

1949-50 to 1964-65 50.16 38.41
1967-68 to 1980-81 23.29 58.45
1980-81 to 1990-91 3.13 80.25
1990-91 to 2003- 04 -15.82 56.96
Source :Bhalla (2007).

13.3.4 1990-91 to 2003-04: Economic liberalization and deceleration of Agricultural

Growth. This period was marked by a perceptible decline in the growth of output and most
crops recorded negligible growth rate of output. Almost all the crops registered a decline in the
growth rate of yield in this period. The overall growth in the crop sector recorded decrease
relative to the previous period. India faced a serious balance of payments crises at the end of the
1990s, which pushed the country to go for major reform in its economic policy popularly known
as the liberalization, privatization and globalization in 1991-93. As per Ashok Gulati, “The
macroeconomic reforms of 1991-93 have had at least two important impacts on the agricultural
sector. First, deregulation of the industry, more open trade, and devaluation are widely agreed to
have stimulated a significant improvement in the rate of economic growth. This has strengthened
and diversified the food demand. Second, domestic and border policies directly affecting
agriculture were not included in the reforms. The reduced levels of industrial protection have
improved incentives for investment in agriculture through improvements in the sector's domestic
terms of trade”. Further, the agricultural sector was not targeted directly by the reforms for a
couple of years, but it was affected indirectly through changes in the exchange rate, export
liberalisation and terms of trade resulting from disprotection to industry. The only measure taken
during the early years of reform that had a direct impact on agriculture was decontrol of
fertilisers and reduction in the fertiliser subsidy2.

Despite major reforms in the economy, the performance of agriculture output came down in the
initial years of the reforms and the growth rate of agriculture GDP decelerated from 3.08% pa
during the 1980-81 to 1990-91 to 2.38% during 1992-93 to 2003-04.The growth rate of overall
crop sector decelerated from 3.19% pa during the 1980’s to only 1.18% pa during the later
period. The deceleration was aided by negative growth in oilseeds (-1.07%) and fibers (-1.17%)
and the poor performance of cereals (0.51%) and pulses (0.23%). It was only drugs and
narcotics, fruits and vegetables, and spices and condiments that performed well in this phase.
Similarly, the terms of trade, which had shown improvement in the 1980s and the early part of
1990s deteriorated in the late 1990s and remained so till 2003-04. The growth rate of food grains
in this period could not keep pace with the growth rate of the population, resulting in reduction in

2
Ramesh Chand,
 the availability of food gains per capita. The adverse effect of falling growth in agriculture was
manifested in the form of severe rural agrarian crises including farmers’ suicide.
Some of the important causes behind the poor performance of the agriculture in the initial years
of the post reform period has been delineated as:

1. The capital formation in the agriculture followed a rising trend since the 1960s and 1970s and
that continued till the mid 1980s. After that, it started declining and the trend has been reversed
after late nineties. The declining trend since 1990s suggests there has been low investment in
agriculture compared to the non-agriculture sector. Total investment in agriculture as a share of
GDP declined from 9.9% during 1980s to 6.0 per cent during 2003-04 predominantly pulled
down by a reduction in public investment.

2. Research and extension services: Gulati and Tervey (2019) found that among the major
investment components of growth of agriculture, the elasticity of research and extension is
highest. The green revolution in India was successful because of the international research
collaboration. The spending on research and extension services in India has been very low as
compared to the developed and other developing countries. Lack of public spending in research
and development has resulted in the non-availability of any major invention in new technology
like biotechnology resulting in increased input in Indian agriculture.

3. Credit extension: Credit, especially the institutional credit is the sine qua non for the
development of the agriculture sector. Empirical evidences show that the share of rural bank
branches in total branches increased soon after the nationalization of banks in late 1960s reached
a maximum in 1990 and since then it has a declining trend. Further, the trend in credit-deposit
ratio and lending to priority sector and agriculture declined in the 1990s compared to 1980s.
Reduction of rural bank branches and the priority sector lending in outstanding credit of
commercial banks led the farmers to approach the non institutional lenders. These lenders
charged exorbitant interest from the borrowers resulting a number of farmer suicides in rural
India.

13.3.5 The Period of Recovery 2004-05 to 2014-15. The year 2004-05 was a turning point. To
reverse the declining trend in the agriculture production in the country, the mid-term appraisal of
the Eleventh Five year plan reviewed the performance of the farming sector and proposed multi-
pronged steps to revive agriculture. As a result, a number of steps were taken to revive the
growth in the agriculture produce after 2004-05, which are highlighted below:
1) A substantial increase in the budget outlay was made to the departments associated with
the development of Agriculture, Animal husbandry and Agriculture Research and Education.
2) The National Horticulture Mission started in 2005-06 and its scope was expanded to
include the medicinal plants and spices.
 3) Support to State Extension Program for Extension Reform, a centrally sponsored scheme
was launched in 2005-06.
4) In 2005-06, a National Fund for Basic, Strategic and Frontier Application Research in
Agriculture and a National Agricultural Innovation Project (in July 2006) were launched.
5) The terms of trade started favouring agriculture soon after 2005-06, when central government
started a massive increase in procurement prices of food grains aided by a significant increase in
international food prices. At the same time, in 2005, trade in agriculture was opened under the
World Trade Organisation (WTO) agreements.
6) An initiative to reform the domestic agricultural marketing was already undertaken through
Model Agriculture Produce Marketing Committee (APMC) Act, 2003.

The initiatives paid off and the overall growth rate of the economy bounced to 8.57 per cent per
annum and agriculture and allied activities marked an impressive growth of 3.33% per annum.
This period of high growth in the agriculture output has been termed as period of recovery. The
growth movement which picked up after 2004-05 reached its plateau in 2012-13 and thereafter it
started falling. The growth rate in agriculture in the period 2009-10 to 2013-14 was 4.3% per
annum. This is one of the highest growth rates recorded in independent India. The net positive
impact of high growth rate on the economy can be gauged from the fact that the number of
farmer suicide in India came down from 18,241 in 2004 to 11,772 in 2012. The robustness of the
agriculture growth during this period can be supplemented by the instability index, which shows
the year-to-year fluctuations or variability of the production in the agriculture. This is due to
dependence on the rainfall and other vagaries of nature, and is measured by the coefficient of
variation.The coefficient of variation has declined from 2.76% during 1961-1988, to 1.87%
during 1988-2004 and to 0.75% during 2004-2014 (Table 2). It shows that volatility in
agricultural growth has been declining and it was low in the decade (2004-14). Variability in
pulses was very high at 20% and 5% for cereals during 1990-2004. But it declined drastically in
the decade 2005-2014. In other words, resilience to rainfall has been rising for Indian agriculture
during this period.

Table 7 Volatility in Agricultural GDP Growth: All India

Years Coefficient of variation
1961-1988 2.76
1988-2004 1.87
2004-2014 0.75
Source: Economic Survey, 2016. GOI.

We have observed that India’s agriculture bounced back to its long term trajectory in this period.
It is pertinent to discuss the important ingredients of growth in this period. The public investment
in agriculture, which observed a declining trend in the post reform period had been reversed. A
significant improvement in public investment was observed followed by private investment in
agriculture. Total gross capital formation as a percentage of agricultural GDP averaged 12.9%
during the five year period ending2003-04. Thereafter, it has continuously risen from 13.5% in
2004-05 to 17.0% in 2012-13. The private investment also flowed positively though moderately
from 10-11% of private investment to the agriculture gross domestic product (GDP) in early
2000s to 14% in 2008-09 and remained at that level thereafter.

Another noticeable features of farm sector growth in this period was overwhelming performance
of Rabi season production compared to the Kharif season production. For the first time, the Rabi
food grain production surpassed the Kharif food grain production between 2004-05 to 2014-15.
Further, a Planning Commission study of the state level growth performance of states found that
high growth occurred not only in the irrigated areas and high productivity states, but in the rain -
fed, low productivity states also in the country.
As a result of the structural changes that took place in the agriculture sector, a quantum jump in
the productivity of the crops has been recorded. An examination of the sources of the growth
during the period 2004-05 to 2014-15 reveals that growth in agriculture output in the study
period was prominently contributed by improvement in the crop yield (Table 3.8). Improvement
in yield contributed maximum to the growth of cereals (92%) followed by foodgrains (88%),
pulses (76%), oilseeds (67%). In case of cotton, the area attributed 31% and yield a 45 %
increased in crop output. Hybrid Bt cotton seeds not only replaced the traditional variety, but
also brought new area under the cotton cultivation. It is clear from Table 13.8 that during the
period of rapid improvement, increase in yield attributed most of the growth registered in crop
production. Lastly, Indian agriculture experienced a rapid drive towards the diversification of
traditional crops to the horticultural crops resulting from the direct consequences of the National
Horticulture Mission which was operationalised in 2005-06. The area under fruits and vegetables
recorded a splendid growth rate of 41.3% and 23.5% per annum respectively during that interval.

Table 8 Growth Rate in Production of Selected Crop Groups and its Decomposition: 2004-
05 to 2014-15
Crop Group Growth Rate(%) Decomposition of Production Change (%)
Producti Interaction
Area Yield on Area effect Yield effect Effect
Foodgrains 0.15 2.57 2.72 9 88 3
Cereals 0.01 2.63 2.64 6 92 2
Pulses 0.73 3.03 3.78 18 76 6
Oilseeds -0.32 2.14 1.81 26 67 7
Cotton 4.44 3.68 8.28 31 45 24
Source: Ramesh Chand and Shrivastva(2017)

In the last two years of the United Progressive Alliance (UPA) rule, the growth in the agriculture
output declined.
Agriculture Growth in NDA Rule (2014-15 to 2018-19). In May, 2014 a new National
Democratic Alliance (NDA) government under Prime Minister Narender Modi took charge at the
Centre. As we have observed that the growth movement in the farm sector output, which picked
up from 2004-05 peaked in 2012-13 and thereaftert started falling. If we exclude the year 2014-
15 from the decadal interval, the average growth rate in agriculture improves to 4% per cent per
annum. The Modi government’s performance in the agricultural sector in the first five years in
office is mediocre compared to the growth achieved under the previous period. The growth rate
achieved in the first five years of NDA-II rule was 2.4%, which is significantly lower than the
more than 4 per cent achieved during UPA-II rule. The first two years of Modi’s first tenure in
office had been marred by two successive droughts.The agricultural growth rate declined 0.2% in
2014-15 and it barely grew at 0.6% in 2015-16. A good monsoon in 2016-17 drove the rate to
6.3%. The sector slowed again in 2017-18, with a 3% growth rate. The average agricultural
growth rate under NDA’s five years is 2.3%, which was the lowest since the economic reforms
in India. In Feburary 2016, Prime Minister Modi set an objective of doubling farmers' income by
2022, which signalled a policy shift from production to income enhancement. To meet the above
stated objective of doubling farmers' income, a committee under the chairmanship of former
agriculture secretary Ashok Dalwai was set up to make recommendations in that direction. The
committee came to the conclusion that India’s agriculture ought to grow by 10.4 per cent per
annum in real term to reach that level by 2022. From the level of real growth which has been
achieved during the first five years of Modi government at the Centre, the aim of doubling
farmers' income by the year 2022 appears hard to achieve, but can be met in near future.

Table 9 Agriculture Growth under the National Democratic Alliance –II (2014-18)(In Per
cent)

Year 2014-15 2015-16 2016-17 2017-18 2018-19 2014-2018

AGDP Growth -0.2 0.6 6.3 5 2.7 2.9
Souce: MOPSI,GOI

Check Your Progress A

1. What was the growth rate of agriculture in the pre-independenc period?

2. Explain salient features of the ‘Beginning of Green Revolution’.

3. What is meant by ‘Maturing of Green Revolution’.

4. Name three reasons of the poor performance of the agriculture in the initial years of the
post reform period.

5. Which of the following statements are ‘True’ or ‘False’?

i) The first half of the 19th century in India can be categorized as the period of stagnation.
 ii) The period from the 2004-05 to 2014-15 has been named as period of recovery.

iii) Despite major reforms in the economy, the performance of agriculture output came down
in the initial years of the reforms.

iv) A number of steps were taken to revive agricultural growth just before 2004-05,

v) In Feburary 2016, the government set an objective of doubling farmers' income by 2022.

13.4 CHALLENGES OF INDIAN AGRICULTURE

A) The shrinking land size: India has 198 million hectares (ha) gross cropped area which is
relatively larger than China where it is 166 million hectares. The average size of the land is
decreasing consistently ever since the agriculture census in this country has been started. The
average size of landholding in India has come down from 2.28 hectares in 1970-71 to 1.08
hectares in 2015-16 and would shrink further in near future. So, one of the challenges before the
country is to raise the production and productivity from the small size farms where it is difficult
to adopt the good quality seeds, capital and technology. It is not so that small size farming is not
efficient or can not be viable. An example from the Chinese economy makes the case clear.
China has an average size of land just 0.7 ha which was 0.46 ha at the time of economic reforms,
and still China produces three times more than what India produces. The message is clear that if
correct incentives are put in the place and right investment is made on infrastructure and
agriculture research and development (R&D), India can make the small farms viable and
sustainable.

Quality Inputs and Efficient Value Chain: Water, seeds, fertilizer and chemicals are the basic
inputs used in the production process and are crucial determinants of the agriculture growth.
Thus timely and sufficient supply of these ingredients are essential for a robust production
system in agriculture.

The Indian agriculture is basically a small holder dominated. One of the key challenges of small
holder agriculture is to build an efficient and inclusive value chain for the different agricultural
commodities. One of the examples of successful small farmers' participation in the value chain is
AMUL in the state of Gujarat. The Government of India’s initiative to motivate the formation of
Farmers Producers' Organizations (FPOs) is a step in right direction. The finance minister has
announced formation of additional 10000 FPOs in union budget 2020, which should link the
exporters/processors and markets so as to realize better prices for the farmers. More than that,
most of the farmers sell their produce at the farm gate or small markets in the hinterland. These
markets lack the modern and scientific equipments for weighing, grading and their functioning is
not transparent resulting in lower value realization by the farmers. There is an urgent need to
upgrade the existing marketing infrastructure so that farmers can receive their rightful dues and a
huge post harvest loss that results from the inefficiency in the system can be corrected.
B. Changing Climatic Patterns: Climate change is a reality. Agriculture is the sector most
vulnerable to climate change due to its high dependence on climate and weather. The people
involved in agriculture are poorer compared with urban residents. Agriculture is part of the
problem and part of the solution. As we know, India has 198 million hectares of gross cropped
area and about 49 per cent of that is irrigated. The rest, more than half of the cropped area
depends on the rains, mainly monsoon rains to irrigate the land. In the last 18 years (2000–01 to
2018–19), India faced droughts in five years (2002, 2004, 2009, 2014 and 2015) and in all of
those, India’s agricultural GDP growth rate and food grain production fell. The sharpest fall in
food grain production was in the year 2002–03 when the rainfall inadequacy was 19.2% and the
annual food grain production fell by more than 38 MMTs. In 2009–10, which was the worst
drought year in recent years, the fall in food grain production was lower compared to 2002–03 at
16.4 MMTs even though the rainfall inadequacy was higher at 21.8%. It has been witnessed that
rainfall pattern has undergone a dynamic change in recent years in India. The variability and
intensity of rainfall in India have recorded major change resulting in droughts in one part of the
country while floods and excess rainfall in other parts of the country.

C India’s population is second largest in the world and very soon it is going to overtake the
population of China. The population pyramid of the country is such that it is dominated by the
young population. The country is the youngest country in the world wherein the median age of
Indians was 29 years in 2019. The urbanization is also increasing at the fastest rate ever since
independence. Thus, the demand for higher value crops, especially vegetables, fruits, eggs, milk
and chicken/mutton will increase in future owing to increase in income and urbanization. Hence,
the challenge before the country is not only to feed the growing population, but also to supply the
nutrients and high value commercial crops to its bulging middle to high income and urban
population. India’s obsession with wheat, rice crop culture has damaged the north western part of
the country. There is an urgent need to shift from the wheat - rice mono crop culture and to high
value low water intensive crops.

13.5 POLICY SUGGESTIONS

Famous economist T.N.Srinivasan once argued the solution to Indian agriculture lies outside the
agriculture and in the non-agriculture sector. The Indian economy has breached the traditional
development strategy and it has moved directly from the primary (agriculture and allied
activities) sector to tertiary (service) sector as dominant output contributing sector by passing
manufacturing sector. The non-agriculture sector and urban growth have been also found
important in reducing the poverty. At the same time, agriculture is found two to three times as
effective in reducing the poverty as relative to the other sectors. Hence, one should adopt a
balanced approach regarding the utility of agriculture and non-agriculture in raising the
agricultural productivity, farm income and reduction of poverty. It is true that India cannot
improve the farm productivity unless a considerable size of the labour force is moved outside the
agriculture sector and fruitfully employed in the non-agriculture sector. At the same time, growth
in the agriculture is important as it is more effective in reducing the rural poverty. You must
notice that the largest source of livelihood comes from the agricultural sector. There has been
more robust backward and forward linkages of agriculture with other sectors of the economy.
Thus, both agriculture and non-agriculture sectors are complementary for the agriculture
population.

Diversification of cropping Pattern: Government policies have been biased towards cereals
particularly rice and wheat. It procures rice and wheat based on minimum support prices in few
states. Cereal-centric policies also provide subsidies for fertilisers, water, power, credit and
seeds. Large part of the subsidy goes to these two crops. These subsidies also benefit large
farmers, few states and irrigated areas and have adverse impact on soil quality, water quantity,
quality and human health. Punjab, Haryana and other states have been focusing mainly on rice
and wheat because of government support to these crops. There is a need to shift from cereal-
centric policies to non-cereal focused policies. Diversification of cropping pattern is obvious for
improving agricultural growth, incomes of farmers and environmental sustainability.

Check Your Progress B

1. Name four challenges before Indian agriculture.

2. Why is it necessary to shift from the wheat - rice mono crop culture to high value low
water intensive crops?

3. Why are the non-agriculture sector and urban growth important in reducing the poverty?

4. Which of the following statements are ‘True’ or ‘False’?

i) The shrinking land size is a challenge to Indian agriculture..

ii) The period from the 2004-05 to 2014-15 has been named as period of recovery.

iii) India is the youngest country in the world.

iv) The agricultural sector provides minimum source of livelihood.

v) Large part of the subsidy goes to the crops of wheat and rice.

13.6 LET US SUM UP

According to all the credible estimates, India’s growth performance during the first half of
nineteenth century was not an impressive one. The growth rate of the primary sector during the
1900-01 to 1946-47 was only 0.46% per annum (pa) which is very low from any standard. The
economy did not show any credible structural change and three-fourth of the work force was
employed in the agriculture throughout the 20th century. That is the reason why economists
called the performance of the Indian economy in the first half of the century as “Static Economy
in Progress”.

The major thrust soon after independence was on institutional and agrarian reforms. India passed
a significant body of land reforms legislation. During this phase, some other steps needed for the
development of agriculture were also taken. These were: the construction of new roads,
provision of additional irrigation facilities through multipurpose projects, provision of additional
credit facilities and production of more fertilizers in the country. Community development
program (CDP) was started to involve people in the process of agricultural and rural
development. Many agricultural research institutions and agricultural universities and colleges
were set up during this period in the country. During the first period, 1949 - 50 to 1964-65 total
crop output in India recorded a trend growth rate of 3.15% pa. This growth rate was fairly high
compared to the pre-independence period and was achieved mainly as a result of increase in
irrigation and net sown area. However, the growth rate of total crop output during 1967- 68 to
1979-80 decelerated to 2.19 % pa. The 1980-81 to 1990-91period witnessed the wider
dissemination of new technology into new areas and extension to new crops resulting in very
impressive growth of the agricultural output from 2.19 % achieved in the earlier period to 3.19%.
The new technology made inroads into new regions of the country which otherwise was confined
to the northwestern states, Punjab, Haryana and western Uttar Pradesh. The new technology was
extended to wheat, rice, maize and a few other commercial crops like cotton, sugarcane and
oilseeds.

The year 2004-05 was a turning point. A substantial increase in the budget outlay was made to
the departments associated with the development of Agriculture, Animal husbandry and
Agriculture Research and Education. The initiatives paid off and the overall growth rate of the
economy bounced to 8.57% per cent per annum and agriculture and allied activities marked an
impressive growth of 3.33% per annum. This period of high growth in the agriculture output has
been termed as period of recovery. Several suggestions have been made to augment agricultural
sector.

13.7 KEY WORDS

Agrarian reforms: Improvement or amendments in the agricultural policies.

Credit extension: Facility of short time loans.

Diversification of cropping Pattern: Rotation of sowing of the crops in a scientific manner so

that soil fertility is sustained.
Green Revolution: Remarkable improvement in the agricultural productivity by the use of
modern agricultural appliances, high quality of seeds, increased use of fertilizers and pesticides
during 1967- 68 to 1979-80 was termed as the ‘Green Revolution’.

Land reforms: Amendments regarding land holdings, such as abolition of zamindari.

“ Ship- to -mouth”: Dependent on imports.

Static Economy: Economy with no change.

Subsidy: Financial contribution of the government to the purchase of fertilizers, pesticides, etc.
by the farmers.

13.8 ANSWERS TO CHECK YOUR PROGRESS

A 4 i) True, ii) True, iii) True, iv) False, v) True

B 4 i) True, ii) True, iii) True, iv) False, v) True

13.8 TERMINAL QUESTIONS

1) India’s Agriculture in colonial period was purely stagnant and declining, discuss.
2) What were the factors responsible for the green revolution in India.
3) Discuss in detail the growth rate of india’s agriculture in the post-independence period.
4) Discuss the causes of deterioration of agriculture growth soon after the reforms.
5) Suggest ways to make agriculture in India vibrant and sustainable.

REFERENCES

Planning Commission (2005): Mid-Term Appraisal of Tenth Five Year Plan (2002-2007),
Government of India, June
Bhalla, G.S (2007), Indian Agriculture Since Independence, National Book Trust, New Delhi.
Soni,R.N(2010), Leading Issues in Agriculture Economics, Vishal Publishing Company,
Jalander(PB).
Gulati et al (2021), Revitalising Indian Agriculture and Boosting Farmers Income. Springer.
DCR.(2018). Dalwai committee report volume 4. https://farmer.gov.in/imagedefault/DFI/DFI%
20Volume%204.pdf..
Mundial, B. (2008). World development report.Agriculture for Development. Washington, DC:
World Bank.
NFHS-4 (2017), National family health survey 2015–16. International Institute for Population
Sciences (IIPS).
Sivasubramonian,S.(2000),The National Income of India in the Twntieth Century, Oxford
University Press, New Delhi.
Blyn,G.,(1966), Agricultural Trends in India,1891-1947,1891-1947, Philadelphia.
Kannan,E&Sundaram,S.(2011), Analysis of Trends in India’s Agricultural Growth. Working
Paper No. 276.The Institute of Social and Economic Change, Bangalore.
Chand, R and Shrivasta,S. (2017), Agriculture Performance in India: Main Trends,
Commercialisation, and Regional Disparities. Rural India Perspective, 2017.NABARD.Oxford
University Press(OUP).
BLOCK 5: Sectoral Development-II: Industrial and Services

In this block you will learn about various Industrial policy resolutions, Industrial policy
statement, Various indicators of industrial growth, phases of growth trends in Indian
industry, Roles and contribution of public and private sector in the economy, difference
in public & private sector, Public- Private partnership (PPP) models, forms, applications
and Challenges, Micro, Small and Medium Enterprises (MSME) meaning, opportunities
and challenges and their present status in the country, Structure of IT industry and
telecommunications industry, Present status of ICT sector in the economy. The block has
4 units.
Unit-14 deals with‘Industrial Policy of Pre & Post’. The unit begins with the introduction
of industrial policy resolutions. The understanding of industrial policy resolution, 1948,
1956, 1977, 1980 and 1991 drafted by the government and amendments made therein are
provided. Indicators of industrial growth and their significance are than highlighted.
Growth trends in Indian industry are discussed in major four phases. Factors that have
played a defining role in shaping industrial policies after independence were given in the
last.
Unit-15 deals with ‘Public& Private Sector’. The unit begins with the meaning of public
and private sector. Respective roles and contribution of public and private sector in the
economy are described and a comparative view of public and private sector is given.
Definition of Public- private partnership is provided along with the different models of
PPP and their application. In the end, PPP model in India and it various forms and
challengesare outlined.
Unit-16 deals with ‘Micro, Small and Medium Enterprises (MSME)’. The unit begins
with the meaning and definition of MSMEs. Features and opportunities of MSMEs are
discussed. Various information technology (IT)initiatives are given. Credit support
initiatives are explained.Highlights of entrepreneurship promotion and development
programmes are then presented. Roles, challenges in growth and development of MSMEs
sector in India are explained thereafter. The chapter ended with the details of the
distribution of MSMEs in India.
Unit-17 deals with ‘Service Sector (ICT & Communication)’. The unit begins with the
brief introduction of IT industry. A list of facilitators of growth of software industry in
India is than provided. Growth drivers of telecommunications industry are discussed.
Role of ICT in economic development and the challenges faced by them are briefly
discussed. A list of ICT products is given along with the government support for ICT
product development is outlined in the last.
Unit-14: Industrial Policy of Pre & Post

Structure
14.0 Objectives
14.1 Introduction
14.2 Industrial Policy Resolution
14.2.1 Industrial Policy Resolution, 1948
14.2.2 Industrial Policy Resolution, 1956
14.2.3 Industrial Policy Statement, 1977
14.2.4 Industrial Policy Statement, 1980
14.3 New Industrial Policy, 1991
14.4 Indicators of Industrial Growth in India
14.5 Let UsSum Up
14.6 Key Words
14.7 Terminal Questions
________________________________________________________________________
14.0 Objectives
________________________________________________________________________

After studying this unit, you should be able to:

• Explain the meaning of industrial policy
• Provide an understanding of industrial policies drafted by the Government at
different points of time and amendments made therein
• identify indicators of industrial growth in India and their significance
• Identify the factors that have played a defining role in shaping industrial policies
after independence
________________________________________________________________________
14.1 Introduction
________________________________________________________________________
Industrial revolution, that began in Europe and later spread to the entire world, is one of
the most notable achievements in the history of mankind. As industrial revolution
resulted into mass scale production in short time.The industrialized states promoted
exports of manufactured goods through fiscal incentives and policy support. The
competitive industrialization in different parts of Europe first and later in the other parts
of the world, forced states/governments to encourage innovations.The science and
technology were promoted, educational institutes were set up. These developments
facilitated them to supply skilled human capital and build infrastructure in the country.
Industrial revolution helped them amass huge wealth and achieve technological
advancements and eventually benefitted them in becoming the industrially advanced
economies or First World nations in the world.
In the colonial period, Indian raw materials exported largely to England, processed in
mills in factories there, and sold back to India as finished goods. When the Britishers left,
India inherited industries that was inefficient and was not producing any exportable
surplus. After independence, the Government felt an urgent need to change the very
nature and type of industries in the country. The first Prime Minister Jawaharlal Nehru
too realized the fundamental problem of industrial sector in India and held that
industrialization was the key to India’s success. Nehru also believed that India should be
economically self-sufficient, although his approach to self-sufficiency led through large-
scale industrialization rather than village industries. In India, there has been a consensus
for long on the role of government in providing infrastructure and maintaining stable
macroeconomic policies. It is due to policy initiative during early years of planning-
particularly the second and third five year plans- that India now has a strong and
diversified industrial base and is a major industrial nation of the world. However,
manufacturing capabilities of China, South Korea and Thailand are well developed.
________________________________________________________________________
14.2 Industrial Policy Resolutions
________________________________________________________________________

Industrial Policy is defined as the strategic effort by the state to encourage economic
transformation, i.e. the shift from lower to higher productivity activities. Industrial policy
refers to any type of selective government intervention or policy that attempts to alter the
structure of production in favour of sectors that are expected to offer better prospects for
economic growth. So, Industrial Policy is the set of standards and measures set by the
Government to evaluate the progress of the manufacturing sector that ultimately enhances
economic growth and development of the country. It is a vision document that provides a
direction to the government to achieve certain predetermined goals in a stipulated period.

An industrial policy has its pre-decided aims and objective that are to be achieved in the
given time frame. Following can be some of the common objectives of an Industrial
Policy;
• To maintain steady growth in productivity
• To create more employment opportunities
• Utilize the available human resources effectively
• To accelerate GDP growth rate

14.2.1 Industrial Policy Resolution, 1948

The Government of India set out in their Resolution dated 6 April, 1948 the policy which
they proposed to pursue in the industrial field. The Resolution emphasised the importance
to the economy of securing a continuous increase in production and its equitable
distribution.It pointed out that the State must play progressively active role in the
development of Industries. It laid down that arms and ammunition, atomic energy and
railway transport would be the monopoly of the Central Government.The State would be
exclusively responsible for the establishment of new undertakings in six basic industries.
If the State realises the necessity to secure the cooperation of private enterprise in the
national interest, the state may do so. The rest of the industrial field was left open to
private enterprise though it was made clear that the State would also progressively
participate in this field. Some of the important take away points this resolution were as
follows;
 • Mixed Economy: The Industrial Policy Resolution, 1948 was first major policy of
independent India which was launched to lay the foundation of a mixed
economy.In mixed economy both private and public enterprises would march
hand in hand to accelerate the pace of industrial development. It means there
would be co-existence of public sector and private sector. The decision regarding
price determination, resource allocation and distribution in public sector shall be
taken by the government. Tata Steel, Hero Motors and Hindustan Unilever fall
under the domain of public sector.However, the market shall take all economic
decisions in case of the private sector. Hinduja, Tata and Birla are examples of the
private sector.
• Priority to Small scale and cottage industries: Small scale and cottage industries
were given the importance due to their wide spread, labour intensive nature
andlow capital and low skill requirements.
• Restrictions on foreign investments: The government restricted foreign
investments to protect domestic industries from global competition.
• Industries were divided into 4 categories
• State monopolies:dExclusive monopoly of central government in arms and
ammunitions, production of atomic energy and management of railways.
According to Cambridge Dictionary, “State monopoly is a situation wherein an
organization owned by a government supplies of all particular product or service,
with no competitors”. For example, LIC, Air India and BSNL used to be state
monopoly in India.
• New undertaking undertaken only by state(coal, iron and steel, aircraft
manufacturing, ship building, telegraph, telephone etc).
• Industries to be regulated by the government(Industries of basic importance): The
entire secondary sector was by and large regulated by the government.
• Remaining sectors were open to private enterprise, individuals and cooperatives.
Although, there was not much important left behind for the private sector to
perform outstandingly well.

During the early years after independence, the Government adopted a policy that
favoured industrialization through public sector intervention and giving limited space to
the private sector. The reason was the private sector had neither enough resources not
willingness to undertaken projects of nation building. The private sector unlike the
Government had no capacity to mobilize funds for megaprojects from anywhere.India
needed to develop heavy and basic industries like iron and steel, power generation, heavy
engineering, to name a few.The Industrial Policy Resolution, 1948 – historically
important policy document that declared India as a Mixed economy- was a step towards
right direction to develop industries through state participation. It showed that the Indian
Government had a socialist bent. It provided some ownership rights of assets but at the
same time, the private sector did get some space to participate in the process of
industrialization between 1948 and 1956.

14.2.2 Industrial Policy Resolution, 1956

The Industrial Policy Resolution of 1948 was followed by the Industrial Policy
Resolution of 1956.The objective was to accelerate the rate of economic growth and the
speeding up of industrialisation as a means of achieving a socialist pattern of society. It
was regarded as the “Economic Constitution of India” or “The Bible of State Capitalism”.
In 1956, capital was scarce and the base of entrepreneurship not strong enough. Hence,
the 1956 Industrial Policy Resolution gave primacy to the role of the State to assume a
predominant and direct responsibility for industrial development. The 1956 Policy
emphasised the need to expand the public sector, to build up a large and growing
coop-erative sector and to encourage the separation of ownership and management in
private in-dustries and, above all, prevent the rise of private monopolies.

The Industrial Policy Resolution - 1956 was shaped by the Mahalanobis Model of
growth. This Model suggested for a shift in the pattern of industrial investment towards
building up a domestic consumption goods sector.This requiredinvestment in building a
capacity in the production of capital goods or heavy industries leading to an economy
with a long term higher growth path. It provided the basic framework for the
government’s policy in regard to industries till June 1991.

The Industrial Policy Resolution - 1956 classified industries into three categories;
a) Schedule A: The first category comprised 17 industries (included in Schedule A of
the Resolution). These industries were exclusively under the domain of the
Government. These included inter alia, railways, air transport, arms and ammunition,
iron and steel and atomic energy.
b) Schedule B:The second category comprised 12 industries (included in Schedule B of
the Resolution). These industries were envisaged to be progressively State owned but
private sector was expected to supplement the efforts of the State.
c) Third Category:The third category contained all the remaining industries and it was
expected that private sector would initiate development of these industries. The
industries would remain open for the State as well.

The Resolution widened the scope of the public sector, rather established the dominance
of the public sector in most of the key areas of the economy. Some of the public sector
enterprises grew too big in size. It was envisaged that the State would facilitate and
encourage development of these industries in the private sector, in accordance with the
programmes formulated under the Five Year Plans. The appropriate fiscal measures and
adequate infrastructure would be insured. Despite the demarcation of industries into
separate categories, the Resolution was flexible enough to allow the required adjustments
and modifications in the national interest.

Following the Theory of Infant Industry Argument, the domestic industry was protected
from global competition, through import quota, import licensing and other import trade
barriers. However, the IPR 1956 came in for sharp criticism from the private sector since
this Resolution reduced the scope for the expansion of the private sector significantly.The
IPR, 1956 was a landmark policy statement and it formed a basis of subsequent policy
announcements.

14.2.3 Industrial Policy Statement, 1977

The Industrial Policy Statement of 1977 laid emphasis on decentralisation and on the role
of small-scale, tiny and cottage industries.This policy was an extension of the 1956
policy, but it focussed on prioritization of small scale industries and home based units to
decentralize economic power in India. Its important focus was on;
• Employment to the poor and reduction in the concentration of wealth.
• Decentralisation of industries
• Priority to small scale Industries
• Created a new unit called “Tiny Unit”
• Imposed restrictions on Multinational Companies (MNC)

This Statement emphasized decentralization of industrial sector with increased role for
small scale, tiny and cottage industries. It also provided for close interaction between
industrial and agricultural sectors. Highest priority was accorded to power generation and
transmission. It expanded the list of items reserved for exclusive production in the small
scale sector from 180 to more than 500. For the first time, within the small scale sector, a
tiny unit was created. The tiny unit is defined as a unit with investment in machinery and
equipment up to Rs0.1million and situated in towns or villages with a population of less
than 50,000 (as per 1971 census). Basic goods, capital goods, high technology industries
important for development of small scale and agriculture sectors were clearly delineated
for large scale sector. It was also stated that foreign companies that diluted their foreign
equity up to 40 per cent under Foreign Exchange Regulation Act (FERA) 1973 were to be
treated at par with the Indian companies. Fully owned foreign companies were allowed
only in highly export oriented sectors or sophisticated technology areas. For all approved
foreign investments, companies were completely free to repatriate capital and remit
profits, dividends, royalties, etc. Further, in order to ensure balanced regional
development, it was decided not to issue fresh licenses for setting up new industrial units
within certain limits of large metropolitan cities (more than 1 million population) and
urban areas (morethan 0.5 million population).

14.2.4 Industrial Policy Statement, 1980

The industrial Policy Statement of 1980 placed accent on promotion of competition in the
domestic market, technological upgradation and modernization of industries. Some of the
socio-economic objectives spelt out in the Statement were as follows;
i) optimum utilisation of installed capacity,
ii) higher productivity,
iii) higher employment levels,
iv) removal of regional disparities,
v) strengthening of agricultural base,
vi) promotion of export oriented industries and
vii) consumer protection against high prices and poor quality.

Policy measures were announced to revive the efficiency of public sector undertakings
(PSUs) by developing the management cadres in functional fields viz., operations,
finance, marketing and information system. An automatic expansion of capacity up to
five per cent per annum was allowed, particularly in the core sector and in industries with
long-term export potential. Special incentives were granted to industrial units which were
engaged in industrial processes and technologies aiming at optimum utilization of energy
and the exploitation of alternative sources of energy. In order to boost the development of
small scale industries, the investment limit was raised to Rs.2 million in small scale units
and Rs.2.5 million in ancillary units. In the case of tiny units, investment limit was raised
to Rs.0.2 million.

Self-assessment Exercise A
1. What are the objectives of industrial policy?
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2. Write three important focus of industrial policy statement, 1977.

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3. Write full forms of the following terms.
FERA………………………………………………………………………………

MRTP…………………………………………………………………………………
MNC……………………………………………………………………………………
IPR………………………………………………………………………………..…

4. Write three objectives of Industrial Policy Statement, 1980.

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________________________________________________________________________
14.3 New Industrial Policy, 1991
________________________________________________________________________

In India, regulatory mechanisms were enforced in various ways. For instance, industrial
licensing under which every entrepreneur had to get permission from government
officials to start a firm, close a firm or decide the amount of goods that could be
produced. Private sector was not allowed in many industries. Some goods could be
produced only in small-scale industries, and controls on price fixation and distribution of
selected industrial products. During late 1980s and early 1990s, India faced high level of
debt, double digit inflation, slow GDP growth and Balance of Payment (BOP) crisis. The
Government’s financial health was unsound and it was on the verse of collapse. The
reasons put forth by experts included high tax rates, industrial licensing, MRTP act and
FERA, among others.

International Monetary Fund (IMF) suggested us to adopt economic reforms, famously

called New Industrial Policy, 1991 or LPG reforms, in a major way. Government decided
to take a series of initiatives in respect of the policies relating to the following areas.
Industrial Licensing, Foreign Investment, Foreign Technology Agreements, Public Sector
Policy, MRTP Act. The reform policies introduced in and after 1991 removed many of
these restrictions. Industrial licensing was abolished for almost all but product categories;
alcohol, cigarettes, hazardous chemicals, industrial explosives, electronics, aerospace and
drugs and pharmaceuticals. The only industries which are now reserved for the public
sector are a part of atomic energy generation and some core activities in railway
transport. Many goods produced by small-scale industries have now been de-reserved. In
most industries, the market has been allowed to determine the prices. Therefore, the New
Industrial Policy, 1991 had the following important features;
i. Creation of a positive business environment by simplifying procedures, reducing
documentation and offering fiscal incentives.
ii. Allowing foreign investment by lowering controls and regulations.
iii. Privatization of public sector enterprises, particularly sick units.
iv. Exit policy for the sick units in private sector for a smooth exit without affecting
welfare of labour.
v. Financial sector reforms to deregulate interest rates, improve credit availability
and to create a conducive environment for banking and finance sector.
vi. Reducing tariff and non-tariff barriers on imports and simplifying procedure for
import of goods and services.
vii. Industry friendly approach of the government to promote business.
viii. Devaluation of Indian rupee by 21 per cent and convertibility of Indian rupee on
current account.

The New Industrial Policy, 1991 had the main objective of providing facilities to market
forces and to increase efficiency.

L – Liberalization: It refers to reduction in government control.Different types of

government regulations and controls from businesses or economic activates in the
country are reduced.The government imposes much less restrictions than before and is
therefore said to be more liberal. Industrial licensing was abolished except for 18
industries. MRTP Act was introduced to check monopolies. The MRTP Act was relaxed
in 1991. MRTP Act was replaced by the Competition Act 2002 that promoted
competition and encouraged industries expand their businesses, incorporate mergers and
acquisitions and adopt best practices in business.
P – Privatization: It refers to increase in the role and scope of Private sector. De-
reservation of the sectors that were originally reserved for the government. This
encouraged the private sector to participate in different economic activities for better
management, efficient use of resources and become competitive.
G – Globalisation:It refers to integration of the Indian economy with the world economy.
Globalization aimed at making Indian economy part of the global network of trade and
commerce, of transport and communication. More and more goods and services,
investments and technology are moving among countries. Most regions of the world are
closer. It could be done by removing all kinds of barriers; qualitative and quantitative on
the export and import of goods and services, man (labour) and machines (capital), etc. It
provided an opportunity for Indian firms to explore their markets in different parts of the
world. However, this also meant that foreign corporations were offered Indian markets
that were formally protected from global competition. Now they can sell their goods and
services.

In pursuit of the objectives of economic reforms, Government took a series of initiatives

in respect of the policies relating to the following areas including Industrial Licensing,
Foreign Investment, Foreign Technology Agreements, Public Sector Policy and MRTP
Act.

Industrial Licensing:Industrial licensing was a system of obtaining a license through a

complex procedure, lengthy documentation and mal-practicingfrom the Government for
setting up an industry. It discouraged entrepreneurs to set up industrial units and
hampered industrialization in the country. Industrial Licensing is governed by the
Industries (Development & Regulation) Act, 1951. The Industrial Policy Resolution of
1956 identified the following three categories of industries: (i) those that would be
reserved for development in the public sector, (ii) those that would be permitted for
development through private enterprise with or without State participation, and (iii) those
in which investment initiatives would ordinarily emanate from private entrepreneurs. The
License Raj or Permit Raj used to be a draconian act discouraging industrial activities in
India. It had created a pessimistic business environment in the country.

Industrial licensing, under the broad umbrella of economic reforms, was abolished for all
industries, except those specified, irrespective of levels of investment. That means,
anyone can set an industrial unit without obtaining a license except certain conditions.
These specified industries (Annex-II), will continue to be subject to compulsory licensing
for reasons related to security and strategic concerns, social reasons, problems related to
safety and over-riding environmental issues, manufacture of products of hazardous nature
and articles of elitist consumption. The exemption from licensing aimed at helping many
dynamic small and medium entrepreneurs who have been unnecessarily hampered by the
licensing system. As a whole the Indian economy will benefit by becoming more
competitive, more efficient and modern and will take its rightful place in the world of
industrial progress.

Foreign Investment: Foreign investments in an economy has several advantages

including technology transfer, marketing expertise, introduction of modern managerial
techniques and new possibilities for promotion of exports. Prior to the LPG reforms
initiated since 1991, The Government had restricted entry of foreign capital through
numerous controls and regulations or tariff and non-tariff barriers. While freeing Indian
industry from official controls, opportunities for promoting foreign investments in India
after 1991 was a step in the right direction. This exposed the Indian industry not only to
foreign capitalbut has brought in advanced technologies, professional experience and
unleash its own potential for a rapid industrial development.

In order to invite foreign investment in high priority industries, requiring large

investments and advanced technology, it has been decided to provide approval for direct
foreign investment upto 51% foreign equity in such industries. This group of industries
has generally been known as the “Appendix I industries” and were areas in which FERA
companies have already been allowed to invest on a discretionary basis. Promotion of
exports of Indian products calls for a systematic exploration of world markets possible
only through intensive and highly professional marketing activities. To the extent that
expertise of this nature is not well developed so far in India. Attraction of substantial
investment and access to high technology involves interaction with some of the world’s
largest international manufacturing and marketing firms.Another important policy move
was replacing FERA with Foreign Exchange Management Act (FEMA). The FEMA
unlike FERA is less regulatory in nature. Presently, the RBI only manages foreign
exchange in the country. It means there are no limits on foreign exchange spending. This
has encouraged import of advanced technologies and superior machines which eventually
benefit local industries in India.

Foreign Technology Agreements:

There is a great need for promoting an industrial environment where the acquisition of
technological capability receives priority. In the fast changing world of technology the
relationship between the suppliers and users of technology must be a continuous one.
Such a relationship becomes difficult to achieve when the approval process includes
unnecessary governmental interference on a case to case basis involving endemic delays
and fostering uncertainty. The Indian entrepreneur has now come of age so that he no
longer needs such bureaucratic clearances of his commercial technology relationships
with foreign technology suppliers. Indian industry can scarcely be competitive with the
rest of the world if it is to operate within such a regulatory environment.

With a view to injecting the desired level of technological dynamism in Indian industry,
Government provides automatic approval for technology agreements related to high
priority industries within specified parameters. Indian companies are free to negotiate the
terms of technology transfer with their foreign counterparts according to their own
commercial judgement. The predictability and independence of action that this measure is
providing to Indian industry is inducing them to develop indigenous competence for the
efficient absorption of foreign technology. Greater competitive pressure induces our
industry to invest much more in research and development than they have been doing in
the past.

Public Sector Policy: The public sector has been central to our philosophy of
development. In the pursuit of our development objectives, public ownership and control
in critical sectors of the economy has played an important role in preventing the
concentration of economic power. It reduces the regional disparities and ensures that
planned development serves the common good. The Industrial Policy Resolution of 1956
gave the public sector a strategic role in economic development. Massive investments
have been made post-independence to build a public sector which has a commanding role
in the economy. Today key sectors of the economy are dominated by mature public
enterprises that have successfully expanded production, opened up new areas of
technology and built up a reserve of technical competence in a number of areas.

After the initial success of the public sector entering new areas of industrial and technical
competence, a number of problems have begun to manifest themselves in many of the
public enterprises. Serious problems are observed in the insufficient growth in
productivity, poor project management, over-manning, lack of continuous technological
upgradation, and inadequate attention to R&D and human resource development. In
addition, public enterprises have shown a very low rate of return on the capital
investment. This has inhibited their ability to regenerate themselves in terms of new
investments as well as in technology development. The result is that many of the public
enterprises have become a burden rather than being an asset to the Government.

Privatization or disinvestment of public sector enterprises (PSEs) is the process of

transferring of the ownership rights from the Government to private sector.
Disinvestment may be undertaken through equity sale at the stock market or strategic sale
to a private company. The term ‘Disinvestment’ was popularized by Keynes. If the entire
government company sold away to private players, and the Government transfers full
control over its ownership to the buyer then it is called privatization. Disinvestment may
be majority disinvestment (Government retaining more than 50% share in the PSE) or
minority disinvestment (Government’s share reduces to below 50%, so influence on
decision making decreases).

The disinvestment process of CPSEs (Central Public Sector Enterprises) in India was
initiated inthe year 1991 with the advent of Government’s new economic policy.
Disinvestment was started mainlythrough sale of minority shareholding in CPSEs and has
considerably evolved over the years influenced bymarket conditions. This is done to
bridge resources gap, and recommendation of bodies like Rangarajan committee and GV
Ramakrishna Disinvestment commission. In 1996, the Government of India set up a
Disinvestment Commission under the Ministry of Industries.The mandate of the
commission was to assess the viability and advice the Government on disinvesting
various PSE's.Many important PSEs like Bharat Aluminium Corporation Limited, Videsh
Sanchar Nagar Limited, Lodhi Hotel, Computer Maintenance Company, Hindustan Zinc
and many more were either privatized or disinvested. Department of Investment and
Public Asset Management (DIPAM) under the Ministry of Finance, Government of India
is tasked with the entire process of disinvestment in India. Disinvestment helped
Government realize massive funds that could be used for welfare activities and financing
of infrastructural developmental projects. However, some of the funds have also been
diverted towards financing of the public debt in the country.

Annual CPSE Disinvestment Target vs. Achievement since 1991-92

Year Target Achieved Achievement
(Rs. Crore) (Rs. Crore) (in per cent)
1991-92 2,500 3,038 121.51
1992-93 2,500 1,913 76.50
1993-94 3,500 0 0.00
 1994-95 4,000 4,843 121.08
1995-96 7,000 168 2.41
1996-97 5,000 380 7.59
1997-98 4,800 910 18.96
1998-99 5,000 5,371 107.42
1999-00 10,000 1,585 15.85
2000-01 10,000 1,871 18.71
2001-02 12,000 3,268 27.24
2002-03 12,000 2,348 19.57
2003-04 14,500 15,547 107.22
2004-05 4,000 2,765 69.12
2005-06 0 1,570 N.A.
2006-07 0 0 N.A.
2007-08 0 4,181 N.A.
2008-09 0 0 N.A.
2009-10 25,000 23,553 94.21
2010-11 40,000 22,763 56.91
2011-12 40,000 14,035 35.09
~
2012-13 30,000 23,857 79.52
2013-14 54,000 21,321 39.48
2014-15 58,425 24,349 41.68
2015-16 69,500 24,058 34.62
2016-17 56,500$ 46,378 82.09
2017-18 72,500 1,00,642 138.82
2018-19 80,000 87,513 109.39
2019-20 90,000 50,294 55.88
2020-21 2,10,000 32,742 15.59
Total 10,97,725 5,29,590 48
Source: Sourced from http://bsepsu.com/Annual_Table.asp

Every year, the government fixes a target for disinvestment of PSEs. For instance, in
1991-92, it was targeted to mobilise Rs 2500 crore through disinvestment. The
government was able to mobilise Rs 3,040 crore more than the target. In 2017–18, the
target was about Rs 1,00,000 crore, and the achievement was about Rs 1,00,057 crore.
Critics point out that the assets of PSEs have been undervalued and sold to the private
sector. This means that there has been a substantial loss to the government and the
outright sale of public assets. Moreover, the proceeds from disinvestment are used to
offset the shortage of government revenues rather than using it for the development of
PSEs and building social infrastructure in the country.

The Disinvestment program has come a long way from the cautious start made in fiscal
1991-92 when small stakes in select CPSEs was divested to financial institutions alone.
As on 31st January, 2018, CPSEs constituted 10.93% and 11.04% of the total market
capitalization of companies listed at BSE and NSE respectively. Government strategies of
disinvestment have taken shape over the years and have been influenced by political
compulsions, budgetary constraints, market conditions and ideology of ruling political
party at the Centre. In a haste of fund-raising funds through privatization/disinvestment,
the government has resorted to multiple shortcuts in the disinvestment process.It has
compromised both the long-term interests of profitable PSUs, and the basic objectives of
the disinvestment programme itself.

There are disadvantages of economic reforms as well. Reforms leads to too much of
dependence on market resulting into unreasonable price rise, undesired allocation of
resources and regional unbalance in the economic development. Availability of funds for
social welfare like health and education and social security benefits etc. may decrease.
Economic reforms increase exposure to global competition eventually leading to Indian
firms, particularly small scale industries, struggling to survive in the long. Undue
political/policy interference by multinational companies may be risky from the point of
view of national security as well as political stability of the nation. Reforms may increase
temptation of the Government to sell profit making public sector enterprises as well. The
process of globalisation through liberalisation and privatisation policies has produced
positive, as well as, negative results both for India and other countries. Some scholars
argue that globalisation should be seen as an opportunity in terms of greater access to
global markets, high technology and increased possibility of large industries of
developing countries to become important players in the international arena. On the
contrary, the critics argue that globalisation is a strategy of the developed countries to
expand their markets in other countries. According to them, it has compromised the
welfare and identity of people belonging to poor countries. It has further been pointed out
that market driven globalisation has widened the economic disparities among nations and
people.

________________________________________________________________________
14.4 Indicators of Industrial Growth
________________________________________________________________________

Trends in performance of Industrial sector are primarily monitored through Index of

Industrial Production (IIP) (monthly) and Annual Survey of Industries, ASI. The Index of
Industrial Production (IIP) is an index which shows the growth rates in different industry
groups of the economy in a stipulated period of time. The IIP index is computed and
published by the Central Statistical Organisation (CSO) on a monthly basis. Whereas
enterprise surveys pursuant to Economic Census provide an idea about the dynamics of
unorganized sector. Ministry of Statistics & PI, through active involvement of both
Central Statistics Office & National Sample Survey Office, is the backbone of Industrial
Statistics in India.Various Ministries/Departments (Department of Industrial Policy and
Promotion, Ministry of Commerce and Industry, Ministry of Micro Small & Medium
Enterprises, Ministry of Corporate Affairs, Indian Bureau of Mines, Ministry of Mines,
Office of Textile Commissioner, Coffee/ Tea Boards etc.) maintain their own statistics.

Indian industry sometimes grew fast, sometimes faster but at times at much slower rates.
The pattern of growth was never same for all years post-independence. The growth trends
in Indian industry can be discussed in various phases as follows.
India Industrial Production
P

Sourcee:https://trad
dingeconomiics.com/india/industrial--production

Phasee I-High Groowth Phase (1950-51 to 1965-66)

This was
w the perio od between 1st plan andd 3rd plan thhat laid downn the foundaation for thee
industtrial develop
pment. Theree was a noticeable acceeleration in industrial ouutput due too
substaantial investtments in thhe industriaal sector, particularly
p in heavy industries inn
manuffacturing andd supportingg infrastructuure.
Phasee ll-Industriaal Decelerati
tion and Stru uctural Retrrogression (11966-80)
Phase of low groowth phase or o industriall deceleratio on from 19665 to 1974. The rate off
% per annum during the 3rd plan to a mere
growthh fell steeplyy from 9.0% m 4.1% per p annum inn
1974. However, th here was a sharp
s increasse of 10.6% in Industriaal productionn in the yearr
1976-777. The raate of industrial growtth for the remaining 4 years comes downn
considderably. Decceleration inn industrial growth duriing the period 1965-1980 indicatess
structu
ural retrogression that pllagued the inndustrial secttor during thhis period.
Phasee III-The Perriod of Indu ustrial Recovvery (1981-1 1991)
The peeriod of 19880s can broaddly be termeed as a perio od of industrrial recoveryy. The rate off
industtrial growth was 6.4% per p annum dduring 1981--85, 8.5% per annum duuring the 7thh
plan and
a 8.3% inn 1990-91. This T is a maarked upturnn from grow wth rates off around 4% %
achievved during thhe latter halff of sixties annd the sevennties. Total fa
factor producctivity whichh
registeered a negattive and neggligible grow wth of -0.2 to -0.3% per p annum in n the periodd
1966-667 to 1979-80 showed a marked im mprovement in the first half of the 80s when itt
registeered a growtth of 3.4% peer annum.
Phasee IV-Reforms Phase (Ju uly 1991 onwwards)
The worst
w industrrial growth was
w observeed in 1991-9 92 when it grew at a raate of 2.3%,
howevver recovered to 6.0% % in 1993--94. Interesstingly,the industrial growth
g thenn
acceleerated to 9.11% in 1994--95 and 13.00% in 1995 5-96 surpasssing the grow wth rates off
1980s. Thereafter,, it declined to 6.1% in 1996-97, thiis deceleratioon continued
d in 1997-988
as welll. The main
n reason for the
t slowdow wn may be thhe tighteningg of the monnetary policyy
in 19995-96 and coonsequent crredit squeezee with high interest rates. The Indusstrial growthh
slowed down in 2000-01 and 2001-02 due to dismal performance by all broad sectors
such as manufacturing, electricity and mining and all end use groups such as capital
goods, intermediate goods and consumer goods, both durable and non-durables.

The year 2004-05 started on a positive note in April 2004 with annual growth of 8.9% in
the Index of Industrial Production (IIP). The year 2004-05 conforms to the normal
historic pattern of industrial buoyancy, 8.4% growth, following a good agricultural year.

The Indian economy has inched closer to the Chinese economy with its dominant
manufacturing sector.

Sectoral Growth Rates as per IIP (%) calculated w.r.t. previous year
Sub-Sector Mining Manufacturing Electricity General
Weights 14.37 77.63 7.99 100.00
2012-13 -5.3 4.8 4.0 3.3
2013-14 -0.1 3.6 6.1 3.3
2014-15 -1.4 3.8 14.8 4.0
2015-16 4.3 2.8 5.7 3.3
2016-17 5.3 4.4 5.8 4.6
2017-18 2.3 4.6 5.4 4.4
2018-19 2.9 3.9 5.2 3.8
2019-20 1.6 -1.4 1.0 -0.8
2020-21 -7.8 -9.6 -0.5 -8.4
Source: RBI

Annual Growth Rates as per IIP (%) calculated w.r.t. previous year
Use- Primary Capital Intermediate Infrastructure/ Consumer Consumer
based goods goods goods construction durables non-
category goods durables
Weight 34.05 8.22 17.22 12.34 12.84 15.33
2012-13 0.5 0.3 5.1 5.4 4.9 6.1
2013-14 2.3 -3.7 4.6 5.7 5.6 3.7
2014-15 3.8 -1.1 6.1 5 4 3.8
2015-16 5 3 1.5 2.8 3.4 2.6
2016-17 4.9 3.2 3.3 3.9 2.9 7.9
2017-18 3.7 4 2.3 5.6 0.8 10.6
2018-19 3.5 2.7 0.9 7.3 5.5 4
2019-20 0.7 -13.9 9.1 -3.6 -8.7 -0.1
2020-21 -7 -18.6 -9.4 -8.7 -15 -2.2
Source: RBI

It is important to note that the annual growth rate as per the IIP data for the period
between 2012-13 and 2020-21 shows that movement has relatively slowed down to
below 5% in all the sub-sectors of industrial sector, be it primary goods or capital goods.
Further, the growth rates of the three major sub-sectors of manufacturing, namely,
mining, manufacturing and electricity, one can see a downward trend during the same
period. Slowdown in industrial performance is not a good sign for overall economy of the
country because, for instance, manufacturing, value added (% of GDP) in India was
reported at 12.96 % of GDP in 2020. The COVID-19 pandemic is visibly having an
adverse impact on the industrial activities in India.

Self-assessment Exercise B
1) Write four features of new industrial policy, 1991.
………………………………………………………………………………..........
………………………………………………………………………………..........
………………………………………………………………………………..........
2) Write three advantages of foreign investment.
…………………………………………………………………………………......
………………………………………………………………………………..........
…………………………………………………………………………………......
3) What do you mean by Liberalization, Privatization and Globalization?
………………………………………………………………………………….….
……………………………………………………………………………………..
……………………………………………………………………………………..
……………………………………………………………………………………..
________________________________________________________________________
14.5 Let Us Sum Up
________________________________________________________________________

Evidently, in the process of evolution of industrial policy in India, the Government’s

intervention has been extensive. Unlike many East Asian countries which used the State
intervention to build strong private sector industries, India opted for the State control over
key industries in the initial phase of development. In order to promote these industries the
Government not only levied high tariffs and imposed import restrictions, but also
subsidized the nationalized firms, directed investment funds to them, and controlled both
land use and many prices.
In India, there has been a consensus for long on the role of government in providing
infrastructure and maintaining stable macroeconomic policies. However, the path to be
pursued toward industrial development has evolved over time. The form of government
intervention in the development strategy needs to be chosen from the two alternatives:
‘Outward-looking development policies’ encourage not only free trade but also the free
movement of capital, workers and enterprises. By contrast, ‘inward-looking development
policies’ stress the need for one’s own style of development. India initially adopted the
latter strategy.
The advocates of import substitution in India believed that we should substitute imports
with domestic production of both consumer goods and sophisticated manufactured items
while ensuring imposition of high tariffs and quotas on imports. In the long run, these
advocates cite the benefits of greater domestic industrial diversification and the ultimate
ability to export previously protected manufactured goods. This facilitated the economies
of scale, low labour costs, and the positive externalities of learning by doing cause
domestic prices to become more competitive than world prices. However, pursuit of such
a policy forced the Indian industry to have low and inferior technology. It did not expose
the industry to the rigours of competition and therefore it resulted in low efficiency. The
inferior technology and inefficient production practices coupled with focus on traditional
sectors choked further expansion of the Indian industry and thereby limited its ability to
expand employment opportunities. Considering these inadequacies, the reforms currently
underway aim at infusing the state of the art technology, increasing domestic and external
competition and diversification of the industrial base. Such activities will create
additional employment opportunities.
In retrospect, the Industrial Policy Resolutions of 1948 and 1956 reflected the desire of
the Indian State to achieve self-sufficiency in industrial production. Huge investments by
the State in heavy industries were designed to put the Indian industry on a higher long-
term growth trajectory. With limited availability of foreign exchange, the effort of the
Government was to encourage domestic production. This basic strategy guided
industrialization until the mid-1980s.
Till the onset of reform process in 1991, industrial licensing played a crucial role in
channeling investments, controlling entry and expansion of capacity in the Indian
industrial sector. As such industrialization occurred in a protected environment, which led
to various distortions. Tariffs and quantitative controls largely kept foreign competition
out of the domestic market, and most Indian manufacturers looked on exports only as a
residual possibility. Little attention was paid to ensure product quality, undertaking R&D
for technological development and achieving economies of scale. The industrial policy
announced in 1991, however, substantially dispensed with industrial licensing and
facilitated foreign investment and technology transfers. These activities threw open the
areas hitherto reserved for the public sector.
The policy focus in the recent years has been on deregulating the Indian industry,
enabling industrial restructuring, allowing the industry freedom and flexibility in
responding to market forces. It provides a business environment that facilitates and
fosters overall industrial growth. The future growth of the Indian industry as widely
believed, is crucially dependent upon improving the overall productivity of the
manufacturing sector, rationalisation of the duty structure, technological upgradation, the
search for export markets through promotional efforts and trade agreements and creating
an enabling legal environment.
________________________________________________________________________
14.6 Key Words
________________________________________________________________________

Industrial policy:Industrial policy refers to any type of selective government

intervention or policy that attempts to alter the structure of production in favour of sectors
that are expected to offer better prospects for economic growth.
Industrial licensing: Industrial licensing was a system of obtaining a license through a
complex procedure, lengthy documentation and mal-practicing from the Government for
setting up an industry.
FERA:Foreign Exchange Regulation Act is a legislation that came into existence in 1973
with the purpose to regulate certain dealings in foreign exchange, impose restrictions on
certain kinds of payments and to monitor the transactions impinging the foreign exchange
and the import and export of currency.
Disinvestment: Disinvestment means sale or liquidation of assets by the government,
usually Central and state public sector enterprises, projects, or other fixed assets.
Globalization:Globalization is the process of interaction and integration among people,
companies, and governments worldwide.
________________________________________________________________________
14.7 Terminal Questions
________________________________________________________________________

Short questions
1. Define industrial policy.
2. Distinguish between privatization and disinvestment.
3. Define industrial licensing.
4. Explain the meaning globalization.
5. Define liberalization.
6. Give two reasons behind privatization of public sector enterprises.
7. How was the state of economic affairs of the economy of India during the early
years of 1990s that led to LPG reforms in the country?
Essay type of questions
1. Discuss in detail Industrial Policy Resolution, 1956.
2. Explain in detail LPG reforms initiated in India since 1991.
3. Discuss how state controls and regulations like MRTP Act, FERA and Industrial
Licensing acted as obstacles on the road of industrialization.
4. Discuss in detail indicators of industrial growth in India.

Note: These questions/exercise will help you understand the unit better. Try to
write answers for them. But do not submit your answers to the University for
assessment. These are for your practice only.

________________________________________________________________________
Further reading
________________________________________________________________________

The following textbooks and online resources can be referred for further in-depth
reading on the topics discussed in this unit.
Ahluwalia, I.J. and I.M.D., Little (1998). India’s Economic Reforms and
Development, Oxford University Press, New Delhi.
 Bhagwati, Jagdish (2004).In Defense of Globalization, Ukraine: Oxford University
Press, March.
Baldev, Raj Nayar (2014). Globalization and India's Economic Integration, South
Asia in World Affairs Series, Georgetown University Press.
Bhattacharjee, Govind (2020). Public Sector Enterprises in India: Evolution,
Privatisation and Reforms, New Delhi: Sage Publications, July 29.
Bhaduri, Amit and Deepak Nayyar (1996). The Intelligent Person’s Guide to
Liberalisation, Penguin, Delhi.
Government of India Handbook of Industrial Policy and Statistics (Various Issues),
Office of Economic Adviser, Ministry of Commerce and Industry, New Delhi.
Guha, Ashok (Ed.) (1990). Economic Liberalisation, Industrial Structure and
Growth in India. Oxford University Press, New Delhi.
Handbook of Statistics on Indian Economy, Reserve Bank of India for various years,
Mumbai.
Mohan, Rakesh (Ed.) (2017). India Transformed: 25 Years of Economic Reforms,
Brookings Institution Press, August 23.
Sachs, Jeffrey D., AshutoshVarshney and NirupamBajpai (1999). India in the Era of
Economic Reforms, Oxford University Press, New Delhi.
Jalan, Bimal (1996). India’s Economic Policy: Preparing for the Twenty First
Century, Viking, Delhi.
Online references:
https://ncert.nic.in/textbook/pdf/jess204.pdf
https://ncert.nic.in/textbook/pdf/keec103.pdf
https://dipam.gov.in
 Unit-15: Public and Private Sector

Structure
15.0 Objectives
15.1 Introduction
15.2 Concept and features of Public Sector and Private Sector
15.2.1 Concept and features of Public Sector
15.2.2 Concept and features of Private Sector
15.3 Role and Importance of the Public Sector and Private
Sector
15.3.1 Role and Importance of the Public Sector
15.3.2 Role and Importance of the Private Sector
15.4 Difference between Public & Private Sector
15.5 Public-Private Partnership Model and Application
15.6 India and PPP Model
15.7 Forms of PPP in India
15.7.1 Government Incentives for PPPs
15.7.2 Challenges before PPPs
15.7.3 Way Forward
15.8 Let Us Sum Up
15.9 Key Terms
15.10 Terminal exercises

1
 15.0 Objectives
After studying this unit, you will be able to:
• Explain the meaning of public and private sector;
• Describe the respective roles of public and private sector in the economy;
• Give a comparative view of public and private sector;
• Discuss the contribution of public and private sector in India;
• Define the public-private partnership;
• Analyse the different models of PPP and their application;
• Indicate the challenges before PPP in India;

15.1 Introduction
Private sector is managed by private individuals. The primary focus of
companies in the private sector is making a profit. Private sector entities have
less exposure to government interference. There are numerous types of
undertakings in the private sector like retail, manufacturing, local services etc.
The role of the private sector is integral to the development of an economy. Not
only does the private sector contribute to national income, but it is also a
principal job provider. The private sector needs a good public sector and stable
macro-economic environment.
The public sector is owned and managed by the government (central, state and
local). Governments provide public goods. Many argue that national defense is
an important public good because the security of the nation benefits all its
citizens which is financed through taxation. Individual countries will reach
different decisions as to which goods and services should be considered public
goods, and this is often reflected in their national budgets. Both the public and
private sector have a role to play.Choosing the right policies to promote
economic growth and development is essential.
In India,since 1991 private sector financing through public-private partnerships
(PPP) has become increasingly popular as a way of procuring, renewing and
maintaining public sector infrastructure in many sectors such as social
infrastructure, transportation, public utilities, communications, government
offices and others in which public services are provided.

2
 In this unit you will learn the concept of public and private sector, their role in
the economy and a comparison of both the sectors. Along with this the
relationship between them is explained through the concept of public-private
partnership. The Government has focused on developing several enabling tools
and activities to spur private sector investments in India through public-private
partnerships (PPPs).

15.2 Concept and features of Public Sector and Private Sector

You must be watching in the news about the scenario of Public Sector and
Private sector. Let us learn what do we mean by Public Sector and Private Sector
and what are their features.
15.2.1 Conceptand features Public Sector
Some goods and services are best provided by the public sector to make sure that
everyone benefits equally. The government needs to provide such goods having
the characteristics of public goods. A public good refers to a commodity or
service that is made available to all members of a society. There are the two
important criteria that distinguish a public good:
(i) it must be non-rivalrous and
(ii) Non-excludable.
Non-rivalrous means that the goods do not decrease in supply as more people
consume them.Non-excludability means that the good is available to all citizens.
These services are administered by governments and available to all. The cost of
public good is collectively paid for through taxation. Examples of public goods
are law and order enforcement, defense, the rule of law and the judicial system.
Public goods also refer to more basic goods, such as access to clean air, drinking
water, use and conservation of natural resources etc. Some countries also treat
social services–such as healthcare and public education–as a type of public good.
Government spending on public goods provide economic and social benefits to
the community which significantly outweigh its costs. The main objective of
public sector is to serve the public interest. The government ensures public
welfare. It is not out of place to mention that Government-owned companies also
make a profit, but the underlying tone remains public welfare.

3
 The private sector will not provide public goods because of the free-rider
problem.This problem happens because some members of a community fail to
contribute their fair share to the costs of a shared resource. Free riding is
considered a failure of the market system. Non-payment for the service/good
makes it infeasible to produce economically.

A mixed economy has a mixture of the both public and private sectors. India has
a mixed economy and the mixture depends on requirements of the economy to
balance profit-making and social welfare.

The public sector includes all government organizations, including the central
government, states, and local. Some government agencies operate as
“corporations.” These agencies are established by an act of Parliament to provide
public services.

Features of public sector: Following are important feature of the public sector:
(i) More stable business and services: Businesses and services in
the public sector are more stable than private ones. By and large
they are not profit driven.
(ii) Job security: Job security and other related facilities is one of the
many appealing features public sector possess and provide a
better and congenial working environment. Working in or with
the public sector holds many advantages for employees, and
consumers.
(iii) Reinvestment of profits: Whatever profits earned are reinvested
in the business and the community.
(iv) Ownership and Control: In India, the public sector ownership,
control and management by a government body can be complete
or partial. These companies usually come under specific
ministries and are functionally administered by them.It is to be
noted that there are types of public sector organisations which

4
 include departmental undertakings (e.g. Railways, Posts, etc.),
statutory corporationse.g. SBI, LIC, etc.) and government
companies(e.g. HPCL, IOCL, etc.).

15.2.2. Concepts and features of Private Sector

The private sector is a part of the national economy that is not owned by the
government. They conduct their operation through companies or entrepreneurs
who mainly focus on earning profit and seekcustomer’s satisfaction.Companies
in the private sector are usually free from state ownership or control. However,
sometimes the private sector can collaborate with the government in a public-
private partnership to jointly deliver a service or business venture to the
community. The private sector makes up a big part of Indian economy.The
extent of private sector participation in infrastructurevaries across sectors and with
the level of national economic development.

Features of the private sector: The main features of the private sector are:

(i) Profit motive: Profits provide reward for the risk taken and the
required return on capital.
(ii) Private ownership and control: Private entrepreneurs own, control
and manage the business. Each formation has its benefits and
legalities depending upon the number of employees, source of
funding, business scale, and government regulations.
(a) When the ownership belongs to a single person, company
is referred to as a sole proprietorship. It is a business
owned, incorporated, and sustained by one person. The
proprietor can employ others for conducting and managing
the business. It bears an unlimited liability towards the
business debts. Privately owned small- and medium-size
businesses constitute the bulk of the private sector. Small
professional entities, like doctors' and lawyers' offices,
plumbers, technicians, contractors, developers and
designers etc. also fall under this category.

5
 (b) Under partnershipa group of persons jointly own a firm.In
partnerships, two or more people come together to conduct
a business. It has lesser legal compliances than a company.
The partners are subjected to unlimited personal liability on
the business debts.
(c) A joint-stock company is a business owned by its investors,
with each investor owning a share based on the amount of
stock purchased. Joint-stock companies are formed in order
to access huge amount of finance for large scale production
which is not possible for an individual to fund. It is created
to fulfil organizational goals. A company is often funded
by debt-equity. It enjoys a separate legal identity and has
certain rights. The owners of a company are called
shareholders. These are the people who invest capital and
are the prime decision-makers for business-related matters.
Employees usually work under a board of directors. The
directors are responsible for carrying the business of a
company based on the decisions taken by the shareholders
in the Annual General Meeting.Large Corporate firms
constitute the most prominent entities of the private sector.
Their importance results from exerting considerable
political and economic influence. Government agencies
exercise regulations on them but do not control them.
(iii) No state interference: There is no interference by the governments in
the ownership and control of a private sector firm. However, any
business or corporate entity operating in the country must operate
under the laws of the land.
(iv) Independent management: The management of the private sector
firm wholly depends on its owners. A sole proprietorship firm is
managed by the ownerwho takesall the decisions and acts on behalf
of the company in legal matters. In the case of management of a
joint-stock company a group of directors who are elected
representatives of the shareholders are responsible for the operation
of the company.

6
 (v) Private finance: The private sector firms raise capital from their
owners or shareholders by varied means. Under a sole proprietorship
the owner contributes capital, and partners invest capital in case of a
partnership. A joint-stock company raises capital through the issue
of share and debentures (a type of long-term debt). It is well to
remember that it depends on the financial strength of the firm,
companies with sounds financials have better options to mobilize
more funds from the market.
(vi) Work culture of employees: The private sector has a competitive
work culture andemployees’performance is very important for
career growth and higher compensation.

Check your progress I

1. What is the private sector?

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2. Explain the concept of public sector?

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3. Give four features of private sector?

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4. Point out four important features of public sector?

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5. How is public sector organized?

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15.3 The Role and Importance of the Public and Private Sector
You have learnt about the concepts and features of Public Sector and Private
Sector. Let us now learn the role and importance of Public Sector and Private
Sector.

15.3.1 Role and importance of Public sector

In early years of India’s independence, capital was scarce and the base of
entrepreneurship was also not strong enough. Hence, the 1956 Industrial Policy
Resolution gave primacy to the role of the public sector which was directly
responsible for industrial development. The strategies for the public sector were
later outlined in the policy statements in the years 1973, 1977, 1980 and 1991.
The year 1991 can be termed as the watershed year, heralding liberalisation of
the Indian economy.

The public sector provided the required thrust to the economy and developed and
nurtured the human resources, the vital ingredient for success of any
enterprise.The public sector emerged as the driver of economic growth. In India,
the public sector is made up of different manufacturing and services which are
run by the government. This is evident from the fact that starting with heavy
capital goods industries, services like transport, communication, and further
extended to academic institutions (schools, colleges, universities, libraries),

8
 health services (institutions and hospitals) to various welfare services. The public
sector as a whole employs millions of peoples in India. It provides a lot of job
opportunities for those interested in a range of career paths.

Over the years, operations of PSEs covers a wide range of activities in the
manufacturing, engineering, steel, heavy machinery, machine tools, fertilizers,
drugs, textiles, pharmaceuticals, petro-chemicals, extraction and refining of
crude oil and services such as telecommunication, trading, tourism, warehousing,
etc. and a range of consultancy services.

Challenges before public sector: With the advent of globalization, the public
sector faced new challenges. No longer the public sector had the privilege of
operating in a sellers’ market and had to face competition both from domestic
and international competitors. Since 1980s there has been a feeling that the
public sector is a burden for the economy. This is largely because of the factors
like (Giovanni Tria, 2014):

(i) bureaucracy and delays in the decision making processes

(ii) irrational taxation,

(iii) hyper-regulation,

(iv) regulatory uncertainty,

(v) inefficiency,

(vi) inability in understanding the problems facing enterprises, and

(vii) absence of knowledgeabout how the markets work.

Technologies can change the public sectors as they have changed a lot of areas in
the private one.Giovanni Tria (2014) emphasised that “the public sector must
take the opportunity coming from the digital innovation to change the way of
thinking: the power does not arise from the ownership of data, but from the

9
 quality of services.Digital transformation can create a new relationship between
public and private sector”.

Liberalising and deregulatory steps were initiated from the year 1991 onwards.
Since then, the thrust has been on reduction of areas reserved exclusively for
public sector and disinvestment of equity of selected public sector enterprises
(PSEs).It was recognised that public enterprises could not compete effectively
with private entrepreneurs without freedom to function and operate
commercially. The public sector needs to change its way of thinking. Financing
the economy’s infrastructure needs will require greater outlays from the public
sector and a more-than-proportionate increase in private investment.

Many scholars have argued that public sector must not venture into those areas,
where the private sector could undertake job efficiently and emphasis was laid
on market driven economy. As of 2022, policy makers getting convinced that
role of the government should be that of a facilitator and regulator rather than the
producer and manager.

15.3.2 Role and importance of Private sector

The private sector has many roles concerning the society and national
economy.The role of private sector is explained below:

(i) Significant stakeholders of the economy: When private firms develop

industrial areas, plants, and job-hubs, they also develop the areas around
them. For example, as per a 2017 study, in India, the private sector’s
share in providing jobs had been over 90 percent, while it also
contributed over 75 percent to domestic capital formation (Harsh
Sachdeva). As such, they enhance the GDP, per capita income,
infrastructure, and quality of life.The private sector is an important
player in the economy due to the input it makes to the national income.
Particularly, contributes to tax revenues and ensures the efficient flow of
capital.

10
 (ii) Generate employment: The private sector plays the pivotal role of
generating employment opportunities in the country. Private firms
employ a major portion of the labour force and act as the backbone of
employment.
(iii) Assist in development: The private sector enhances the process of
industrialization. By introducing new commodities, equipment,
machinery and technology, companies in the private sector produce
innovative ideas that modify methods of production and lead to better
economic development. The intense competition forces the companies
to develop newer technologies and ways to cut down resource wastage.
Also, to satisfy the customers better, companies develop innovative
products and services that have improved the quality of life.
(iv) Provision of goods and services: The sector is responsible for providing
essential goods and services to most citizens of the country at a
competitive price.
(v) Promote diversification of business: The private sector encompasses
varied businesses and provides new companies with the opportunity to
develop no matter the type of business. With this freedom, private
companies are able to diversify their operations.
(vi) Some industrial houses in India have played a major role in
industrialisation of the country. They are often cited as examples of
successful entrepreneurs in the country. Though some have existed
since the pre-independence time, others have come up later. Successful
diversification has been an important feature of operation of the
industrial houses.

The importance of private sector in Indian economy since 1990s has been
enormous. Liberalisation has led to inflow of foreign direct investment (FDI)
along with modern technology, which provided ample incentive to private sector
to grow faster. This also fueled competition amongst same industry players as
well as in public sector enterprises.

There has been faster increase in total investment of private sector. These
investments were made in sectors like financial services, transport, social
services, manufacturing, infrastructure, agriculture products, information

11
 technology and telecommunication. Manufacturing companies covering sectors
like automobile, chemicals, textiles, agri-foods, computer hardware,
telecommunication equipment, and petrochemical products are the main driver
of growth of Indian economy. As of early 2022, the trend shows a marked
increase in investment in areas covering pharmaceutical, biotechnology,
semiconductor, contract research and product research and development.

Challenges before private sector: The private sector is constrained by the

multiple regulations governing the entry, exit, and operations of firms. These
pose an enormous compliance burden—especially on MSMEs that have limited
resources—and discourage entrepreneurial talent and reduce jobs. Multiple land
acquisition policies and variations in rules on how land can be acquired and
compensation paid to the land seller haveadded to the complexity of doing
business. Securing environmental clearances for new projects has also been a key
roadblock for investors.

Both have a role in the economy: For the progress and development of the
country, both the sectors must go hand in hand as only one sector cannot lead the
country to the path of success.Stiglitz (2016) has highlighted that in all successful
economies, private sector has played an important role. MSME’s have played an
especially important role in job creation. But MSME’s often face special
problems in accessing finance.

15.4 Difference between Public & Private Sector

There are some structural and operational differences between public and private
sector Jean Murray (2021) has explained the main differences between public
and private sector in the following way:

(i) Profit Incentive. Private firms have a profit incentive to cut

costs and develop products demanded by consumers. Whereas
in the public sector, this profit motive is often absent.
Therefore, government bodies have a greater tendency to be
overstaffed and inefficient.

12
 (ii) Ownership: Individuals own private-sector businesses.
Governmental agencies arenot owned by individuals; they are
owned by and operate on behalf of the public through
officials.
(iii) In the private sector working environment is quite competitive
which is missing in the public sector because they are not
established to meet commercial objectives. The employees of
the public sector have the security of the job along with that
they are given the benefits of allowances, perquisites, and
retirement benefits like gratuity, pension, etc. which are
generally not available in the case of the private sector.
(iv) Employment: Employment differs between the public and
private sectors. In the public sector, civil service employees
work for central, state, or local government agencies. They
receive pay and benefits under different systems than private
employees. In the private sector, employers have more
flexibility. Each employer can set its own employment rules,
as long as they abide by central and state employment laws.

(v) Efficiency and Productivity: Because private-sector businesses are

focused on making a profit, they are often considered more
productive and competitive. Public-sector organizations, on the
other hand, are de facto monopolies. As there is no incentive to
make a profit, public organizations tend to be less efficient and less
productive. Still, public-sector organizations have an important
role in the economy by providing public goods, reducing
unemployment, and stabilizing the economy.
(vi) Bureaucracy. For political reasons, it is sometimes more difficult
to get rid of surplus workers in the public sector than the private
sector. Private businessmen donot have to worry about political
popularity and so it is easier to retrench more employees if it helps
efficiency and profit. The public sector, on the other hand, is more
likely to employ surplus workers in unproductive jobs.

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 In general public sector uses seniority for promoting employees, however, merit
cum seniority is also taken as a base for promoting employees. Unlike private
sector, where performance is everything, and so merit is considered as a
parameter to promote them.
Check your progress II
1. What is the role of the private sector?
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2. Who is the single biggest creator of jobs?
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3. Highlight four importance of public sector in Indian economy?
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4. What goes wrong in public sector? Give four factors.
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5. Distinguish between Public sector and Private sector?
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14
 6. Indicate four challenges faced by private sector?
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--------------------------
15.5 Public-Private Partnership Model and Application
The expression PPP is a widely used concept world over but is often not clearly
defined.World Bank (2012) has defined“public–private partnership (PPP) as a
long-term contract between a private party and a government agency for
providing a public asset or service, in which the private party bears significant
risk and management responsibility”. Private sector businesses leverage
governmental assets and resources while developing, financing, owning and
operating public facilities or services.

The private sector may also contribute investment capital depending on the form
of contract. As regards allocation of risks, the design of contract should take into
account who are best able to manage those risks so that costs are minimizedalong
with improvementin performance.

PPPs have become an increasingly popular way to get major infrastructure

projects built. PPPs rely on the recognition that public and private sectors each
have certain advantages relative to other in performing specific tasks. The
responsibilities of the private sector could entail finance, design, construction,
operation, management and maintenance of the project.

Rationale for PPPs:There are following major aspects that drive governments to
enter into PPPs for infrastructure projects. (ADB 2008):

(i) Inadequacy of funds with the governments is the main reason to

mobilize private sector capital for infrastructure investment.
(ii) The government aims to increase efficiency and use available
resources more effectively.Since the public sector is structured
in such a way that it has no incentives for efficiency to build
and operate infrastructure projects.

15
 (iii) The intention is to push reform through a reallocation of roles,
incentives, and accountability. PPP provides an opportunity to
reallocate respective roles of public and private sector.
(iv) Setting the optimal level of private-sector participation and risk
transfer should result in projects being completed on time and
on budget. Private-sector risk-management capabilities look at
the entire spectrum of relevant risks, often with a particular
focus on their potential commercial and financial effects.

In meeting the public needs there exists a growing acceptance that private sector
partnerships serve as an additional and complementary instrument to supply of
infrastructure and services. However, there are no any standardized and globally
accepted schemes of public and private sector relations which fit to all
economies. Governments choose the level and coverage of private sector
engagement in consistent with economic profile, fiscal condition and business
environment.

How to make PPPs a successful venture? PPPs are complex arrangements and
can create potential problems for both the public and the private sectors if they
are not properly designed and administered. This requires precautionary
measures for the success of PPPs. Ultimately, the success of PPPs depends not
only on developing mutual trust between government officials and private sector
executives, but on building and maintaining public confidence in the integrity of
the partnerships (Rondinelli, 2004). For PPPs to work effectively, governments
must retain responsibility and accountability for deciding among competing
objectives; define chosen objectives for services provision; set standards, criteria,
output targets; and safeguard the broader public interest. To implement PPP
transaction requires the passage of laws and establishment of separate regulatory
bodies. This is essential for the success of a PPP project.

Features of PPP: The main features of PPP are:

(i) PPP describes a range of possible relationships among public and

private entities in the context of development, infrastructure and other
services (ADB, 2008).

16
 (ii) The purpose is to make use of private sector’s expertise in commerce,
management, operations, and innovation to run the business efficiently.
(iii) Governments contract with private organizations takes place
through three types of contracts:
a. Service contracts. Contracts with a private firm to provide a
specific service for a specified period of time.
b. Management Contracts. Contracts to provide services more
efficiently while maintaining ownership control.
c. Lease Contracts. Used extensively for both public services and
commercial operations.
(iv) Co-ownership or co-financing of projects,
(v) Build operate-transfer (BOT) arrangements,
(vi) Governments around the world use turnkey projects with consortia of
private companies to build telecommunications, transport, shipping,
airport, utility, and water and sewerage infrastructure.
(vii) There are benefits for both citizens and governments in PPP
arrangement. PPPs facilitate to the generation of resources and
knowledge transfer.

15.6 India and PPP Model

You have learnt the features, importance and difference between public sector
and private sector as well as their model. Let us now learn PPP model in Indian
context.

In the Indian context, the term PPP is used very loosely. According to the
National Public Private Partnership Policy 2011, “a Public Private Partnership
(PPP) means an arrangement between the government/statutory
entity/government owned entity on one side and a private sector entity on the
other, for the provision of public assets and/or public services, through
investments being made and/or management being undertaken by the private
sector entity. This is done for a specified period of time, where there is well
defined allocation of risk between the private sector and the public entity.The
private entity receives performance linked payments that conform (or are

17
 benchmarked) to specified and pre-determined performance standards,
measurable by the public entity or its representative”.

Since the need of infrastructural development in India is on the rise, the public
private partnership is the way to go forward as it provides innovation, diversity,
and higher productivity, efficient and cost effective delivery of projects. With the
announcement of industrial policy of July 1991, a new wave for PPP was felt and
it was decided to allow private participation in the power sector which opened up
the doors for independent power producers. The National Highways Act, 1956
was altered in 1995 to empower private support. In 1994, through a focused
offering process, licenses were conceded to eight-cell cellular telephone utility
administrators in four metro urban areas and 14 administrators in 18 state circles.
The main objectives of pursuing PPP model in India relate to the following:
(i) Better infrastructure.
(ii) Risk sharing.
(iii) Optimum allocation of resources.
(iv) Innovations.
(v) Aid in growth of other sectors.
(vi) The catalyst for the economy.
(vii) More employment generation.
(viii) Improve the image of the country.
(ix) Attract foreign direct investment (FDI).
For smooth operation of PPP a separate wing has been setupin 2006 under
Department of Economic Affairs (DEA), Ministry of Finance. This wing acts as
the Secretariat for Public Private Partnership Appraisal Committee (PPPAC),
Empowered Committee (EC), and Empowered Institution (EI) for the projects
proposed for financial support through Viability Gap Fund (VGF).
The PPP Cell is responsible for policy level matters concerning PPPs, including
policies, schemes, programmes, model concession agreements and capacity
building. The PPP Cell is also responsible for matters and proposals relating to
clearance by PPPAC, scheme for financial support to PPPs in infrastructure
(VGF Scheme) and India Infrastructure Project Development Fund (IIPDF).

18
 15.7 Forms of PPP in India
In India PPPs take a wide range of forms varying in the degree of purpose,
involvement of the private entity, legal structure and risk sharing. The private
sector participation in the infrastructure building have broadly been taken place
through corporatisation of existing PSUs (e.g. GAIL, ONGC, IOC, etc),
greenfield investment for development of new projects. PPP in the form of BOT
or BOOT model in the road sector and concession agreements with the private
sector such as rehabilitate, operate, and transfer (Lakshmanan, 2008). India
majorly follows 3 types of PPP models out of many models available. They are:
(i) Hybrid Annuity Model (HAM)
(ii) Build-Operate-Transfer (BOT)
(iii) Engineer-Procure-Construct (EPC)

Table 15.1 Differences among BOT, EPC and HAM.

BOT EPC HAM

Private (60 per

cent)
Risk Private Public
Public (40 per
cent)

Private (60 per

cent)
Finance Private Public
Public (40 per
cent)

Operations and Management Private Public Private

Revenue Private Public Public

HAM is a mixture of BOT and EPC where the financing, risks, operations, etc,
are distributed between Government and a private partner. Look at Table 15.1
which shows the difference in these models:
(source: https://www.jatinverma.org/public-private-partnership-in-india)

19
 (i) BOT (build operate transfer) models used for two-thirds of the
total PPP projects in India. User-fee based BOT model widely
used in medium- to large-scale projects, especially in energy
and transport (road, ports and airports). Annuity-based BOT
model commonly used in sectors/projects not meant for cost
recovery by levying a fee on sectors such as health and
education.
(ii) Modified design-build (turnkey) contracts yield time and cost saving
benefits; also enable efficient risk-sharing and improve quality.
(iii) Performance- based management/ maintenance contracts
suitable for sectors (water supply, sanitation, solid waste
management and road maintenance) constrained by the
availability of economic resources to improve efficiency

15.7.1 Government incentives for PPPs

The Government has facilitated the PPP sector by offering:
(i) Viability Gap Funding (VGF): Viability Gap Funding of up to 40
per cent of the cost of the project can be accessed in the form of a
capital grant.
(ii) India Infrastructure Project Development Fund (IIPDF): It helps
the Central and the State Governments and local bodies through
financial support for project development activities (feasibility
reports, project structuring etc.) for PPP projects.
(iii) India Infrastructure Finance Company Ltd(IIFCL): It provides
long-term debt for financing infrastructure projects that typically
involve long gestation periods since debt finance for such projects
should be sufficient to meet the requirements.
(iv) Foreign Direct Investment (FDI): Up to 100 per cent FDI in equity
of special purpose vehicles (SPVs) in the PPP sector is allowed on
the automatic route for most sectors.The proposals shall include
the requisite information necessary for satisfying the eligibility
criteria.
Contribution of PPP: It is pertinent to note that PPPs have contributed towards
the growth and development of the Indian economy in multiple ways. For
example, several airports including Mumbai airport and the T3 of Delhi airport

20
 are built on the PPP model. The PPP has seen several successful infrastructural
projects over the past decade.
It has rightly been observed that “selection of right PPP model for a right project
at a right time through realistic planning would go a long way in providing
meaningful and hassle free infrastructure development. This will ultimately
increase the infrastructure standards and thereby sustain the overall
macroeconomic developments of the country” (Lakshmanan, 2008).
Aman Hans (2017), a NITI Aayog specialist in PPP has pointed out that “a
mature PPP framework, along with a robust enabling ecosystem shall enable the
Government to accomplish to a considerable extent that “the government has no
business to do business”. Thus promote private sector investments and
participation towards the nation building”. PPP is emerging as the new success
route in India’s attempts to build world-class infrastructure. The prospect of
future investments is bright because PPP investments are being pulled by
increased demand for infrastructure services.

15.7.2Challenges before PPPs

A number of negativities have surfaced in the forms of various bottlenecks and
challenges. In India challenges arise from overextended balance sheets, contract
disputes, land acquisition problems, and lack of a dispute-resolution mechanism.
Ray(2014) and Khan (2021)both have highlighted the following challenges:
(i) As with any situation where ownership and decision rights are
separated, public-private partnerships can create
complex principal-agent problems.
(ii) Regulatory Approvals for Projects: The key execution
challenges during construction project that developer’s face
include: acquisition of land and right of way, securing
necessary clearances, and financial closure.
(iii) Project authorities are finding it difficult to implement
initiatives that are afflicted by higher cost inflation and/or
unrealistic estimates of streams of expected revenue.
(iv) Some approved projects get delayed or abandoned because
investors cannot secure financial closure due to their
unrealistically aggressive bids.

21
 (v) The most important challenge before state governments is to
develop well-designed PPP projects in social infrastructure so
that private investors, including NGOs, are sufficiently
motivated to invest.
(vi) Changes in the PPP model during execution: Given the long-
term nature of these projects, it is difficult to identify all
possible contingencies and issues that may come up during
project development. The parties may not have anticipated
these contingencies when the contract was signed.
(vii) It is also possible that some of the projects may fail or may be
terminated prior to the projected term of the project. The
reasons may be changes in government policy, failure by the
private operator or the government to perform their
obligations, or due to external circumstances.
(viii) In certain cases, environment and social considerations are
also important. These issues can become very complicated and
politically challenging.

15.7.3 Way Forward

To develop the PPP projects in India, the Kelkar Committee (2015)
recommended that:
(i) PPPs should not be used by the government to evade its
responsibility for service delivery to citizens.
(ii) This model should be adopted only after checking its viability for
a project, in terms of costs and risks. PPP structures should not be
adopted for very small projects, since the benefits are not
commensurate with the costs.
(iii) PPP must not be a short cut only to save money or bridge fiscal
gaps or transfer risks. It should be used to improve service
quality or bring efficiency improvements.
(iv) The prevention of Corruption Act, 1988 should be amended to
distinguish between genuine errors in decision making and acts
of corruption by public servants.

22
 The committee has emphasised that India’s success in deploying PPPs as an
important instrument for creating infrastructure will depend on a change in
attitude and in the mind-set of all authorities dealing with PPPs. The public
agencies partnering with the private sector, government departments supervising
PPPs, and auditing and legislative institutions providing oversight of PPPs
should have positive attitude towards PPPs.

Check your progress III

1.What do you mean by Public-Private Partnerships?
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2. Indicate three rationale of Public-Private Partnership.
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--------------------------
3. Explain three areas where PPP is desirable?
------------------------------------------------------------------------------------------
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--------------------------
4. Write three incentives which government provide for having PPP in
India?
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--------------------------
5. Write three recommendation of Kelkar committee for improving
working of PPP in India?
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--------------------------

23
 15.8 Let Us Sum Up

The private sector consists of all privately owned, for-profit businesses in the
economy. It is a major part of the economy and encompasses all for-profit
businesses that are not owned or operated by the government. The private sector
is the main provider of goods and services. Companies and corporations that are
government run are part of what is known as the public sector.Private sector
businesses can also collaborate with government run agencies in arrangements
called public-private partnerships (PPPs).

Public sector is mainly concerned with public goods which are commodities or
services that benefit all members of society, and which are often provided for
free through public taxation.Public goods are the opposite of private goods,
which are inherently scarce and are paid for separately by individuals. A public
enterprise primarily focuses on providing cheaper goods and services to the
general people. It includes: central government bodies, state government entities
and even local government authorities. Public sector can be broadly divided into
two sections depending on its government control. Financed entirely by a
government body and More than 51 percent share capital of an enterprise is
owned by a government entity.
As opposed to the public sector that the government operates, the primary
objectives of the private sector are profit maximization and acting in the best
interest of the stakeholders.Although focused on profit maximization, private
firms help in economic development by enhancing the GDP, employment, per
capita income, infrastructural facilities, etc.The sector plays a crucial role in
economic development. India’s private sector has been the major engine of
growth and employment generation.
Since 1991, India has adopted the policy of privatisation through which private
sector is gaining importance and is progressing faster. As compared to private,
public sector has number of limitations.

Given the pressure of funds on central, state, and local governments, they
have increasingly turned to public-private partnerships, or P3s, as a means to
solve problems.PPP is recognized as an effective way of delivering value-

24
 for-money public infrastructure or services. For looking at various aspects of
PPP, the PPP cell was set up in 2006 under department of economic affairs.

PPPs combine the professionalism of the corporate sector with the welfare
objectives of the state. The PPPs have resulted in projects which are known for
their world class facilities and advanced amenities.

Public-private partnerships (PPPs) have played a vital role in spurring economic

growth in India. Regardless of which political party has been at the helm, public-
private partnerships have had a reasonable success rate in India. Public-private
partnerships in India have integrated public infrastructure with the superior
financing and maintenance provided by private enterprises. This has led to the
development of many good airports and buildings across India.

15.9 Key Terms

Build, Own, Operate, Transfer (BOOT): Is a project model in which a private

organization conducts a large development project under contract to a public-
sector partner, such as a government agency. A BOOT project is often seen as a
way to develop a large public infrastructure project with private funding.
Variations on the BOOT model include BOO (build, own, operate), BLT (build,
lease, transfer) and BLOT (build, lease, operate, transfer).

Build-Operate-Transfer (BOT): In a BOT project, the public sector grantor

grants to a private company the right to develop and operate a facility or system
for a certain period. Operator finances, owns and constructs the facility or system
and operates it commercially for the project period, after which the facility is
transferred to the authority. In a BOT the project company or operator generally
obtains its revenues through a fee charged to the utility/ government rather than
tariffs charged to consumers.

Free Rider: Is a failure of the conventional free market system that occurs when
those who benefit from resources, public goods, or services do not pay for them
or under-pay. The problem occurs when some members of a community fail to
contribute their fair share to the costs of a shared resource. The free rider

25
 problem is the burden on a shared resource. The failure to contribute makes the
resource economically infeasible to produce. Thus, the good may be under-
produced, overused or degraded.

Principal-Agent Problem: This problem can occur in government when officials

have incentives to act in their own interests rather than as agents for the people,
who are the principals. Elected officials, unelected officials, and lobbyists all
face different pressures to act against the public interest. Sometimes, principal-
agent problems occur because government officials lack the knowledge to act
effectively as agents for the people. Principal-agent problems in government can
be reduced by changing incentives to minimize conflicts of interest.

15.10 Terminal exercises

1. Analyze the role and contribution of public sector in Indian economy. What
are the challenges before public sector?
2. Does more job creation come from public or private sector? Which sector is
best for job creation?
3. Why is private sector growing fast since 1991 in Indian economy? Highlight
its contribution in recent years.
4. How Do Governments and the Private Sector Cooperate? Why does India
need a public-private partnership policy?
5. Discuss the different models of PPP adopted in India. Describe the challenges
and how to go forward with PPP in India.

Books/References

26
 Asian Development Bank (2008, September). Public-Private Partnership
Handbook, Business Guide,
https://www.adb.org/sites/default/files/institutional-document/31484/public-
private-partnership.pdf

GoI. November 2015. Report of the Committee on Revisiting and Revitalizing

the Public Private Partnership model of Infrastructure, Department of Economic
Affairs, Ministry of Finance, New Delhi
https://www.pppinindia.gov.in/infrastructureindia/documents/10184/0/kelkar+Pd
f/0d6ffb64-4501-42ba-a083-ca3ce99cf999

Hans, Aman, November 22, 2017. Rebooting public private partnership in

India, NITI Aayog, GoI, New Delhi
https://niti.gov.in/writereaddata/files/document_publication/REBOOTING%20P
PP%20IN%20INDIA_blog.pdf

Khan, Yaruqhullah (2021, June 29). Why does India need a new public-private
partnership policy, Money Control,
https://www.moneycontrol.com/news/economy/policy/explained-why-does-
india-need-a-new-public-private-partnership-policy-7101931.html

Lakshmanan, L 2008. Public-Private Partnership in Indian Infrastructure

Development: Issues and Options, RBI, Occasional Papers, Vol 29, No.1,
Summerhttps://www.rbi.org.in/scripts/bs_viewcontent.aspx?id=1912

MURRAY, JEAN (2021, January 26). Public Sector vs. Private Sector: What’s
the Difference,The Balance Samll business,
https://www.thebalancesmb.com/public-sector-vs-private-sector-5097547

Ray, Gautam, 2014. PPP projects in India: Progress, prospects and problems, in
Commonwealth Governance and Growth
http://www.commonwealthgovernance.org/assets/uploads/2014/03/10-India-
PPP-Gautam-Ray.pdf

27
 Rondinelli, Dennis A. (2004). Partnering For Development: Government-
Private Sector Cooperation in Service Provision,
http://projects.mcrit.com/foresightlibrary/attachments/article/1239/unpan006231
.pdf

Sachdeva, Harsh (n d). Private Sector, Wall Street Mojo,

https://www.wallstreetmojo.com/private-sector/

Stiglitz, Joseph E.(2016, May 11). Role of Government and the Private Sector in
a Development State, Namibia
https://www8.gsb.columbia.edu/faculty/jstiglitz/sites/jstiglitz/files/May%2011%
20Namibia_Role_of_Government.pdf
Tria, Giovanni (2014, October 23). The public and private sector relationships:
The entrepreneur standpoint, Directors of Institutes and Schools of Public
Administration (DISPA) Meeting – Roma,
https://sna.gov.it/fileadmin/files/attivita_internazionali/DISPA/ROMA/Parisi.pdf

28
Unit – 16 Micro, Small and Medium Enterprises

Structure

16.0 Objectives
16.1 Introduction
16.2 Definition of MSME
16.3 Features of MSMEs
16.4Government Support to MSMEs
16.4.1 Information Technology Initiatives
16.4.2 Credit Support Initiatives
16.4.3 Skill Development
16.5 Challenges in Growth and Development of MSME Sector in India
16.6 Problems of MSMEs
16.7 Role of MSMEs in Propelling Economic Development
16.8 MSMEs in India
16.9 Let Us Sum Up
16.10 Key Words
16.11 Answers to Check Your Progress
16.12 Terminal Questions

______________________________________________________________________________
16.0 Objectives
______________________________________________________________________________

After studying this Unit, you should able to

• Explain the meaning and definition of MSME
• Describe the opportunities provided to MSMEs
• Identify the challenges faced by MSMEs in the country
• State the problems of MSMEs
• Discuss the role of MSMEs in propelling economic development
• Describe the present status of MSMEs in the country
______________________________________________________________________________
16.1 Introduction
______________________________________________________________________________

Micro, Small and Medium Enterprises (MSMEs) occupy an important placein both developed
and developing countries of the world. They are helping in achieving the important goals of an
economy viz., poverty alleviation, economic growth, employment creation, reduction in
incomeand gender inequalities, prevention of migration from rural to urban areas etc.
Recognizing the contribution of the MSMEs, the United Nations declared 27th of June of every
year as MSME day. In spite of the several initiatives by the government in providing financial
assistance, technologyassistance and upgradation, infrastructure development, skill development
and training,enhancing competitiveness and market assistanceto help the growth of MSMEs in
the country, they still face several challenges. There challenges include:infrastructure
bottlenecks, availability of finance, marketing of products, procurement of inputs, timely
payment of dues by creditors etc. In this you will learn the definition of MSMEs, opportunities
provided by the Government to promote the growth of MSMEs in the country, challenges faced
by the MSMES and the present status of MSMEs in the country.

______________________________________________________________________________
16. 2Definition of MSME
______________________________________________________________________________

The MSME is largely used to describe a small business in the private sector. The World Bank
has identified three criteria viz., number of employees, asset size and annual sales for defining
MSME. If a business unit satisfies at least two of the three criteria it is recognized as MSME by
the World Bank. The table 1 provides the three criteria based World Bank definition of MSME.

Table 1: World Bank Definition of MSME

Enterprise size Employees Assets Annual Sales
(US $) (US $)
Micro 10 10000 10000
Small 50 3 mn. 3 mn.
Medium 300 15 mn. 15 mn.

In our country, prior to 2006, the definition provided by the Industrial Development and
Regulation (IDR) Act, 1951was adopted to identify small industries. Theyincluded tiny, cottage,
traditional, and village enterprises. They were collectively termed as Small Scale Industries
(SSIs) under the Act.They were defined in terms of “number of employees”. But the government
experienced difficulty in collecting reliable data on the number of employees. Hence,the MSME
Development Act 2006 (MSMED) took investment as a criterion for defining the MSMEs. This
was because it was relatively easy to measure and verify investment. According to a report
published in 2014, there were267 definitions of the MSMEs in 155 economies. However, about
90 percent of the institutions across the world take number of employees as the basis for defining
a MSME. Many other definitions are based on turnover and value of assets. The other variables
considered for defining a MSME include loan size, years of experience, type of technology, size
of the manufacturing space, and initial investment amount etc.The table 2 shows the Indian
definition of MSME as per MSMED Act, 2006.

Table 2: Definition of MSME (MSMED Act.)

Initial investment in Plant and Machinery (in Rs.)

Category/Enterprise Micro Small Medium
size
Manufacturing <25,00,000 25,00,000 to 5,00,00,000 to
5,00,00,000 10,00,00,000
Services <10,00,000 10,00,000 to 2,00,00,000 to
2,00,00,000 5,00,00,000
Thus, the MSMED Act. distinguished between manufacturing enterprise and service enterprise
while defining a MSME. The investment limit for recognizing an enterprise under MSMEs was
less for service providers as compared to manufacturers.The RBI in its “Report of the Experts
Committee on MSMEs, 2019” observed that thedefinition based on investment limits in plant
and machinery/ equipment which were decided in 2006 does not “reflect the current increase in
price index of plant and machinery/equipment”.To their small scale of operations and informal
organisation, MSMEs do not always maintain proper books of accounts. This essentially results
in their not being classified as MSMEs.
Accordingly, the government amended the MSME definition by adopting composite criteria of
classification for manufacturing and service units. According to the new definition of MSMEs,
there will be no difference betweenmanufacturing and service sectors. Further, a new criterion of
turnover has been added in theprevious criteria of classification which was based only on
investment in plant and machinery. Thus, the new definition of MSMEs is as follows:
(i) A micro enterprise, where the investment in plant and machinery or
equipment
doesnotexceedonecrorerupeesandturnoverdoesnotexceedfivecrorerupee
s;
(ii) A small enterprise, where the investment in plant and machinery or
equipment
doesnotexceedtencrorerupeesandturnoverdoesnotexceedfiftycrorerupee
s;and
(iii) A medium enterprise, where the investment in plant and machinery or
equipmentdoesnotexceedfiftycrorerupeesandturnoverdoesnotexceedtwo
hundredandfiftycrorerupees.

Look at table 3 for revised definition.

Table 3: MSMED Act Revised Definition of MSME w.e.f.1.7.2020
Investment and Micro Small Medium
Turnover
Investment in Plant <1,00,00,000 <10,00,00,000 <50,00,00,000
and Machinery or
Equipment (Rs.)
Turnover excluding <5,00,00,000 <50,00,00,000 <250,00,00,000
exports (Rs.)

In brief, the amended definition of MSMEs has not shown any distinction between
manufacturing and service providing enterprises. Further, a new criteria turnover is added to the
definition. Furthermore, the new definition significantly enhanced the limit of investment in
plant and machinery for recognition of MSMEs.This amendment to the definition of MSME is
helpful in many ways. The Government felt that the MSMEs including even the very successful
ones were not making attempt to grow for the fear that if they outgrow the size of what is defined
as the MSME,they would lose the benefits that they get. Therefore, MSMEs preferred to remain
within the definition rather than grow. This is preventing them from reaping the benefit of
economies of scale. Hence, the revision of definition would shed the fear and help the enterprise
to grow and realize the advantages of economies of scale. The removal of distinction between
manufacturing and service sector is done to facilitate the ease of doing business. This definition
helps businesses such as retail to claim the benefits of MSME.There is no need for any MSME to
prove that it is basically a manufacturing unit to claim the benefits. Inclusion of the criteria of
turnover in the recognition of MSME is also done with a purpose. Currently there is no check on
the investment in plant and machinery claimed by an enterprise and is based on self-
authentication. With the definition requiring turnover, firms would need to register on GST
thereby making them eligible for the scheme. Hence, the additional inclusion of turnover may
help in bringing in better authentication of the MSME.The Government decided not to count the
turnover with respect to exports in thelimits of turnover for any category of MSME units whether
micro, small or medium. This isyet another step towards ease of doing business.

______________________________________________________________________________
16.3 Features of MSMEs
______________________________________________________________________________
MSMEs exhibit special features which are distinct from large enterprises. Some such features are
discussed in this section.

(i) Limited Investment:In MSMEs, particularly micro and small enterprises, capital is supplied
by an individual or a small group of individuals. As per a census of small scale units in India,
micro and small business enterprises are run mostly as sole- proprietorship or partnership model.

(ii) Personal Character/Owner-Management:A micro and small businesses are identified with
its owners; who themselves act as managers. Managers as such have maximum motivation to
work; as they themselves happen to be the owners also.

(iii) Labour-Intensive:Micro and small enterprises are fairly labour intensive with
comparatively smaller capital investment than the larger units. With any given investment,
employment possibilities would be greater in comparison with corresponding factory system.

(iv) Unorganized Labour:Micro and small business enterprises employ less number of workers
as compared to big business enterprises. Workers of these units do not form labour unions and
remain unprotected.

(v) Local Area of Operations:The area of operations of micro and small enterprises is generally
local as they have less capital and less marketing facilities at their disposal. There is a local touch
between employer and employees and between employer and customers. These days products of
some small scale enterprises are also exported to many countries of the world.

(vi) Flexibility: MSMEs are more adaptable to the changing business environment. So in case of
amendments or unexpected developments, they are flexible enough to adapt and carry on, unlike
large industries.

(vii) Use of Local Resources: Micro and small business units use indigenous resource. As a
result they can be located anywhere subject to the availability of these resources like raw
materials, labour etc.
(viii) Gestation Period: Compared to large units, a micro industrial unit has a lesser gestation
period, i.e. the period after which the return on investment starts.

(ix) Sustainable Development Goals (SDGs): MSMEs are best suited as compared to large
enterprises for achieving the SDGs such as creation of employment to lift people out of poverty.

______________________________________________________________________________
16.4Government support to MSMEs
______________________________________________________________________________
India is one of the fastest growing economies of the world. In the last half-decade, India has been
witnessing a respectable rate of economic growth. This growth has been driven by many factors
such as i) robust socio-economic policies of the government; ii) an influx in the domestic and
foreign capital;iii) rise in disposable income; iv) increasing consumption etc. among many other
positive attributes. MSME sector is likely to continue to play a significant role in the growth of
the Indian economy. In the last ten years, MSME sector has shown impressive growth in terms of
parameters like number of units, production, employment, and exports. Given the right set of
support systems and enabling framework, this sector can contribute much more, enabling it to
actualize its immense potential.
MSME sector has emerged as a highly vibrant and dynamic sector of the Indian economy over
the last six decades. It created more than 11 crore employment opportunities and has the
potential to create more at a lower capital cost as compared to large industries. It also helps in
industrialization of rural and backward areas. This may result in reducing regional imbalances
and more equitable distribution of national income and wealth. MSMEs are complementary to
large industries as ancillary units. The MSME sector contributes enormously to the socio-
economic development of the country. Ministry of MSME envisions a vibrant MSME sector by
promoting growth and development of the MSME sector, including Khadi, Village and Coir
Industries. This is done in cooperation with concerned Ministries/Departments, State
Governments and other Stakeholders.
The government is providing support to existing enterprises and encouraging creation of new
enterprises through many initiatives which can broadly be classified into information technology
initiatives, credit support initiatives and skill development initiatives. These initiatives provide
lot of opportunities to MSMEs to start new business and continue existing businesses in an
efficient manner.

16.4.1 Information Technology(IT) initiatives

Governmenthas taken several IT initiatives to facilitate the ease of doing of business of MSMEs.
Some of the initiatives are as follows:
MyMSME: One of the complaints of the MSME units pertains to availability of information on
the government schemes for the sector at one place. MyMSME is a mobile application that
provides information on all schemes implemented by the Ministry of MSME at one place. The
MSMEs can apply for any of these schemes through this application. They can also lodge
grievances pertaining to Ministry of MSME through this app.

MSME SAMBANDH:The Public Procurement Policy for Micro and Small Enterprises (MSEs)
order 2012 has mandated every Central Ministry/Department/PSU to set an annual goal for
procurement from the MSME sector at the beginning of the year. This is done with an objective
of achieving an overall procurement goal of minimum 25 per cent of the total annual purchases
from the products or services produced or rendered by MSEs. Out of 25% target of annual
procurement 4% is exclusively reserved for MSMEs owned by SC/ST and 3% for MSEs owned
by Women entrepreneurs. In order to make the Public Procurement Policy more effective, a
Public Procurement Portal “MSME SAMBANDH” was launched on 8th December, 2017. The
Portal tracks the procurement made by CPSEs from MSEs including SC-ST MSEs on a quarterly
basis. It contains the necessary information relating to the requirement of CPSEs in terms of
items required, quantity, specifications, last purchase price etc. Hence, the portal helps in
effective monitoring while also enabling MSEs to build their capacities and participate in Public
Procurement market.

MSME SAMADHAN: MSMED Act, 2006 contains provisions to deal with cases of delayed
payment to Micro and Small Enterprises (MSEs). As per the provisions, the buyer is liable to pay
compound interest with monthly rests to the supplier on the amount at three times of the bank
rate notified by Reserve Bank. This provision is applied in case he does not make payment
within 45 days of acceptance of the goods/service. The Ministry of MSME has launched MSME
Delayed Payment Portal –MSME SAMADHAN for empowering MSEs across the country to
directly register their cases.

Udyam: Due to non-registration, the government was not able to collect quality data on MSMEs
and it became a serious constraint in passing on the benefits of welfare measures to all the
MSMEs. Many MSMEs were hesitant to register themselves with the government due to a
lengthy registration process. To overcome this, the government introduced a single page Udyog
Aadhaar Memorandum (UAM) equivalent to the previous 11 forms protocol for self-certification
of the MSMEs. The registration process under UAM was completely paperless (online). After
completing the registration, the applicant was able to receive a unique Udyog Aadhaar Number
(UAN). This UAN was an identification number that can be used in applications of all MSME
schemes. More than 8.6 million (as of January 2020) units were registered under the scheme.
Along with the change in the definition of MSMEs based on investment and turnover the
government changed the registration procedure from UAM to Udyam. With the new
classification, any new person setting up an MSME has first to be registered under the Udyam
Registration and do a self-declaration regarding the size of the business they conduct. The new
Udyam Registration can be filed online with no requirement to upload any documents,
certificates, papers, or proof. Few salient points of registration are as follows:

1. The new classification of MSME has been to include both Manufacturing and Services and the
criteria for division of Micro, small and medium enterprises relates to both Turnover and
Investment.
2. Any person who intends to set up an MSME should file Udyam Registration in Udyam
Registration Portal based on self-registration.
3. E-Certificate will be issued after the registration is completed.
4. Businesses will be automatically upgraded or degraded from one classification to another
based on their filing.
5. All units having multiple GST under single PAN shall be considered as one Enterprise /
Udyam.
6. Calculation of investment in Plant and Machinery be based on previous ITR filed.
7. Calculation of turnover shall be based on GST filed or on a self-declaration basis if GST is not
there.
8. No fees is charge for registration.
9. Aadhar Number is Mandatory for filing Udyam (of Proprietor, Managing Partner for
Partnership, Karta for HUF) and for Companies GSTIN is required.
10.Self-declaration to be given where necessary information is not available via other sources i.e.
GST, PAN, Aadhar, etc.

Benefits of MSME Registration

Some of the benefits to registered MSMEs provided by the government include:

1.Collateral free loans: The purpose of the coverage of Collateral Free Loans (CGTMSE)is to
provide collateral free loans up to Rs. 200 lakhs (Up to Rs. 100 lakhs for Retail Trade) to Micro
and Small Enterprises, as defined under MSMED Act. The coverage of the Scheme is extended
to all new and existing Micro and Small Enterprises (both in the Manufacturing Sector as well as
in the Service Sector) as defined under MSMED Act, 2006. The Central Government provides
guarantee to these loans.
2.Equity infusion through MSME Fund of Funds: MSMEs are facing a severe shortage of
equity. The Fund of Funds created by the Central Government provides equity funding for
MSMEs, which have growth potential and viability. This scheme is expected to facilitate equity
financing of Rs.50,000 crores in the MSME Sector.

3.Subordinate debt for MSMEs:Credit Guarantee Scheme for Subordinate Debt

(CGSSD)aimed at providing personal loans through banks to MSME promoters for infusion as
equity or quasi-equity. The scheme had targeted to support 2 lakh Covid-hit MSMEs that are
stressed and NPA accounts as of April 30, 2020, that are eligible for restructuring. Subordinate
debt means unsecured debt.
4.Guaranteed Emergency Credit Line (GECL) facility to MSME borrowers, including
interested MUDRA borrowers: The Scheme aims at mitigating the economic distress being
faced by MSMEs by providing them additional funding up to Rs. 3 lakh crore in the form of a
fully guaranteed emergency credit line. The main objective of the Scheme is to provide 100 per
cent guarantee Member Lending Institutions (MLIs), i.e., Banks, Financial Institutions (FIs) and
Non-Banking Financial Companies (NBFCs) for any losses suffered by them due to non-
repayment of the GECL funding by borrowers.
5.Special concessions during registration of Enterprises on Government e-market portal:
The objective of Policy is promotion and development of Micro and Small Enterprises by
supporting them in marketing of products produced and services rendered by them. Under the
Scheme:
i. Every Central Ministry /Department / PSUs shall set an annual target for 20% procurement
from MSME Sector with a sub-target of 4% to MSMEs owned by SC/ST entrepreneurs.
ii. Tender sets free of cost and exemption from payment of earnest money to registered MSMEs.
iii. MSEs are given price preference in procurement of up to15% over other competitors.
iv. 358 items are reserved for exclusive procurement from MSMEs.
v. Ministry /Department/CPSUs shall prepare their annual procurement plan to be uploaded on
their official website.
vi. For enhancing participation of MSMEs in government procurement, Ministry
/Department/CPSUs shall conduct Vendor Development Programmes or Buyer Seller Meets
for MSEs especially for SC/ST entrepreneurs.
6.Special consideration in international trade fairs: The Government of India will reimburse
75% of air fare by economy class and 50% space rental charges for MSMEs of General category
entrepreneurs. Further the reimbursement of 100% of space rent and economy class air fare are
provided to women/SC/ST and North Eastern Entrepreneurs participating in international trade
fairs.
7.Bar Code registration subsidy: The Central Government reimburses all Registered
MSMEs 75% of the barcode registration fees.Besides, they will also be reimbursed 75% of the
annual Barcode renewal fees for the first 3 years.
8.Subsidy on NSIC Performance and Credit ratings: The National Small Industries
Corporation (NSIC) credit rating scheme for performance and credit rating helps MSMEs to get
an independent, trusted credit rating agency opinion on their capabilities and credit-worthiness.
The rating makes credit available at attractive interest rates. Thisalso enables MSMEs to get
recognition in global trade. Further, it ensures prompt sanctions of credit from banks and
financial institutions. The rating of MSMEs is done at subsidized fee structure. The rating also
facilitates vendors/buyers in their capability and capacity assessment and also enables the
MSMEs to ascertain the strengths and weaknesses of their existing operations and take corrective
measures.

i. Protection against delay in payment

ii. Reduced rate of interest from banks
iii. Concession in electricity bills
iv. Reimbursement of ISO Certification expenses
v. Preference in procuring Government Tenders
vi. Subsidy for patent registration

16.4.2 Credit Support Initiatives

One of the key aspects of MSMEs is access to credit. MSMEs require credit to establish/expand
the business. To provide credit facilities to the MSMEs, the Government of India has come up
with many schemes. Some of the well recognised MSME loan schemes of 2020 are as follows:

Pradhana Mantri Mudra Yojana: The Pradhan Mantri Mudra Yojana (PMMY) scheme was
launched on 8th April 2015. This scheme provides loans up to 10 lakh to non-corporate and non-
farm small or micro-enterprises. These loans are known as MUDRA (Micro Units Development
and Refinance Agency Limited). MUDRA provides refinance to banks, microfinance institutions
(MFIs) and NBFCs for lending loans. The borrowers can approach any of these lending
institutions directly or apply online through the UdyamiMitra portalfor these loans. There are
three different schemes viz., ‘Shishu’, ‘Kishore’ and ‘Tarun’ under Mudra which signify the
stage of development and the funding need of the beneficiaries. ‘Shishu’ offers loans up to
Rs.50,000, ‘Kishor’ provides loans above Rs.50,000 up to Rs.5 lakhs and ‘Tarun’ provides loans
above Rs.5 lakhs up to Rs. 10 lakhs to micro-units.
Prime Minister’s Employment Generation Programme (PMEGP): PMEGP is a Government
of India’s credit-linked subsidy programme introduced in the year 2008. The scheme is designed
by merging Prime Minister’s Rojgar Yojna and Rural Employment Generation Programme. The
programme focuses on generating self-employment opportunities among unemployed youth and
traditional artisans through micro-enterprises in non-farm sector. The PMEGP Scheme is being
implemented by Khadi and Village Industries Commission (KVIC) at the national level and the
Directorates of KVIC and DICs and Banks at the State level. The maximum cost of the
project/unit admissible in the manufacturing sector is Rs.25 lakhs and in the service sector is
Rs.10 lakhs. Assistance under the scheme is available only to new units. The subsidy under the
scheme is 25% of the cost of the project in rural areas and 15% in urban areas for general
category. Similarly the subsidy is 35% of the cost of the project in rural areas and 25% in urban
areas for special category beneficiaries.

Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE): Ministry of
MSMEs and Small Industries Development Bank of India (SIDBI) jointly established the
CGTMSE by contributing corpus of about Rs.27,000 croresin order to implement a credit
guarantee scheme for MSMEs. The trust provides guarantee to the loans provided to MSMEs by
banks without any third-party guarantee or collateral. The guarantee coverage under this scheme
ranges from 85% for Micro Enterprise (up to Rs 5 lakh), 75% for others and 50% for retail
activity. Both existing and new enterprises are eligible under the scheme. The maximum limit of
loan under the scheme is Rs.2 crores. In case of default, the trust settles the claim up to a
maximum of 85% of the amount in default of the credit facility not covered by primary and
collateral security. The main objective is that the lender should give importance to project
viability and secure the credit facility purely on the primary security of the assets financed. The
other objective is to provide both term loan and working capital facilities from a single agency to
the borrower.

Credit Linked Capital Subsidy Scheme (CLCSS): The objective of the Scheme is to facilitate
technology up-gradation in MSMEs. Under the scheme an upfront capital subsidy of 15 per cent
on institutional finance of upto Rs 1 crore availed by the MSMEs for induction of well-
established and improved technology in the specified 51 sub-sectors/products is approved. In
other words, the major objective is to upgrade their plant & machinery with state-of-the-art
technology, with or without expansion to the existing enterprises. The scheme is also applicable
to new MSMEs which have set up their facilities with appropriate eligible and proven technology
duly approved under scheme guidelines.

Thus, the government has been helping the MSMEs to get institutional credit either directly from
the financial institutions, guaranteeing the repayment of loans taken by the MSMEs from the
financial institutions. MSMEs are provided subsidy on the loans taken and capital subsidy for
upgrading technology.

16.4.3 Skill Development

The Government through its agencies organize various Entrepreneurship promotion and
development Programmes (ESDP) to nurture the talent of youth by enlightening them on various
aspects of industrial/business activity required for setting up MSEs. These programmes are also
organized in ITIs, Polytechnics and other technical institutions/business schools, where
skill/talent is available to motivate them towards self-employment. The following activities are
conducted under the ESDP Scheme:

(i) Industrial Motivation Campaigns (IMCs): Two days Industrial Motivation Campaigns are
organized to identify and motivate traditional / non-traditional entrepreneurs having potential for
setting up MSEs for making them self-employed.

(ii) Entrepreneurship Awareness Programmes (EAPs):Entrepreneurship Awareness

Programmes are being organized regularly to nurture the talent of youth by enlightening them on
various aspects of industrial activity required for setting up MSEs. These EAPs are generally
conducted in ITIs, Polytechnics and other technical institutions, where skill is available to
motivate them towards self-employment. The course contents of such Entrepreneurship
Awareness activities are designed to provide useful information on product/project, selection and
project profile preparation, marketing avenues/ techniques, product/service pricing, export
opportunities, infrastructure facilities available, financial and financial institutions, cash flow,
accounting product casting etc.

(iii) Entrepreneurship-cum-Skill Development Programme (E-SDP):TheseComprehensive

training programmes are organized to upgrade skills of prospective entrepreneurs, existing
workforce and also develop skills of new workers and technicians of MSMEs. This is done by
organising various technical cum skill development training programmes. The objective is to
provide training for their skill upgradation and to equip them with better and improved
technological skills of production. The specific tailor made programmes for the skill
development of socially disadvantaged groups (SC/ST, PH and women) are organized in various
regions of the states, including the less developed areas.

(iv) Management Development Programmes (MDPs):- The objective of MDPs is to impart

training on management practice system to improve the decision-making capabilities of existing
& potential entrepreneurs. This will result in higher productivity and profitability. Inputs on a
variety of topics of managerial functions are provided to the participants in short duration
training programmes. These programmes are of short duration and the curriculum is designed
based on the needs of the industry and are customized, if required by the clients themselves.

Check Your Progress A

1. What is the present definition of MSME in India?
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2. State the procedure for registration of a MSME.
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3. Match the following:
A. MSME Sambandh a. Payment issues
 B. MSME Samadhan b. Registration
C. Udyam c. Credit
D.PMMY d. Procurement

4. State whether the following statements are True or False:

1. The Industrial Development Act distinguished between Micro, Small and Medium
Enterprises.
2. The present MSME definition distinguishes between manufacturing and Service
enterprises.
3. The Credit Linked Capital Subsidy Scheme is aimed at technology up-gradation in
MSMEs.
4. Among the skill development programmes, the duration of the Employment-cum-Skill
Development programme is the longest.
5. CGTMSE is aimed at providing loans to MSMEs without any guarantee.

______________________________________________________________________________
16.5Challenges in Growth and Development of MSME Sector in India
______________________________________________________________________________

The growth and contribution of MSME sector in India has not been to the desired extent due to
several challenges faced by the sector. Some of the major challenges as pointed out by the expert
committee of RBI on the MSME sector are as follows:
Inadequate Policy and InstitutionalInterventions:There are many institutions in India to
support and help the MSME sector.The Ministry of MSME formulates policies for overall
growth of the sector. The Office of Development Commissioner MSME implements these
policies. As mentioned earlier, MSMED Act, 2006 contains several provisions for the promotion
and development of the MSME sector. For financing MSME the central government established
Small Industries Development Bank of India (SIDBI). Broad policies for facilitating financial
support to MSMEs are formulated by RBI and Securities Exchange Board of India
(SEBI).However, there are no clear cut policies to address the problems of the sector in the
following areas:

a)Infrastructure development: Due to infrastructural bottlenecks the MSMEs are not able to
compete with large industry in the domestic sector and also not able to enter global markets. The
basic amenities such as work sheds, tool rooms, product testing laboratories, electricity, rural
broadband and innovation hubs are not adequately available to the MSMEs. This is acting as a
deterrent to the growth of the sector. The development of MSME clusters is done mainly by
Government organizations and the private investment is not coming for the development of these
clusters.

b)Formalization of the sector: As per 73rd round of National Sample Survey (NSS), there are
63.39 million MSMEs in the country. However, a large number of MSEs exist in the informal
sector and are not registered with any statutory authority. Reasons for lack of registration are
many and varied. For nano/household type of enterprises, in their view, not obtaining registration
is an escape from official machinery, paperwork, costs etc. For them, it is perhaps “the art of not
eing governed”. Registration offers them little by way of tangible benefits. There are
otherMSMEs who, upon reaching a minimum size seek legitimacy and acknowledgement of
their existence to seek benefits or credit. While Udyog Aadhaar offers a simple mode of
registration, it is usually not enough. Often, more is needed e.g., Shops and Establishments,
PAN, GST, etc. Lack of formalization impacts the sector in terms of development. It also
impacts in availing credit from financial institutions like banks and in terms of policy making as
well as development interventions. Registration provides information on nature of business,
location, segmentation, etc. In the absence of a robust system of registration for capturing
information on operational units, new units and exits, reliance has to be placed on proxy data or
on national census/ surveys, which are infrequent.
c)Technology adoption: Many MSMEs are not able to adopt new technologies due to paucity of
funds. This has been adversely affecting the competitiveness of these units both in domestic and
international markets.

d)Backward and forward linkage: MSMEs face the challenges both in having access to quality
raw material and market for finished products. National Small Industries Corporation (NSIC)
through market assistance scheme facilitates MSMEs to discover markets for their products.The
Government e-Marketplace (GeM) portal has enabled MSMEs to connect with buyers from
Public Sector Undertakings (PSUs) and Government Departments. However, very few MSMEs
are availing benefits under these schemes. MSEs find it difficult to access proper market for
selling their products due to their lack of scale and in-house capabilities. Inaccessibility to
remunerative market affects their growth and sustainability. In order to support MSMEs in
selling their products at a competitive price, Public Procurement Policy for MSMEs was
introduced in the year 2012. The policy was revised in November, 2018, and came into effect
from April 1, 2019. The objective of Policy is promotion and development of MSMEs by
supporting them in marketing of their products and services.However, complexity of the public
procurement system and its process deters MSMEs to participate in public procurement. MSMEs
face constraints in terms of financial, technical and administrative capacities to access
procurement opportunities, prepare tender documents, apply the procedures and execute the
contracts.

e)Credit gap: Due to non-registration, many MSMEs lack access to formal credit. Further,
banks face challenges in credit risk assessment of MSMEs as these units do not have financial
information, historical cash flow data etc. Further, very few MSMEs are able to attract private
equity support and venture capital financing.

f)Timely payments to MSMEs and their effective implementation: Most MSMEs have been
facing problems of working capital due to non-payment of dues by the customers. Though the
Government initiated several steps to address this problem, problems still exist in
implementation of these initiatives. Buyers tend to use MSMEs as an alternative to banks. In
order to delay payments, buyers raise objections or point errors in submitted bills. Credit notes or
adjustment notes are often used to avoid cash payment. Strict legislative measures of payments
within fixed days (and penalty in the form of charging interest) have had limited effect as
MSMEs do not complain for fear of loss of future business. Electronic bill discounting systems
(such as TReDS) have provided a partial solution but the problem persists.

g)Availability of authentic data at one place on MSMEs: Implementation of Goods and

Services Tax (GST) has made turnover data available at a single network about MSMEs
registered under GST. However, this data alone is not sufficient to identify a MSME. The data
on investments in plant and machinery is not available in GST network. Income tax data base
contains only information relating to financials of the units. Udyam portal contains only
registration related information of MSMEs. There is no single interface available for the lenders
to access and map data on MSMEs. In the absence of authentic source of data on MSMEs,
thelenders have to primarily rely upon manual information furnished by the units.

h)Imperfectinformation andcapacitygaps: Entrepreneurs and MSMEs suffer from lack of

information including market information. Many entrepreneurs and MSMEs also struggleto find
the support needed to strengthen their business management, marketing,record and
bookkeeping, strategic and financial planning to be able to
grow,gainmarketshareandalsohandleshocks. Lack of professional business management skills
may further limittheir capacity to adopt research and development(R&D) and innovation in
promoting productivity. This would ultimately affect growthofMSMEs.

i)Accesstobasicinfrastructure:Access to basic infrastructure is one of the important

challenges faced by MSMEs. Since MSMEs have limited financial means, good basic
infrastructure is important to MSMEbusiness operations. Access to a stable electricity supply,
road networks, ports andairports, water supply, as well as Information Communication and
Technology (ICT), and in particular, broadband internet, isimportant to fostering development
and reducing the challenges thatMSMEs already face in growing their businesses. Access to
ICT and digitalization canbe very important to allow MSMEs to improve
informational,capacityandfill financegaps.

j)EntrepreneurshipandWomenEntrepreneurs: Fostering the capacity of women

entrepreneurs and business owners has asignificant potential to reduce poverty and inequality
globally. According to UN, the global economy could see as much as US$ 28 trillion growth by
2025, ifwomen participate equally as men in entrepreneurship. Unfortunately, womenMSME
entrepreneurs, particularly those from rural poor communities, are oftenin a disadvantaged
position in growing their business. They lackland documents in their name and/or
collateralneeded to access formal sources of credit.

Thus, many governmental interventions are mostly supply-side oriented. They are not able to
effectively address the whole requirements of MSMEs.

______________________________________________________________________________
16.6 Problems of MSMEs
______________________________________________________________________________

The growth of the economy is dependent considerably on MSMEs which contribute significantly
to the GDP by generating mass employment in every nook and corner of India. In view of its
significance, the government is expected to provide adequate support to ensure MSMEs’ growth.
However, the MSMEs suffer with the following problems:

1. Ease of doing business remains a bottleneck:Most MSMEs in India face problems in the
initial stages because of too many regulations and approvals. They face problems relating to
loan, enforcing contracts and dealing with construction permits. In fact, the time taken by
businesses to enforce a contract remains longer. Entrepreneurs have to comply with 12
procedures to start a business in Mumbai, whereas globally there are just five procedures to
comply with on an average.

2. Lack of financial expertise: A large number of entrepreneurs lack the financial knowledge to
steer the business in the right direction. Those entrepreneurs without sound financial knowledge
may not be in a position to make crucial business decisions related to MSME loans. In absence
of financial knowledge, you may end up taking wrong decisions that may cost the business
unless you are seeking any external advice. Also, the knowledge about finance is important
because you have to rely on an MSME loan to tide over crises that may knock at the door
anytime. Hence, it is important to understand everything related to MSME loans, find out about
the MSME loan interest rate and compare the same in the market before availing a loan.

3. Lack of Access to Financing Solutions:Most businesses face perennial problems of

accessing finance or availing an MSME loan even as the government has implemented measures
to make credit for businesses readily available to foster entrepreneurship. The regulatory
loopholes that cause a delay in getting licenses, insurance, and certifications also hamper the
prospects of MSMEs. Most businesses face problems related to manufacturing, timely purchase
of raw materials, or even access to new technologies or acquire new skills due to lack of funding.
Another major problem is the economic slowdown that has led to liquidity crunch, but the
government had given a breather to MSMEs by asking banks not to declare any stressed loan
account of MSMEs as NPA till March 2020 and work on recasting their debt.

4. Technology remains a major deterrent:Most businesses fail to reap the benefits of the latest
technological developments in their sector due to a lack of expertise and awareness. Hence
MSMEs need to be apprised of the technological developments that are significant for the
growth of their businesses. It is important for scientific research bodies to remain involved with
the local MSME clusters, and take notice of their technology-related problems and issues.
However, there have been concerted efforts to offer solutions to MSMEs on these issues as the
government is working towards the launch of E-commerce portal ‘Bharat Craft’ that will act as a
direct interface between sellers and buyers.

5. Labour issues:Most SMEs face frequent labour issues and especially in the new normal
times.The ongoing migrant crises has manifested itself as one of the most difficult areas for
industries to operate in such times of pandemic. Apart from labour problems, businesses also
need to emphasize skill development, training, and ensuring market linkages to facilitate both
urban and rural micro-entrepreneurs. The emphasis on skill development can benefit the sector
substantially and more so at the time of crisis.
6. Lack of Trust:It is seen that banks refrain from extending MSME loan since the amount
remains small and also, banks believe MSMEs lack the required repayment capacity. In such a
situation, they end up implementing stricter regulations on these start-ups. Some businesses also
fail to keep track of their credit rating that hampers the prospect of availing loans. Moreover,
traditional lending options make it difficult for business owners to meet strict eligibility criteria
besides the lengthy procedure of MSME loan approval further dampens their spirits.

7. Absence of collateral in loan:Some businesses may find it difficult to avail MSME loan as a
result of a strict collateral protocol. Since small companies may not have the property to
substantiate the criteria to avail a loan, business owners may opt for unsecured business loans
from lenders.
Despite these challenges, the success in business is not elusive if you are determined and these
problems can be easily addressed if you get the right support from the lender.

______________________________________________________________________________
16.7 Role of MSMEs in Propelling Economic Development
______________________________________________________________________________

1. MSMEsandtheirpotentialcontributionstoSustainable Development Goals (SDGs) that

help in economic development:The 17 Sustainable Development Goals (SDGs), also known as
the Global Goals, were adopted by the United Nations in 2015. The goal aimed to end poverty,
protect the planet and ensure that by 2030 all people of the world enjoy peace and prosperity.
MSMEs are widely recognized for the important contributions they maketo achieve SDGs in
terms of contributions to economic growth, creation ofdecent jobs, provision of public goods and
services, as well as poverty alleviation andreduction in inequality. The MSMEs are considered
important contributors of employment and directly benefit the poor andvulnerable, particularly
women and youth. Job creation helps in reducing poverty, increasingincome and positively
impact household investments in education and health overtime. MSME development has the
potential for wide reaching impacts on the SDGsglobally, including SDG 1 (end poverty), SDG 2
(zero hunger), SDG 3 (good health andwell-being), SDG 5(genderequality),SDG
8(promoteinclusiveandsustainableeconomic growth, employment and decent work), and SDG 9
(improve sustainableindustrializationandfostering innovation).

2. Other ways in which MSMEs help in propelling economic development are as follows:

i) MSMEs drive innovation and expand the tax base.

ii) MSMEs also increase the competition amongst the peers. The continuous struggle for
supremacy among MSMEs brings out the best in a business. This triggers a win-win situation for
both provider and the consumer. Moreover, this increases the aggregate productivity as well as
economy-wide efficiency.

iii) New entrepreneurs entering MSME sector bring forth innovations, ideas and skills.

iv) In recent years, MSMEs have registered a higher growth rate as compared to the global
industrial sector. The chief advantage of the MSME sector is its potential to generate
employment at low capital expenditure.
v) The economic growth in many Asian countries such as Korea, Taiwan and Japan is directly
proportional to the spurt in MSME activities. MSMEs play a very significant role in the rapid
industrialisation and development of China, where approximately 99% of the total business
ventures are MSMEs. These MSMEs together produce around 60% of the total industrial output
and approximately 40% of the total profits and taxes achieved by the various industries in China.
Again, various SMEs in the US generate more than half of the gross domestic products.

vi) MSMEs act as a cushion against recession as they quickly adapt and innovate as per the
changing circumstances. There is a big connection between the various levels of poverty, hunger
and economic well-being of the society and the general condition of various MSMEs in the
country.

vii) In almost every country, the MSMEs are a large proportion of all businesses in the country.
In most developing and developed economies, over 90% of MSMEs improve the employment
rate. In fact, when big industries downsize and cut down jobs, MSMEs keep developing and
creating more jobs.

viii) MSMEs adapt fast to the dynamic business world by switching on to e-commerce and
online transaction of goods and services. The advancement in technology has not only eased out
the process of selling and buying, it has helped the entrepreneurs to cut cost on advertising and
marketing too. The various e-commerce platforms make life easy for MSMEs.

ix) MSMEs play a vital role in being service providers and traders to the primary industry.

x) MSMEs also produce the finished goods as well as services.

xi) MSMEs contribute heavily to the development of various sectors such as manufacturing,
agriculture and ICT services.

xii) There is a reciprocal relationship between an MSME and the economy. Development in
economy ensures the creation of more MSMEs. The creation of more MSMEs ensures a boost in
the economy.
______________________________________________________________________________
16.8MSMEs in India
______________________________________________________________________________

In India, MSMEs are the important drivers of economic development, innovation and
employment. As per the National Sample Survey, India has approximately 6.4 crore MSMEs.
Bulk of them are micro-enterprises numbering about 6.3 crore. They constitute about 94% of the
total MSMEs. They are followed by small enterprises. There are about 3.3 lakh small enterprises
in the country and constitute about 5% of the total MSMEs. The number of Medium enterprises
are about 5,000 and constitute less than one percent of the total MSMEs in
India.Outof633.88estimatednumberofMSMEs,324.88lakhMSMEs(51.25%)areinruralareaand309
lakhMSMEs(48.75%)areintheurbanareas.

Table 4: DistributionofEnterprises (in lakhs)

Sector Micro Small Medium Total Share %
 Rural 324.09 0.78 0.01 324.88 51
Urban 306.43 2.53 0.04 309.00 49
All 630.52 3.31 0.05 633.88 100

The MSME sector contributes very significantly to the growth of the economy. Its share in
manufacturing output is about 45%. While in exports of the country the share of the sector is
more than 40%, it is about 30% in total Gross Domestic Product (GDP) of the country.The
MSME sector provides employment to about 111 million people. The Table 5 provides the data
on the contribution of MSME sector to GDP of the country.

Table 5: Share of MSME Sector in the GDP of the country

Year Total Share of
Gross MSME
Domestic in GDP
Product (%)
(GDP)
(Rs. in
Crores)
2012-13 9944013 29.94
2013-14 11233522 29.76
2014-15 12445128 29.39
2015-16 13682035 28.77
2016-17 15391669 29.25
2017-18 17098304 29.75
2018-19 18971237 30.27
Source: Annual Report Ministry of MSME 2020-21
While the agriculture sector produces the highest volume of goods in India, MSME sector stands
next only to agriculture in terms of volume of goods produced and services provided. The
MSME sector in India is not homogeneous. The enterprises vary widely in size. They produce
variety of goods and services. They employ different levels of technology. However, the sector
has the potential to grow at a faster pace. The National Manufacturing Policy proposes to
increase the share of manufacturing sector in GDP from the present 16% to 25% by 2022 to shift
a part of population from agriculture to industry. Since the MSMEs contribute about 45% to the
manufacturing sector, they need to play a very big role in increasing the share of manufacturing
sector in the GDP of the country.
EstimatednumberofMSMEsincountry
TheMSMEsinIndiaareplayingacrucialrolebyprovidinglargeemploymentopportunitiesatcompara
tivelylowercapitalcostthanlargeindustriesaswellasthroughindustrializationofruralandbackwarda
reas and helping the country toreduceregionalimbalances. They
areassuringmoreequitabledistribution of national income and wealth.As mentioned earlier,
theNSS 73rdround, conducted by National Sample Survey Office, Ministry of Statistics &
ProgrammeImplementation during the period 2015-16, found that there were 633.88 lakh
unincorporated non-agriculture MSMEs in the country engaged in different economic
activities (196.65 lakh inManufacturing, 0.03 lakh in Non-captive Electricity Generation and
Transmission, 230.35lakh in Trade and 206.85 lakh in Other Services).
Table 6:NumberofMSMEs in India(ActivityWise)
Activity Estimated number of MSMEs (in lakhs) Share %
Rural Urban Total
Manufacturing 114.14 82.50 196.65 31
Trade 108.71 121.64 230.35 36
Other Services 102.00 104.85 206.85 33
Electriciy 0.03 0.01 0.03 --
Total 324.88 309.00 633.88 100
Source: Annual Report Ministry of MSME 2020-21

EmploymentGeneration by SMES in the country

As per the
NSS,MSMEsectorhascreated11.10crorejobs(360.41lakhinManufacturing,387.18lakhinTradea
nd362.82lakhinOtherServices and
0.07lakhinelectricityGenerationandTransmission,)intheruralandtheurbanareasacrossthecountry
.Majority of the jobs are created in Trade followed by other services and manufacturing. Table 7 shows the
distribution of employment by various activities.

Table 7: Distribution of employment by various activities

Activity Employment (in lakhs) Share
Rural Urban Total %
Manufacturing 186.56 173.86 360.42 32
Trade 160.64 226.54 387.18 35
Other Services 150.53 211.69 362.22 33
Electricity 0.06 0.02 0.07 --
Total 497.79 612.11 1109 .89 100.00
(45%) (55%) (100%)
Source: Annual Report Ministry of MSME 2020-21
Most of the employment generation in MSME sector is provided by Micro enterprises (about
97%). Small enterprises generate about 2.9% of the total employment of the sector. The
medium enterprises provide employment to only 1.75 lakh people. Thus, the employment
generation potential of Micro enterprises is very high in India. Between the rural and urban
areas, the employment generation by MSME sector in urban areas is much higher as
compared to rural areas.

Distribution of MSMEs in the country

The MSMEs are disproportionately distributed among the various states of the country. Two
states of the country viz., Uttar Pradesh and West Bengal account for more than one fourth of the
total MSMEs. Five states of the country (UP, West Bengal, Tamil Nadu, Maharashtra and
Karnataka) account for about 50 percent of the total MSMEs of the country. Ten states of the
country account for more than three-fourths of the MSMEs of the country. Table 8 shows state-
wise distribution of MSMEs.

Table 8: State-wise Distribution of MSMEs in the country

State Number of %share
Enterprises
UttarPradesh 89.99 14
WestBengal 88.67 14
TamilNadu 49.48 8
Maharashtra 47.78 8
Karnataka 38.34 6
Bihar 34.46 5
Andhra Pradesh 33.87 5
Gujarat 33.16 5
Rajasthan 26.87 4
Madhya Pradesh 26.74 4
Total of above ten 469.36 74
States
Other State/UTs 164.52 26
Total MSMEs 633.88 100
Source: Annual Report Ministry of MSME 2020-21
Regarding the status of MSMEs in the country the following points are important to remember:
1. Most of the MSMEs (95%) in India are Micro enterprises.
2. Majority of the Micro enterprises are located in rural areas. Majority of the small and most of
the Medium enterprises are located in urban areas. Promotion of agro-based industries may help
in locating more number of small and medium enterprises in the rural areas.
3. MSMEs have been contributing significantly (30%) to the GDP of the country.
4. About three-fourths of the MSMEs are concentrated in manufacturing and trade. Other
services occupy the remaining MSMEs. This is one of the important reasons why the MSMEs
were worst affected as trade was badly hit by COVID-19.
5. About 80% of the MSMEs are owned by males. Hence, there is need for promotion of women
entrepreneurship in the country.
6. Among the various social groups, SCs and STs own very less percentage of MSMEs as
compared to OBCs and others. Hence, there is need for promotion of entrepreneurship among
SCs and STs.
7. MSMEs provide about 11 crore jobs in the country. About 55% of these jobs are in urban
areas. About 97% of this employment is provided by micro enterprises. About 80% of the
employees of MSMEs are males. Hence, there is need for promotion of employment of women
in MSMEs.
8. MSMEs are not evenly distributed across the country. Top ten states of the country account for
about three-fourths of the MSMEs.

Check Your Progress B

1. What is the reasons for non-registration of MSMEs in India?
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2. Which states occupy the top four positions in terms of number of MSMEs in India.
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3. State whether the following statements are True or False:
1. The number of micro enterprises are more in rural areas than in urban areas in India.
2. MSMEs contribute about 30% to the GDP of the country.
3. Manufacturing MSMEs are higher in percentage as compared to other categories.
4. Small and Medium enterprises generate more employment as compared to micro
enterprises.
5. The number of women employees are more in MSMEs as compared to male employees.
______________________________________________________________________________
16.9Let Us Sum Up
______________________________________________________________________________

MSMEs occupy a key role in both developing and developed countries in terms of contribution
to GDP, employment, exports and also in reduction in social, gender and income inequalities.
However, the identification of MSMEs is not the same throughout the world as the definitions of
MSME vary from country to country. The World Bank identified number of employees, assets
and sales turnover as the basis for identification of MSMEs. In India, till 2006, the small
industries were identified on the basis of number of employees. The MSMED Act 2006 took
investment as a criterion for defining the MSMEs. It was because relatively easier to measure
and verify investment. The Act distinguished between manufacturing and service enterprises for
the purpose of identification of MSMEs.The Government amended the definition of MSMEs in
2016 by adding turnover to investment and removed the distinction between manufacturing and
service enterprises. The substantial enhancement of investment limits aimed at encouraging the
MSMEs to expand their capacities without losing the governmental benefits. Government of
India has initiated several steps to promote MSMEs, help them to overcome their problems and
improve their ease of doing business. The Government also simplified the process of registration
of MSMEs, as registration is mandatory for MSMEs to receive the governmental benefits. The
growth of MSMEs has not been happening to the desired extent as they face several challenges
such as infrastructure bottlenecks, credit, timely payment from customers, skill gap, marketing of
products, availability of inputs etc. The development of MSMEs in India is skewed. Majority of
the enterprises are located in urban areas and concentrated in a few states. Very less number of
MSMEs is owned by socially disadvantaged and women. Micro Enterprises are generating
employment in a significant way as compared to small and medium enterprises. However, most
of the employees of the MSMEs are men.
______________________________________________________________________________
16.10 Key Words
______________________________________________________________________________

MSME: Micro, Small and Medium Enterprise

Micro Enterprise: An enterprise, where the investment in plant and machinery or equipment
doesnotexceedonecrorerupeesandturnoverdoesnotexceedfivecrorerupees.
Small Enterprise: An enterprise, where the investment in plant and machinery or equipment
doesnotexceedtencrorerupeesandturnoverdoesnotexceedfiftycrorerupees.
Medium Enterprise: An enterprise, where the investment in plant and machinery or
equipmentdoesnotexceedfiftycrorerupeesandturnoverdoesnotexceedtwohundredandfiftycrorerupe
es.
MyMSME: A mobile application that provides information on all schemes implemented by the
Ministry of MSME at one place. The MSMEs can apply for any of these schemes or lodge
grievances pertaining to Ministry of MSME through this app.
MSME SAMBANDH:A Portal tracks the procurement made by CPSEs from MSEs including
SC-ST MSEs on a quarterly basis and contains the necessary information relating to the
requirement of CPSEs.
MSME SAMADHAN: MSME Delayed Payment Portal –MSME SAMADHAN for
empowering MSEs across the country to directly register their cases in case of delayed payments
from customers.
Udyam:Any new person setting up an MSME has first to be registered under the Udyam
Registration and do a self-declaration regarding the size of the business they conduct. The new
Udyam Registration can be filed online with no requirement to upload any documents,
certificates, papers, or proof.
Pradhana Mantri Mudra Yojana(PMMY): The scheme provides loans known as MUDRA
(Micro Units Development and Refinance Agency Limited)up to 10 lakhs to non-corporate and
non-farm small or micro-enterprises. MUDRA provides refinance to banks, microfinance
institutions (MFIs) and NBFCs for lending loans.
Prime Minister’s Employment Generation Programme (PMEGP): Thisis a Government of
India’s credit-linked subsidy programme designed by merging Prime Minister’s Rojgar Yojna
and Rural Employment Generation Programme. The programme focuses on generating self-
employment opportunities among unemployed youth and traditional artisans through micro-
enterprises in non-farm sector.
Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE): Ministry of
MSMEs and Small Industries Development Bank of India (SIDBI) jointly established the
CGTMSE. The trust aimed to implement a credit guarantee scheme for MSMEs to the loans
provided to SMEs by banks without any third-party guarantee or collateral.
Credit Linked Capital Subsidy Scheme (CLCSS):The objective of the Scheme is to facilitate
technology up-gradation in MSEs. Under the scheme an upfront capital subsidy of 15 per cent on
institutional finance of upto Rs 1 crore availed by the MSEs for induction of well-established and
improved technology in the specified 51 sub-sectors/products approved.
Entrepreneurship promotion and development Programmes (ESDP): They are meant to
nurture the talent of youth by enlightening them on various aspects of industrial/business activity
required for setting up MSEs.
______________________________________________________________________________
16.11 Answers to Check Your Progress
______________________________________________________________________________

A. 3) A-d; B-a;C-b; D-c.

4) 1. False; 2. False; 3.True; 4. True; 5. False.

B.3)1.True; 2. True; 3. False; 4. False; 5. False

______________________________________________________________________________
16.12 Terminal Questions
______________________________________________________________________________

1. Define MSME and explain the superiority of the present definition over the earlier definitions.
2. Explain the various initiatives taken by the Government to help the growth of MSMEs.
3. Explain the process of registration of MSMEs and the benefits of registration.
4. Explain the challenges faced by MSMEs in India.
5. Describe the role of MSMEs in economic development.
6. Describe the present status of MSMEs in India.

****
UNIT 17 SERVICE SECTOR (ICT & COMMUNICATION)
Structure
17.0 Objectives
17.1 Introduction
17.2 IT Industry
17.2.1 Facilitators of Growth of Software Industry in India
17.3 Communications (Telecom) Industry
17.3.1 Status of Telecom Industry in the Country
17.3.2 Growth Drivers of Telecommunications Industry
17.4 Role of ICT in Economic Development
17.5 Challenges Faced by ICT Industry
17.6 ICT Products
17.7 Government Support to ICT Product Development
17.8 Let Us Sum Up
17.9 Key Words
17.10 Answers to Check Your Progress
17.11 Terminal Questions

______________________________________________________________________________
17.0 Objectives
______________________________________________________________________________

After studying the Unit, you should able to

• Explain the meaning of ICT sector
• Discuss the structure of IT Industry
• Analyse the Telecommunications Industry
• Describe the present status of ICT sector in the country

______________________________________________________________________________
17.1 Introduction
______________________________________________________________________________

The economy of a country consists of three sectors viz. primary sector, secondary sector, and
tertiary sector or service sector. The primary sector consists of the activities that use natural
resources for production/extraction of raw materials and include agriculture and allied
activities, forestry, mining etc. The secondary sector also known as the industrial sector is
associated with the activities which involve the conversion of raw material into usable products
and includes heavy manufacturing, light manufacturing, energy-producing, food processing,
etc. The service sector produces intangible goods, more precisely services instead of goods. It
comprises various service industries including warehousing and transportation
services; information services; securities and other investment services; professional services;
waste management; health care and social assistance; arts, entertainment and recreation.
Countries with economies centered onthe service sector are considered more advanced than
industrial or agricultural economies.ICT sector is one of the important part of services sector and
consists of Information technologies (IT) and Communication industries. Let us discuss
these two industries separately.
______________________________________________________________________________
17.2 IT industry
______________________________________________________________________________

The IT industry covers IT services, IT-enabled services (ITES), e-commerce (online business),
Software and Hardware products. IT based services are essential for any organization to increase
productivity, ease of doing business, and grow efficiently and economically. IT contributes to the
economic growth of the country and makes governance more transparent and accessible. It has
made access to government services and information easier and less expensive. Information
technology has also made management and delivery of government services much easier and
plugged leakages. The IT industry has become the backbone of our economy to prosper
exponentially and to generate millions of jobs.

ITindustryinIndiacanbroadlyb e classifiedintothreesectors viz., i) Software, ii) ITservices and iii)

InformationTechnologyEnabledservices-BusinessProcessOutsourcing(ITeS-BPO)as shown in
the following diagram:
Structure of IT Industry

Software Products
(infrastructure Software and
Enterprise Applications
Software)

Software

Engineering and R&D Services

Project Oriented Servics (IT

consulting, System
integration, CADM,
Networking Consultation &
Integration, Software testing)

IT Industry IT outsourcing (Application

Management, Infrastructure
IT Services
outsourcing and Network
infrastructre management)

Training and Support (IT

education and training,
Hardware support and
installation and Software
testing)

Customer interaction services,

ITeS‐BPO finance and accounting, HR
services and KPO Services)

Source: Indian IT Sector Profile Report, SESEI

According to the Ministry of Electronics and IT, “the IT sector is the biggest
employmentgenerator and has helped the growth of several ancillary industries such as
transportation, real estate, catering, security, housekeeping etc. Direct employment in the IT
services and BPO/ITeS segmentis estimated to reach 4.47million in FY 2020-2021 with an
addition of 1,38,000 people (36 percent women employees). Indirect job creation is estimated to
be over 12.0 million.” The IT industry accounted for 8% of the country’s GDP in 2020.According
to RBI, “India’s exports of software services are estimated at US$ 133.7 billion during 2020-21,
registering 4.0 per cent growth over the previous year. TheITandIT
EnabledServices(ITeS)sectorsgohand-in-hand,inevery aspect.IT software and service industry
has emerged as one of the fastest growingsectors in the Indian economy. It recorded a growth
rate exceeding 50 per cent in exports and40 per cent both domestic and exports together over the
last five years.

According to the Department for Promotion of Industry and Internal Trade (DPIIT) of the
Government, Computer Software and Hardware industry attracted about US $180 billion (about
Rs.5.23 lakh crores) Foreign Direct Investment (FDI) during April- 2020 to September -2001
which is about 14 percent of the total FDI flows into the country.

Among the various constituents of the IT industry in the country, IT services account for about
52 percent of total IT sector revenues. Of the revenues about 80 percent
comesfromtheexportmarket. Business Processing Management (BPM) accounts for about 19
percent of the total IT industry revenue and around 87% of revenue comes from
theexportmarket. Software products and engineering services account for about 20 percent of
the total IT revenues and around84 percentof revenuecomes fromexports. Hardware accounts
for about 9 percent of IT revenue in the country. Since production of computer hardware is
one of the priority areas of the Government under Atmanirbhar Bharat, the government is
giving a push to domestic manufacturing of electronics. It is providing a production linked
incentive (PLI) of Rs 7,350 crores for production of laptops, tablets, PCs and servers in the
country. This will help improving the domestic production and export of hardware from the
country.

______________________________________________________________________________
17.2.1Facilitators of Growth of Software Industry in India
______________________________________________________________________________

1. Availability of highly qualified talent pool: One of the greatest strengths of India happens
to be its skilled human resources. Availability of highly qualified talent pool at lower
rateshelps the IT industry in cutting the cost for about 60-70 % and become competitive in the
global market. This large pool of qualified skilledworkforce hasenabledIndianIT companiesto
helpclientssaveUS$200billionduringthelast fiveyears.
2. Increasing adaption of emerging technologies: Disruptive technologies like AI (Artificial
Intelligence),Social Media, Mobility, Analytics and Cloud (SMAC), embedded systems etc.
are the emerging trendsof the industry. India has been creating a future-ready digital
workforce. India has a large number of employees with SMAC skills.The SMAC market is
expected togrow to USD225billionby 2020. In fact, India is among the top 10 nations in the
world in terms of technological advancements and funding in artificial intelligence, according
to findings from a studypublished by The Brookings Institution.

3. Government policy support: Government of India envisions a digitally

equippedIndiaandemphasizing on activities to promote programmes for skill development and
uplifting infrastructurecapabilities. R&D programmes are being supported by GoI at every
possible level to maintain India’sstrategicadvantageinITandIT-enabledServices in
theglobalmarket. Some of the Governmental initiatives in promoting the IT industry in the
country are as follows:

a) The Department of Electronics and Information Technology (DeitY) has drafted India’s first
‘Internet ofThingsPolicy’in October2016 to help the country to become a digital economy.
The vision of the policy is
“todevelopconnectedandsmartIoTbasedsystemforourcountry’sEconomy,
Society,Environmentandglobal needs.”
b) In 2013, Ministry of Communication and Information Technology of the Government of
India had releasedthe ‘National Cyber Security Policy’ to protect information, such as personal
information, financial/bankinginformation, sovereign data etc.As part of the policy, the
government has proposed to create a workforce of around500,000 trained in cyber security. It
also proposes to provide fiscal benefits to businesses to adopt bestsecuritypractices.
c) In order to promote further growth of ICT industry, the government has approved ‘National
Policy onInformation Technology 2012’which aims to make at least one individual in every
household e-literateamongotherobjectives.
d) The Ministry of Electronics andInformationTechnology(MeitY),GovernmentofIndia set up
Software Technology Parks of India, an Autonomous Society
in1991,withtheobjectiveofencouraging,promoting and boosting the Software Exports from
India.
e) Under Digital India Programme, the India BPO Promotion Scheme (IBPS) was approved to
incentivizeBPO/ITES Operations across the country for creation of employment opportunities
for the youths and growth of IT-ITES Industry.
f) As per the FDI policy, 100% FDI has been allowed in the software / IT industry under the
automatic route(i.e.,noneed toobtainprior government approval).
g) In September 2021, the Indian government launched Phase II of Visvesvaraya PhD
Scheme to encourage research in 42 emerging technologies in Information Technology (IT),
Electronics System Design & Manufacturing (ESDM) and Information Technology Enabled
Services (ITES).

4. Emerginggeographiesandverticals,productsandautomation are helping the industry to grow

further.

5. UseofITinemergingverticals such as retail,healthcare,utilities

etc.aredrivinggrowthinIndianITsector.
6. RevivalindemandforITservicesfromUSandEurope is also helping the industry to grow.

______________________________________________________________________________
17.3Communications (Telecom) Industry
______________________________________________________________________________

The telecom sector is one of the fastest growing sectors in India. It has been undergoing an
innovative phase over the past few years. India has become the second largest
telecommunication market in the world after China. The telecom sector has assumed the position
of an essential infrastructure for socioeconomic development of the country. Telecom services in
India can bedividedintotwobroad segments,wire-lineservices(includes
fixedlinetelephoneandBroadband)andwirelessservices(includesmobilephone–
GSMandCDMA).The other telecommunication servicesthat includeinternet services, broadband
services, VSAT, have also evolvedgradually and have become an integral part of the Indian
telecom industry. On the other hand, the wire line segmenthas been witnessing adrastic decline in
its subscriberbase in the last 10 years. The following diagram presents the various telecom
services in India.

Telecommunication Services in India

Wireline (Fixed line Telephone and

Broadband)

Wireless (Mobile phone-GSM:3G,4G

Telecom Services and CDMA-1x and HSD-wireless data
cards)

Other Telecommunication Services

(Internet services, Public Mobile Radio
Trunked Services (PMRTS), Global
Mobile Personal Communication by
Sattelite (GMPCS), Very Small
Aperture Terminals (VSAT), Mobile
Value Added Services etc.

17.3.1 Status of Telecom Industry in the Country

Several studies have shown positive correlation of theInternetandMobileServicesongrowthof
theGDPofa country. Telecommunication sector has delivered a visible transformation to the
society, the common manand helped India’s overall socio-economic development. The policy
framework of the country has also facilitated the growth and development of the sector.
Indiantelecomindustryiscurrentlytheworld’ssecondlargesttelecommunicationsmarket. India has
the second-largest number of telephone connections in the world. The following tables show
the data pertaining to various dimensions of Telecommunications scenario in India as reported
by Telecom Regulatory Authority of India. It can be seen from Table 1 that there are about
117 crore telephone subscribers in India as on 31.12.2020. The urban subscribers are 10
percent more than the rural subscribers. Most of the subscribers are wireless (mobile)
subscribers. The number of wire line subscribers (fixed line) is very insignificant at about two
percent of the total subscribers of telephones in the country. In fact, it has been declining
rapidly for the past ten years. There are very few rural consumers who opted for fixed line
connections. There is a slight difference of about five percent in the number of rural and urban
telephone subscribers in the country. There are about 80 crore internet subscribers in the
country which has been helping the government in its objective to make India a digital
economy. About 94 percent of internet subscribers in the country are broad band subscribers,
which again is a good sign. In internet access, broadband technologies provide higher data rate
in terms of Mbps, whereas narrowband connections provide slower data rate such as 56 kbps.
About 97 percent of the internet subscribers of the country are wireless internet subscribers. A
wireless network allows devices to stay connected to the network but roam undeterred to any
wires. A wired network uses cables to connect devices, such as laptop or desktop computers,
to the Internet or another network. A wireless network is much more advantageous as
compared to wired network.

Table 2: Subscriber base of Telecommunications as on 31.12.2020(in millions)

Number %
Total Subscribers both wireless and 1,174 100
wireline
a)Urban Subscribers 648 55
b)Rural Subscribers 526 45
Wireless subscribers 1154 98
a) Urban subscribers 630 55
b) Rural Subscribers 524 45
Wire line Subscribers 20 2
a)Urban Subscribers 18 90
b)Rural Subscribers 2 10
Internet Subscribers 795 100
a)Broadband subscribers 747 94
b)Narrowband subscribers 48 6
a)Wireless internet subscribers 770 97
b)Wired internet subscribers 25 3
a)Urban internet subscribers 487 61
b)Rural internet subscribers 308 39
Of 100 people in the country 59 persons are internet subscribers. However, there is wide
variation between urban and rural areas in this percentage. In rural areas only about 35 of 100
persons are internet subscribers, in urban areas about 104 per 100 persons hold internet
subscription. This may be because of a person holding more than one internet connection. As far
as teledensity is concerned (connections per 100 persons) it is about 86 in the country. While in
urban areas the teledensity is about 138, in rural areas it is only about 59. This shows the need
for further expansion of telecommunication network in the rural areas. The share of private
sector in both telephone and internet connections is about 90 percent. It is a commonly known
fact that the smart phones help in mobile commerce, mobile banking, access to government
services etc. There are about 49 crore users of smart phones in India and this number needs to go
up substantially for achieving the objective of transforming Indian economy into a digital
economy. The Government is moving fast in this direction. The Department of
Telecommunications is targeting 100% broadband connectivity in the villages, 55% fiberisation
of mobile towers, average broadband speeds of 25 mbps and 30 lakh kms of optic fibre rollouts
by December 2022. By December 2024, it is looking at 70% fiberisation of towers, average
broadband speeds of 50 Mbps and 50 lakh kms of optic fibre rollouts at a pan-India level.

According to Invest India, a National Investment Promotion and Facilitation Agency, the
Telecom Sector of India provides direct employment of 2.2 million people and indirect
employment of 1.8 million people. According to one estimate, telecom as well as telecom
manufacturing sector is expected to createover10 millionemployment opportunities by 2025. The
employment opportunitiesare expected to be created due to combination of government’s efforts
to increase penetration in
ruralareasandtherapidincreaseinSmartphonesalesandrisinginternetusage.Riseinmobile-
phonepenetration and decline in data costs will add 500 million new internet users in India,
creating opportunities for new businesses. According to Swedish telecom gear maker Ericsson,
themonthlydatausageperSmartphoneinIndiaisexpectedtoincreasefrom3.9GBin2017to18GBby202
3.

However, in recent times, the financial downturn in the economy coupled with the policy
andregulatory uncertainty led to deteriorated fundamentals of telecom service providers.
Considering the role of telecom as the backbone of economic and socialdevelopment, the
Government has taken corrective measures to put back the sector on track. Some critical areas
requiring immediate attention of the Government, however, are rationalisation of levies and
makingmore spectrumavailable at a reasonable price to the industry to facilitate the launch of 5G
services.

17.3.2Growth Drivers of Telecommunications Industry

Growingyoungpopulation&Changinglifestyle:Mobileinternetispredominantlyusedbyyoungst
ers. However, there is a wide variation in the use of mobile internet between urban and rural
youth. The next wave of growth in mobile internet
usersisgoingtocomefromruralareas,wheremobiledatapenetrationamong youth is very low at
present.
Increasing rural market: Rural market would be a key growth driver for telecom industry in
comingyearsas telecompenetrationin ruralareasisstillverylowas comparetourbanareas.

Favorable policy support: Government of India has fast-tracked reforms in the telecom sector
andcontinues to be proactive in providing room for growth for telecom companies. Some of
major
stepssuchasDigitalIndiaProgramme,NationalDigitalTelecommunicationPolicy2018,National
e-Governance Plan etc. have been taken up by GoI to promote R&D, innovation and to attract
investmentinTelecomsector inIndia. In the Union Budget 2021-22, the government allocated Rs.
14,200 crores (US$ 1.9 billion) for telecom infrastructure that entails completion of optical fibre
cable-based network for Defence services, rolling out broadband in 2.2 lakh panchayats and
improving mobile services in the North East.

Tele-density in rural areas remains one of the main areas of growth for telecom players
where the tele-density is low.

Rising income will be a key determinant of demand growth in the telecommunication

sector in India, with the emergence of an affluent middle class triggering demand in the
mobile and internet segments.

India's young population, rapid urbanization and growing middleclass is expected to

ensure a growing subscriber base in the target demography. It is estimated that 93.3% of
India's population is estimated to be aged under 65 years, with 26.3% aged under 15 years.
This is driving growth in content consumption through various streaming apps, and the
demand for high speed internet is expected to grow by leaps and bounds.

Despite such a strong broadband subscriber addition, there is still a large headroom for
wireless broadband penetration to improve, as it still remains low at 57.7% as of March
2020. The growth in social media usage, rapidly increasing content consumption and many
organizations gradually transitioning to 'Work from Home' will continue to drive demand for
data.

DTH operators are likely to benefit from a rising subscriber base and higher market
penetration. Innovations in paid TV services, migration from SD to HD boxes have increased
consumption of -smart TV's and HD services, offering more opportunities to service operators.

Increased penetration of affordable devices, combined with cloud computing, analytics

and rising consumer expectations is driving the rapid growth of the IOT market. The
Indian Government is planning to develop 100 smart city projects, where IoT would play a
vital role in development of those cities. Telecom will play a critical role in providing
connectivity and solutions in this market.

In the era of 5G, telecom companies stand to earn 70% of their revenue from core
beneficiaries of 5G. Currently, they earn 30% from enterprises. While implementation and
rollout of 5G is still some time away, the standards and ecosystem on 5G have already
gathered pace with more and more use cases coming into picture.

The Government of India has introduced Digital India Program where sectors such as
healthcare, banking, will be connected through internet providing ample opportunities for
growth in the sector.

Post COVID-19 related lockdown, work from home may become a new normal for many
organizations, thus creating opportunities for different telecommunication services across
the spectrum- fixed line, broadband, enterprise solutions besides pure mobile connectivity.

Check Your Progress A

1. What is the structure of the IT industry?
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2. State the various telecom services in India.
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3. Match the following:
A. Telecom Service a. HR services
B. IT services b. IT Outsourcing
C. ITeS-BPO c. R&D Servics
D. Software d. CDMA

4. State whether the following statements are true or false:

1. Warehousing and transportation services come under Primary Sector.
2. The IT industry covers IT services, IT-enabled services (ITES), e-commerce (online
business), Software and Hardware products.
3. IT services account for about 52 percent of total IT sector revenues.
4. ThemonthlydatausageperSmartphoneinIndiaisexpectedtoincreasefrom3.9GBin
2017to18GBby2023.
5. About 94 percent of internet subscribers in the country are broad band subscribers.

______________________________________________________________________________
17.4 Role of ICT in Economic Development

TheICTindustry (telecommunicationsoperators, computerandsoftwareproducers,

electronicequipment manufacturers) is playing an increasinglyimportantroleintheglobaleconomy.
Theindustryhas been playing anotablerolein contributingtosocialgoods such
asimprovingeducationandhealthcareaccessandservices. It is estimated that justoneaction—
bringingmobilebroadbandlevelsinemergingmarketsupto thoseofmorematuremarkets—
couldaddbetweenUS$300andUS$420billiontotheworld’sGDP.10to14milliondirectandindirectjob
s will be createdinareassuch as equipment manufacturing and outsourcing/ off shoring services.

Investments in ICT lead to economic sustainability:

InvestinginICTisakeydriverofeconomicdevelopmentforemerginganddevelopedmarketsalike.
Infact,investinginICTcanhelpcountriesincreasetheirannualGDPgrowthby0.6–
0.7percentonaverage,onanannualbasis asseveralstudieshaveshown. This impact of investing in ICT
is created by a combination of directandindirecteffectsontheeconomy.Directeffects
comefrominvestmentsininfrastructure,
increasedavailabilityandpenetrationofservices,andincreasedemploymentintheICTsector. ICT’s
indirect effects include productivity
gainsforbusinesses,increasedforeigndirectinvestmentsasaconsequenceofacountrybeingICT-enabled,the
creationofinnovativeindustryclusterssuchasknowledge cities, and higher exports of ICT services
such asoutsourcing.

Social Benefits of ICT: Beyondencouragingeconomicgrowth,theICTindustryis helping to

achieve social sustainability by improvingthe way societies and governments provide
education, healthcare,andservicestocitizens.Additionally,theICT industry is changing the way
people interact with eachother,creatinglonger-termandlargelypositivechangesinavarietyofareas.

Impact on Education: The ICTsectorhas alreadydramaticallychanged

thewaypeoplestudy.AwiderangeofinformationisavailablefreeontheInternet—
somethingthatwasunthinkablejust20yearsago.
Theuseofemail,websites,andvirtualclassroomsandlibrarieshasproliferated,facilitatingthesh
aringofinformationonalargescale.

Impact on Health care: The use of ICT for health (e-health) has the potential
totransformhealthcarebyefficientlyconnectingpeopleandimprovinginformationsharing.Currently,
e-health is predominantly seen in developed countries.
ButastheavailabilityofICTspreadsrapidlyinthe
developingworld,thereisanopportunitytoexpandhealthcareaccesstoareaswheredistance,poverty,andsc
arceresourcesarecurrentlybarrierstoevenbasiccare.
ThankstoICT,doctorscanaccesspatients’medicalrecordsmoreeasily,haveimmediateaccesstotestresultsfr
omalaboratory, anddeliverprescriptionsdirectlytopharmacists.

Impact on Government Services: Early breakthroughs in e-government—such as the useof ICT

to provide and improve public-sector services,transactions, andinteractions—
haveenabledgovernmentorganizations to deliver better services more efficiently.InIndia, for
example,taxpayersnowfiletax returnselectronically. Manyothertransactions—
rangingfromrenewingdrivers’ licensesandpayingparkingticketstomanaginggovernmentbenefits—are
conductedonline. Citizenshaveamucheasierandfasteraccesstogovernmentservices because of ICT.

Improved information access and communication: ICTischangingthewaypeopleare

accessinginformation(withGoogleandWikipedia,forexample)andinteractwitheachother(blogs,social
networkingsites,virtualrealitysites etc.). Social networking websites have changed the
jobrecruitmentrules. Todaythesesitesaretheplacestofindajobandrecruitthe talent.

ICTs helps, builds and transforms the lives of the farmers: ICTs plays a very crucial role by
disseminating information to farmers to help them make better well informed decisions. Through
ICTs people can obtain the latest up-to-date information, learn and practice sustainable farming.

ICT helps in improving quality and productivity in manufacturing sector: ICT helps in
creation of new models of E-businesses, save the costs, improve the quality and quantity of
production and increase the competition in markets. According to the economic literature, ICT
deepens the capital—the increase of services per capital unit. Thus, the firms tend to use IT in
the production process.
______________________________________________________________________________
17.5 Challenges Faced by ICT Industry
______________________________________________________________________________

The IT and Communication industries too face a few challenges. The challenges faced by
these two industries are discussed separately:

Challenges faced by IT Sector

1. Cyber Security Threats: There have been frequent instances of in data breaches during the
recent years. The industry losing significantly because of these data breaches. Common types of
cyber-attacks are Fishing, Ddos, Spyware, Ransomware, Malware including viruses like Trojans,
Worms, Key loggers etc.

2. Talent Shortage: Businesses are in the need of people with combinations of skill that have
not previously been aligned, like analysts with coding abilities, or paramedics who understand
statistics. The industry is looking for super-specialized skill sets which are in short supply. There
is a huge gap in the skills the work demand and the skills job applicants have. Our education
system still needs to be revamped. And that affects the industries that seek highly skilled
employees. Unemployment is high in our country, but the fact is that many companies are not
able to find talent to fill the positions. Retention of employees is one of the biggest challenges
for the IT industry. Software companies recruit people, train them but in the end, they witness
their resignation once they are enough experienced in the job. Organizations invest into
employees to integrate them into the workflow.

3. Cloud Computing: All organizations in the IT industry are using the cloud for a wide variety
to perform tasks like data backup, disaster recovery, email, virtual desktops, software
development and testing. Rather than buying or owning physical data centres and servers one can
access services such as computing power, storage and databases from the cloud provider.
However, there are numbers of issues and concerns associated with cloud such as cost, service
provider reliability, downtime, data overload, password, security issue, data privacy etc.

4. Remote Workplace: The pandemic has made remote work (work from home) a new normal.
Working remotely can present unique challenges due to the lack of manager or teammates to
consult or to provide immediate responses or sources. Infrastructure is the prime need to
undertake such tasks, but to have such an infrastructure large investments are flown in acquiring
assets that can support, govern and handle the heavy data loads. However, there are threats to
these arrangements too, hacking and preventing the theft of data needs powerful firewalls and
software. This is an added cost to the IT industry.

5. Risks of outsourcing: More companies are opting for outsourcing due to talent shortage or
cost reduction. But outsourcing has created some challenges like security threats, legal
complications, cultural and time zone issues.

6. Government rules of different countries: US companies hire highly skilled employees from
other countries to work in their companies for special assignments. These employees were given
H1-B visa but the trump administration changed the policy of H1-B visas which caused a
negative impact on the organizations which are dependent on the US market. New procedures set
by the US government to acquire H1-B made it difficult for companies to prove that the
employee/workers who were travelling on an H1-B visa are supposed to serve a purpose in the
project and not travelling for personal benefits or hidden gains.

Challenges faced by Telecommunications Industry

1. Adaptation of Organization to Digital Transformation:With the availability of new
technologies, the variety and quality of services from telecom companies and internet service
providers (ISP) are increasing, profit margins are decreasing. Hence, telcos have to take a
fresh look at the level of ICT innovation and adapt their organization to digital transformation,
which is expensive.

2. Increase in Costs: With millions of subscribers, a variety of new products, bundled and
customized solutions, the operational support services like service configuration, order
fulfillment, customer care, and billing are becoming increasingly complex. Hence, the cost of
handling these operations requires resources and different tools. This has been raising the
costs further.

3. Requirement of Operational and Technological Innovations: Telecommunication

providers need to upgrade their IT and connectivity infrastructure and focus on providing data
and voice services that are high quality, reliable, and affordable. Security of the networks has
become a major priority for the Telcos and they are facing challenges with the emergence of
new threats that are powered by new technologies. So, a number of operational and technical
innovations are needed to meet customer expectations of complete system security.

4. Impact of Internet of Things: One more challenge waiting in the wings for telcos and
Internet Service Providers is the impact of Internet of Things (IoT) that is leading to explosive
growth in the connected devices. This growth is generating billions and trillions of new data
 sources and thus, it is expected that this growth will push the data to be handled by networks
to zettabytes per year.

______________________________________________________________________________
17.6ICT Products
______________________________________________________________________________

According to Organisation for Economic Cooperation and Development (OECD) “ICT goods are
those that are either intended to fulfill the function of information processing and communication
by electronic means, including transmission and display, or which use electronic processing to
detect, measure and/or record physical phenomena, or to control a physical
process”ICTproductsmustprimarilybeintendedtofulfillorenablethefunctionofinformationprocessin
gandcommunicationbyelectronicmeans,includingtransmissionand display. Thus, the ICT
products are broadly categorized as follows:

Broad Categories of ICT Products

1 Computersandperipheralequipment
2 Communicationequipment
3 Consumerelectronicequipment
4 MiscellaneousICTcomponentsandgoods
5 ManufacturingservicesforICTequipment
6 Businessandproductivitysoftwareandlicensingservic
es
7 Informationtechnologyconsultancyandservices
8 Telecommunicationsservices
9 LeasingorrentalservicesforICTequipment
10 OtherICTservices

Let us learn them one by one.

1.Computer and Peripheral Equipment: This category includes Point of Sale terminals,
ATMs, Lap Tops, Notebooks, Input devices (Keyboard, Joystick, Mouse etc.), Scanners, Printers
(Inkjet Printers, Laser Printers, Other printers), Two-in-one/three-in-one printers, Removable
storage units, parts and accessories of computing machines, Monitors and projects etc.

2. Communication Equipment: It includes- Burglar or Fire Alarms, Transmission apparatus,

Television cameras, telephone sets, mobile phones etc.

3. Consumer Electronic Equipment: It includes Video game consoles, Video camera recorders,
Digital cameras, Radio broadcast receivers, Television receivers, Monitors and projectors, Sound
recording or reproducing apparatus, Video recording or reproducing apparatus, Microphones,
loudspeakers, headphones, earphones, audio-frequency amplifiers, electric sound amplifier sets
etc.

4. MiscellaneousICTcomponentsandgoods: Sound video, network and similar cards, Printed

circuits, Valves and tubes, Diodes, transistor and similar semi-conductor devises, photosensitive
semiconductor devices, light emitting diodes, Electronic integrated circuits, Magnetic media,
Optical media, Other recording media, Cards with magnetic stripe, Smart cards, Liquid crystal
devices etc.

5. ManufacturingservicesforICTequipment:Includes‐
Electroniccomponentmanufacturingservices,
Computerandperipheralequipmentmanufacturingservices,Communicationequipmentmanufacturi
ngservices, Consumerelectronicsmanufacturingservices, Magnetic
andopticalmediamanufacturingservices etc.

6. Businessandproductivitysoftwareandlicensingservices: Includes-Operatingsystems,
Networksoftware, Databasemanagementsoftware,
Developmenttoolsandprogramminglanguagessoftware,
Generalbusinessproductivityandhomeuseapplications, Otherapplicationsoftware,
Licensingservicesfortherighttousecomputersoftware, Softwareoriginals,
Systemsoftwaredownloads, Applicationsoftwaredownloads, On-linesoftware etc.

7. Informationtechnologyconsultancyandservices: Includes-
Businessprocessmanagementservices, ITconsultingservices, ITsupportservices,
ITdesignanddevelopmentservicesforapplications, Websitehostingservices,
Applicationserviceprovisioning, OtherhostingandITinfrastructureprovisioningservices,
Networkmanagementservices, Computersystemsmanagementservices etc.

8. Telecommunicationsservices: Includes-Carrierservices, Fixedtelephonyservices,

Mobiletelecommunicationsservices, Privatenetworkservices, Datatransmissionservices,
Othertelecommunicationsservices, Internetbackboneservices, NarrowbandInternetaccessservices,
BroadbandInternetaccessservices, OtherInternettelecommunicationsservicesetc.

9. LeasingorrentalservicesforICTequipment:Includes-
Leasingorrentalservicesconcerningcomputerswithoutoperator,
Leasingorrentalservicesconcerningtelecommunicationsequipmentwithoutoperator,
Leasingorrentalservicesconcerningtelevisions,radios,videocassetterecordersandrelated
equipmentand accessories etc.

10. Other ICT Services: Includes-

Engineeringservicesfortelecommunicationsandbroadcastingprojects,
Maintenanceandrepairservicesofcomputers andperipheralequipment,
Maintenanceandrepairservicesoftelecommunicationequipmentandapparatus,
Installationservicesofmainframecomputers,
Installationservicesofpersonalcomputersandperipheralequipment,
Installationservicesofradio,televisionandcommunicationsequipmentandapparatusetc.
______________________________________________________________________________
17.7Government Support for ICT Product Development
______________________________________________________________________________

The Government of India introduced the National Policy on Software Products-2019 with a
vision to drive the rise of India as a Software Product Nation and synergies with the IT/ITES
sector. The policy is aimed at making India as a global player in development, production and
supply of innovative and efficient Software Products. This is expected to facilitate the growth
across the entire spectrum of ICT.
The following programmes have been implemented/are under implementation under the Policy:
1. National Software Product Mission (NSPM)
2. Indian Software Product Registry (ISPR)
3. Innovation Challenge for Development of Indian Video Conferencing Solution (Software
Product)
4. ICT Grand Challenge (ICTGC) under National Policy on Software Products
5. Start-up Accelerator Programme of MeitY for Product Innovation, Development and Growth
(SAMRIDH)
6. Next Generation Incubation Scheme (NGIS)
Let us learn them one by one.
1. National Software Product Mission (NSPM):The Mission has been constituted to evolve
and monitor schemes, programmes and strategy for the implementation of National Policy on
Software Products (NPSP 2019).
2. Indian Software Product Registry (ISPR):
Indian Software Product Registry (ISPR) has been created to analyse numbers/ statistics/
database of Indian Software Product Companies (ISPC). This will bring all software products at
one single platform to provide a common pool of Indian Software Products thereby providing a
trusted trade environment. It serves as a gateway to the Indian Software Product Company
(ISPC) with exposures to millions of global players.

3. Innovation Challenge for Development of Indian Video Conferencing Solution (Software

Product): Thechallenge has been launched to develop innovative Video Conferencing solution.
The end product will be an Indian Software Product at par with International video and audio
quality, should work in low and high network scenarios. The winner of the challenge who will be
provided financial support of Rs 1 Crore (One Crore) with additional Rs.10 Lakhs towards O&M
for next three years and will be adopted for Government use.
4. ICT Grand Challenge (ICTGC) under National Policy on Software Products:The Grand
challenge has a provision to conduct 20 challengesto develop a variety of software products
addressing socio-economic challenges. For example, the Ministry of Jal Shakti has announced to
develop a ‘Smart water supply measurement and monitoring system’ via an ICT Grand
Challengeto deploy at the village / semi-rural / semi-urban levels.
5. Start-up Accelerator Programme of MeitY for Product Innovation, Development and
Growth (SAMRIDH):A significant numbers of start-ups die within the first few years and
around 50% of the Start-ups fail by 4th year of their inception. The key reason for the failure of
these start-ups is due to lack of right funding at the right time, not understanding market
dynamics for their products, limited knowledge of user perception of their product, and not
improving their product through constant innovation and continuous feedback, lack of funds for
other needs such as research and development, expansion of organisation, use of latest
technologies for growth etc.SAMRIDH, implemented by MeitY (Minitry of Electronics and
Information Technology) under its Start-up Hub known as MSHis aimed at creating a conducive
platform to Indian Software Product star-ups to enhance their products and securing investments
for scaling their business. The program will focus on accelerating the 300 start-ups by providing
customer connect, investor connect, and international immersion in next three years. Also, an
investment of up to ₹ 40 lakh to the start-up based on current valuation and growth stage of the
Start-Up will be provided through selected accelerators. It will also facilitate equal matching
investment by the accelerator / investor. The programme aims to further the Indian start-up
growth.

6) Next Generation Incubation Scheme (NGIS): The scheme is to create a vibrant software
product ecosystem to complement the robust IT Industry for continued growth, new employment
and enhance competitiveness. Under this schemestart-ups working towards solutions/
outstanding software products for futuristic problems/ emerging ICT technology/ societal
problems are identified and promoted through technical and financial support and training. The
scheme is launched in 12 locations of the country and aims to handhold 300 Tech Start-ups.

Check Your Progress B

1. What is the meaning of ICT product?
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2. Explain the meaning of SAMRIDH.
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3. State whether the following statements are True or False:
1. Computer and Peripheral EquipmentPoint of Sale terminals,
2. Telecommunication services include network management services.
3. National Policy on Software products was framed in 2020
4. Indian Software Product Registry serves as a gateway to the Indian Software Product
Company
5. ICTGC) under National Policy on Software Products is meant to develop a variety of
software products addressing socio-economic challenges.
______________________________________________________________________________
17.08 Let Us Sum Up
______________________________________________________________________________

Services sector plays an important role in an economy. ICT sector is a prominent sector in
services sector. It consists of Information Technology (IT) Industry and Communications
Industry. The IT industry covers IT services, IT-enabled services (ITES), e-commerce (online
business), Software and Hardware products. IT industryinIndiacanbroadly be
classifiedintothreesectors viz., i) Software, ii) ITservices and iii)
InformationTechnologyEnabledservices-BusinessProcessOutsourcing(ITeS-BPO) and is the
biggest employment generator and has helped the growth of several ancillary industries in the
country. The telecom sector is one of the fastest growing sectors in India. India has become the
second largest telecommunication market in the world afterChina. Several studies have shown
positive correlation of theInternetandMobileServices ongrowthof theGDPofa country.
ICTproductsmustprimarilybeintendedtofulfillorenablethefunctionofinformationprocessingandco
mmunicationbyelectronicmeans,includingtransmissionand display. The Government of India
introduced the National Policy on Software Products-2019 with a vision to drive the rise of India
as a Software Product Nation and synergise with the IT/ITES sector.

______________________________________________________________________________
17.09 Key Words
______________________________________________________________________________

IT industry: Consists ofthreesectors viz., i) Software, ii) ITservices and iii)

InformationTechnologyEnabledservices-BusinessProcessOutsourcing(ITeS-BPO).

Telecom services: Consists of twobroad segments--wire-lineservices(includes

fixedlinetelephoneandBroadband)andwirelessservices(includesmobilephone–GSMandCDMA).
The other telecommunication services include internet services, broadband services and VSAT.

ICT Products: The products that are either intended to fulfill the function of information
processing and communication by electronic means, including transmission and display, OR
which use electronic processing to detect, measure and/or record physical phenomena, or to
control a physical process.

National Software Product Mission (NSPM):The Mission has been constituted for the
implementation of National Policy on Software Products (NPSP 2019).

Indian Software Product Registry (ISPR): It serves as a gateway to the Indian Software
Product Company (ISPC) with exposures to millions of global players.

Innovation Challenge for Development of Indian Video Conferencing Solution (Software

Product): The challenge has been launched to develop innovative Video Conferencing solution.
ICT Grand Challenge (ICTGC) under National Policy on Software Products: The Grand
challenge has a provision to conduct 20 challengesto develop a variety of software products
addressing socio-economic challenges.

Start-up Accelerator Programme of MeitY for Product Innovation, Development and

Growth (SAMRIDH):SAMRIDH, implemented by MeitY (Minitry of Electronics and
Information Technology) under its Start-up Hub known as MSHis aimed at creating a conducive
platform to Indian Software Product star-ups to enhance their products and securing investments
for scaling their business.

Next Generation Incubation Scheme (NGIS): The objective of the scheme is to create a
vibrant software product ecosystem to complement the robust IT Industry for continued growth,
new employment and enhance competitiveness.

______________________________________________________________________________
17.10 Answers to Check Your Progress
______________________________________________________________________________

A. 3) A-d; B-b;C-a; D-c.

4) 1. False; 2. True; 3.True; 4. True; 5. True.
B. 3)1.True; 2. False; 3. False; 4. True; 5. True

______________________________________________________________________________
17.11 Terminal Questions
______________________________________________________________________________
1. Explain the various components of IT industry in India.
2. Describe the facilitators of growth of software sector in India.
3. Describe the status of Telecommunications Industry in India.
4. Explain the market players of telecommunications in India.
5. Explain the various ICT Products.
6. Describe the Government support to development of ICT products.
 BLOCK 6 : EXTERNAL SECTOR OF INDIAN ECONOMY
Foreign trade plays an important role in the economy of any country and is considered as an
engine of growth. Like in every other economy, Indian economy and foreign trade are closely
interlinked. Foreign trade is a crucial part of development strategy. It has been an effective
mechanism of financial growth, creation of job opportunities and poverty reduction in the
economy. Foreign trade results in proper use of the resources of the country; making available
necessary inputs for industrialization; providing outlet for surplus production; earning much
needed foreign exchange.

Balance of payments (BOP) is an accounting statement of all international monetary transactions

of a country. These transactions arise due to flow of goods, services and capital between a
nation’s residents and the residents of the rest of the world during a given period of time. BOP is
a key to understanding how people trade one country’s money for that of another country. In
addition, the transactions documented in the balance of payments have major implications for
macroeconomic concerns like growth, inflation and unemployment.

This is the era of globalization. The economic upheaval in a corner of the world has its
repercussions all over the globe. The WTO has been the cornerstone of the multilateral rules-
based global trading system since its inception in 1995. The WTO is an international
organization that deals with the global rules of trade. The policies of the WTO impact all aspects
of the global society.

Unit 18: Structure of India’s Foreign Trade: explains different components of India’s foreign
trade. It includes important trends in India’s foreign trade, main imports and exports, trade in
services, traditional and emerging markets. It highlights different aspects of India’s foreign trade
policy 2015-20. The concept of foreign trade multiplier, its working, importance and
shortcomings have been elaborated.

Unit 19: Balance of Payments (BOP) and Exchange Rate: explains the concept of Balance of
Payments, its components and importance. The causes of disequilibrium of BOP and policy
measures for correcting them are discussed. The concept of exchange rate, its types and
significance along with its method of determination and its impact on BOP have been elaborated.

Unit 20: World Trade Organization (WTO): explains the background of establishing World
Trade Organization (WTO). The principles, objectives, functions and organizational structure of
WTO are discussed. Special agreements, namely Intellectual Property Right, Agriculture and
Trade in Services vis-a-vis WTO have been explained. Besides, India’s concerns in respect of
WTO and its working during 2015-21 have been elaborated.

1
 UNIT 18: STRUCTURE OF INDIA’S FOREIGN TRADE

Structure

18.0 Objectives
18.1 Introduction
18.2 Trends in India’s Foreign Trade
18.3 Value of India’s Foreign Trade
18.4 Composition/pattern of Foreign Trade
18.4.1 Composition of Exports
18.4.2 Composition of Imports
18.4.3 Main Imports and Exports of India
18.5 Trade in Services
18.6 Direction of India’s Foreign Trade
18.6.1 Traditional Markets and Emerging Markets
18.7 Indian Foreign Trade Policy
18.7.1 Foreign Trade Policy 2015-20
18.8 Foreign Trade Multiplier
18.8.1 Assumptions
18.8.2 Its Working
18.8.3 Importance
18.8.4 Shortcomings
18.9 Let Us Sum Up
18.10 Key Words
18.11 Answer to Check Your Progress
18.12 Terminal Questions

2
 18.0 OBJECTIVES

After going through this unit, you will be able to:

• Discuss the significance of foreign trade in the Indian economy;

• analyze the broad trends in India’s foreign trade;
• spell out the composition of India’s exports and imports;
• determine the direction of trade;
• examine the contour of India’s foreign trade policy and
• state the concept of foreign trade multiplier.

18.1 INTRODUCTION

Foreign trade, more generally, has been considered as an engine of growth. Like in
every other economy, Indian economy and foreign trade are closely interlinked.
Foreign trade has a significant impact on the GDP growth as well as expansion. As
such foreign trade is a crucial part of development strategy. It has been an effective
mechanism of financial growth, creation of job opportunities and poverty reduction
in the economy. Foreign trade results in proper use of the resources of the country;
making available necessary inputs for industrialization; providing outlet for surplus
production; earning much needed foreign exchange. It helps the country to deal
with the periods of natural calamities (droughts, floods, etc.) through import of
food grains and other necessary consumer goods. In the present age of
globalization, the government has initiated changes in its strategy on trade, foreign
investment, and tariffs. An appropriate and skillfully designed foreign trade policy
is essential for India’s rapid economic growth. In this unit, you will learn
examining trends in volume of trade, composition of trade; and direction of trade
in post – reform period. We will also examine the principal features of India’s
foreign trade policy. We will sum up the discussion with highlight on the concept
of foreign trade multiplier.

18.2 TRENDS IN INDIA’S FOREIGN TRADE IN THE POST-REFORM

PERIOD: 1991-2020

3
 During 2019-20, total of exports and imports trade of India represents 43.3 per cent
of the country's GDP. Earlier, till 1980s this volume ranged between 15 to 20 per
cent of GDP. As per the WTO data for the year 2018 India's share in global
exports of merchandise was 1.7 percent and in global imports 2.6 percent. In the
services sector, India's share in global exports 3.5 percent and imports was 3.2
percent. The low world share of India’s exports, however, does not bring out the
importance of foreign trade for the Indian economy. All-out efforts are being made
by the government to raise the share of India in the global exports. In this section,
we will analyze the trends in value, composition and direction of exports and
imports and highlight the growing importance of services trade in recent times.

18.3 VALUE OF INDIA’S FOREIGN TRADE

The value of India’s exports grew at the rate of 14.5 per cent a year
during the 20 year after 1991. The first decade of reforms is
characterized by a relatively low growth of 8 per cent a year, while
the second decade stands apart for its strong growth rate of 21
percent a year. In general, the growth rate of Indian exports has
been higher than the world exports throughout the post-reform
period. This is in contrast to the pre-reform period when the Indian
growth rates had been below the world average. Looking at the level
rather than growth, the value of exports stood at $23 billion in
1993-94 which increased to $45 billion in 2001-02. In other words,
during the early phase of the reforms, it took as many as eight
years to double the value of exports. However, thereafter within a
period of four years, the export value increased to more than doubled
from $45 billion in 2001-02 to $105 billion in 2005-06. Further, between 2002-03
and 2010-11, the value of exports increased nearly five times from about $54

4
 billion to $250 billion. Consistent with this trend, India's share in the world exports
first increased slowly from about 0.6 percent in 1993 to 0.7 percent in 2001 and
then increased relatively faster to 1.7 percent in 2018. India's total merchandise
trade as a percentage of the gross domestic product (GDP) increased from 28.2
percent in 2004-5 to 43.2 percent in 2011-12. India's merchandise exports as a
percentage of GDP increased from 11.8 per cent to 16.5 percent during the same
period.
From 1991 to 2018, the total value of goods exports increased more than 16 times
from $18 billion to over $322.5 billion. During the same time span, goods imports
increased almost 22 times from $ 24 billion to $508 billion.
(Source:Comtrade,2020.https://www.nordeatrade.com/en/explore-new-market/india/trade-
profile).

The sustainability of India's export and prospects for further growth are strongly
contingent on the trends in world demand. Economic survey 2019-20 has observed
that export growth remains subdued with external demand weakened by slowdown
in global investment, output and heightened trade tensions, notwithstanding
resilient service exports. The global pandemic in form of Covid -19 adversely
affected trade. We are witnessing a sharp recovery presently.
Check Your Progress A
1. Identify four major trends in India’s foreign trade since 1991.
………………………………………………………………………………
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2. Indicate India’s position in global trade.

5
 ………………………………………………………………………………
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3. Highlight the importance of foreign trade in Indian economy.
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4. Which of the following statements are True or False?
i) Foreign trade is considered as an engine of growth.
ii) During 2019-20, total of exports and imports trade of India were
lower than those during the 1980s.
iii) The first decade of reforms is characterized by a relatively low
growth.
iv) From 1991 to 2018, the total value of goods exports increased more
than 16 times.
v) Global pandemic in the form of Covid -19 did not affect India’s
foreign trade.

18.4 COMPOSITION/PATTERN OF FOREIGN TRADE

18.4.1 Composition of Exports
Composition of foreign trade refers to the items of imports and exports. Over the
last seven decades, India’s foreign trade has undergone a complete transformation
in terms of composition of commodities. Manufacturing holds an important part of
India’s exports growth. Four sectors viz. engineering, gems and jewelry,
petroleum and textiles contributes to about three-quarters of India’s exports. The

6
 composition of India’s exports trade has undergone structural changes mainly as a
result of industrial progress.

India's merchandise trade increased exponentially in the 2000s decade from US$
95.1 billion in 2000-01 to US$ 793.8 billion in 2011-12. India's share in global
exports and imports also increased. Its ranking in the leading exporters and
importers stood at 19 for exports and 10 in imports in 2018 rank. Total export from
India (merchandise and services) stood at US$ 528.45 billion in 2019-20, while
total import was estimated at US$ 598.61 billion. Merchandise export stood at US$
314.31 billion in 2019-20, while merchandise import touched US$ 467.19 billion
in the same period. The estimated value of services export and import for 2019-20
stood at US$ 214.14 billion and US$ 131.41 billion, respectively.

Some of the major changes can be identified as follows:

(i) The most striking aspect of the structural change in India's exports is that the
share of capital-intensive products has more than doubled. The capital-
intensive groups such as transport equipment, machinery, and base metals
registered higher growth than the traditional groups like textiles.
(ii) The share of petroleum products in India's export basket increased
dramatically from about 2 percent in 1993 to as high as 13.7 percent in 2019.
This export surge has been driven mainly by India's private sector oil
refineries.
(iii) There has been a consistent structural change in export leading to
increase in the shares of human capital and technology-intensive products
and a consistent decline in the shares of natural resource and unskilled
labour-intensive products.

7
 (iv) The phenomenal growth of ‘mineral products’ has been driven by
‘mineral fuels and oils’ while ‘organic chemicals’ and ‘pharmaceutical
products’ are responsible for the export growth of ‘chemical products’.
(v) The export growth of ‘machinery’ has been driven primarily by ‘electrical
machinery and equipments’. The growth of ‘transport equipments’ has been
brought about by ‘vehicles other than railway or tramway rolling-stock’ and
‘ships, boats and floating structure’.
A total of 68 dynamic products in India’s export basket have been identified, of
which 50 belong to the capital-intensive category and the remaining 18 belong to
the traditional category.
The combined share of these 68 products in India's total exports has increased
very fast. The capital-intensive category as a whole contributes about 56 percent
of India's total exports. This indicates a high degree of concentration in export
activity.

To sum up compositional changes in India's export basket have been taking place
over the years. While the share of primary products in India's exports fell over the
years mainly due to the fall in shares of traditional items like textiles and leather
and leather manufactures even though the share of engineering goods and
chemicals and related products increased. In short, the proportions of high value
and differentiated products have increased in India’s export basket.
The composition of trade is now dominated by manufactured goods and services.
The diversification in export products has risen rapidly following the reforms. In
recent times, the composition of India’s exports has become more broad- based
with visibly decreased dependency on any one product category.

18.4.2 Composition/Pattern of Imports

8
 There has been a shift in India’s import trade from primary products to capital
goods and other intermediate manufactures. Now the import of primary fertilizers,
iron and steel, non-ferrous metals, and other industrial inputs has increased
substantially. The changes in the composition of imports have occurred to meet the
consumption and investment needs of the growing economy of India. The most
notable change is the rise in share of capital goods imports. The strong growth of
the manufacturing and services sector is reflected in its import bill. The shares of
import bill telecommunications, equipment, office machines, and aircrafts have
risen appreciably. Fuel imports remain a major import item. The other product
categories in India’s imports include: electronic goods, gold and silver, chemicals,
pearls and precious and semi-precious stones, iron and steel, non-ferrous metals,
professional instruments, optical goods, etc., and computer software. Due to the
greater rise in the demand for edible oils as compared to production, India’s
dependency on edible oils continues. As India has multiplied domestic production
capacity for manufacturing capital goods, its import share of capital goods has
declined.
Table 18.1: Commodity-wise Composition of Exports (Share in Total Exports
Percent)
2011-12 2019-20 (April-November)
Items
Petroleum 18.5 13.7
Products
Pearl, Precious, 9.3 7.0
Semiprecious
Stones
Drug 2.6 5.0
Formulations,
Biologicals
Gold and Other 4.3 4.5
Precious Metal
Jewellery
Iron and Steel 2.7 3.0

9
 Products of Iron 2.3 2.8
and Steel
Organic Chemicals 1.7 2.8
RMG Cotton 3.2 2.6
including
Accessories
Ship, Boat and 2.7 2.5
Floating Struct
Other 5.0 2.3
Commodities
Source: Department of Commerce, Government of India

Table 18.2: Commodity-wise Composition of Imports in (Share in

Total Imports Percent)
2011-12 2019-20 (April-November)
Items Items Per cent
Petroleum: 27.4 21.0
Crude
Gold 11.6 6.4
Petroleum 4.3 5.6
Products
Coal, Coke and 3.6 4.8
Briquittes, etc.
Pearl, Precious, 5.8 4.6
Semiprecious
Stones
Fertilizers 1.9 3.6
Manufactured
Telecom 2.3 3.2
Instruments
Organic 1.9 2.7
Chemicals
Industrial 2.2 2.6
Machinery for
Dairy etc.
Iron and Steel 2.8 2.5

Source: Department of Commerce, Government of India

18.4.3 Main Items of Imports and Exports of India

10
 Since liberalization, there has been an increasing diversification of both exports
and imports. The transformation in the composition of India’s exports has been
made possible because of rapid growth and diversification of Indian industries. The
composition of imports also underwent changes.
India’s imports primarily consist of petroleum products, fertilizers, capital goods,
edible oils, etc., wherein there is little flexibility to reduce its imports bill.

The main items of exports of manufactured goods from India consist of:
(i) gems and jewellery,
(ii) readymade garments,
(iii) machinery and instruments,
(iv) drugs, pharmaceuticals, and fine chemicals,
(v) manufacturer of metals,
(vi) transport equipment,
(vii) primary and semi-finished iron and steel,
(viii) cotton yam, fabrics, and made ups,
(ix) electronic goods,
(x) dyes, intermediates, and coal tar chemicals,
(xi) leather and manufacturers, handicrafts, leather footwear, and
others,
(xii) petroleum products.

India’s exports of agricultural and allied products include:

(i) marine products,
(ii) raw cotton,
(iii) oil meals, fruits and vegetables,
(iv) spices, cashewnuts, coffee and tea,

11
 (v) unmanufactured tobacco,
(vi) cereals, and others.

Important items of imports of goods to India consist of:

(i) Petroleum Crude,
(ii) Gold, Pearl, Precious, Semiprecious Stones,
(iii) Petroleum Products Coal,
(iv) Electronics Components,
(v) Telecom Instruments,
(vi) Organic Chemicals,
(vii) Industrial Machinery for Dairy etc.,
(viii) Iron and Steel,
(ix) Plastics, plastic articles,
(x) Medical apparatus,
(xi) Other items.

Check your progress B

1. Name four main items of exports by India.

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2. Name four main items of imports by India.

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 ………………………………………………………………………………
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3. Point out three major changes in India’s imports.

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4. What is the most striking aspect of the structural change in India's exports in
the recent past?.

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5. Which of the following statements are True or False?

i) Manufacturing holds an important part of India’s exports growth.

ii) The share of capital-intensive products in India's exports has more

than doubled.

iii) The share of import bill of telecommunications, equipment, office

machines, and aircrafts has decreased appreciably.

iv) India’s main item of exports is petroleum crude.

v) India has emerged as a leading exporter of software.

13
 18.5 TRADE IN SERVICES

India’s services trade has been a major driver of its exports over the past two
decades. The country has emerged among the fastest growing nations in global
services trade as can be seen from Table 18.3.

Table 18.3: India’s trade in services (2014-18) (value in $ billion)

Year Exports Imports Trade balance

2014 157.20 128.36 28.83

2015 156.28 123.57 32.71
2016 161.82 133.53 28.29
2017 185.29 154.60 30.70
2018 205.11 176.58 28.52
Source: ITC Trade Map, https://www.tpci.in/research_report/india-services-trade/

This sector has not only attracted significant foreign investment flows but also
contributed significantly to exports as well as provided large-scale employment.
India’s services sector covers a wide variety of activities such as trade, hotels and
restaurants, transport, storage and communication, financing, insurance, real estate,
business services, community, social and personal services, and services associated
with construction.
18.5.1 India’s Services Exports
India’s services exports have significantly grown in the post reform period as can
be seen from Table 18.4 below. The trade in services has been growing faster than
the merchandise trade, and the share of services in the total export trade has been
increasing.
Table18.4: Service Exports as percent of GDP

2009-14 2014-19 2018-19

Exports 7.7 7.5 7.7
Imports 4.4 4.3 4.6
Source: Reserve Bank of India.

14
 India is now the world’s back-office because companies from rich nations have
outsourced business processes and other IT-intensive and knowledge-based
operations to Indian partners. India’s services trade surplus has increased due to the
surge in IT exports. There has been considerable growth in transport, travel, and
other services, such as telecommunications, financial, construction, and legal. The
software services are mainly responsible for the surplus in services trade. Over the
years, the composition of services exports from India has undergone considerable
change. Some of these changes can be highlighted as follows:

An analysis of services exports from India reveals that the largest services
segment, software and IT-enabled services, has graduated to newer services. The
new services include: packaged software implementation, systems integration,
network infrastructure management, and IT consulting. There remains a huge
untapped potential for IT-enabled services.

Under the miscellaneous services segment, India’s entertainment industry covers

film, music, broadcast, television, and live entertainment and is basically an
intellectual-property-driven sector with small to large players spread across India.
Education process outsourcing includes: imparting online education, training, and
coaching, and other related services through the Internet and has emerged as a
significant segment for services exports. The travel and tourism sector has also
shown significant growth in recent years.

India’s imports of services have increased from $ 128.36 billion in 2014 to $

176.58 billion in 2018. The relative shares of the various constituents of service
imports have not varied much with business services constituting about a third of

15
 service imports, which is in consonance with the rising level of economic activity
in the country. The component of travel services has however been steadily
increasing reflecting the growing attractiveness of global destinations to the
domestic tourists in the country. India has maintained trade surplus in all the major
services. However, the trade surplus has shown fluctuations in the past five years.

Table 18.5: India’s imports of services (2014-18)

Code Service label 2014 2015 2016 2017 2018

S All services 128.36 123.57 133.53 154.60 176.58

SOX Memo item: Commercial 127.40 122.69 132.85 153.96 175.45

services

3 Transport 58.90 52.26 47.95 57.06 66.74

10 Other business services 26.87 29.81 32.74 35.44 38.71

4 Travel 14.59 14.84 16.38 18.44 21.31

SN Services not allocated 5.10 5.97 12.26 14.43 16.83

8 Charges for the use of 4.85 5.01 5.47 6.52 7.91

intellectual property n.i.e.

9 Telecommunications, 4.32 3.80 4.75 6.07 7.09

computer, and
information services

6 Insurance and pension 5.88 5.23 5.07 6.29 6.75

services

16
 7 Financial services 4.12 3.12 5.02 5.80 4.04

11 Personal, cultural, and 1.39 1.37 1.89 2.14 2.54

recreational services

5 Construction 1.13 0.96 0.95 1.22 2.49

12 Government goods and 0.96 0.88 0.68 0.64 1.13

services n.i.e.

2 Maintenance and repair 0.22 0.31 0.32 0.51 1.00

services n.i.e.

1 Manufacturing services 0.03 0.03 0.05 0.04 0.04

on physical inputs owned
by others

Source: ITC Trade Map; values are in US$ billion

18.6 DIRECTION OF INDIA’S FOREIGN TRADE

After independence, India’s trade expanded in many new directions. Change has
been evident in countries which India trades with. The direction of both imports
and exports of India has changed significantly. India has trading relations with all
the major trading blocs and all the geographical regions of the world. At present,
India’s major trading partners are: China, U.S.A., U.K., Russia, Japan, Germany,
France, Iran, Iraq, Belgium, Saudi Arabia, UAE, Hong Kong, Singapore. Trade
with emerging markets and developing countries has expanded spectacularly.
Within Asia, while the share of North East Asia (consisting of China, Hong Kong,
Japan) and ASEAN (Association of South East Asian Nations) fell there was a
noticeable rise in the share of West Asia-GCC (Gulf Cooperation Council)

17
 countries. The country has recently signed free trade agreements with South Korea
and ASEAN, and has entered into negotiations with several partners (EU,
MERCOSUR, Australia, New Zealand and South Africa). The top five countries of
exports are U.S.A., U.A.E., China, Hong Kong and Singapore. As regards the
direction of imports, the top five countries of imports are China, Saudi Arabia,
UAE, U.S.A. and Switzerland.
Table 18.6: Direction of trade in 2018
Countries Exports Imports
(per cent) (per cent)
United States 16.0 6.4
China 5.1 14.5
United Arab Emirates (UAE) 8.8 5.3

Saudi Arabia 5.6

Iran
Iraq 4.5
Hong Kong 4.1
Singapore 3.2
Other Countries 62.7 63.6
Source: Comtrade, 2020.
The destination-wise exports of major items to the major trading partners show
great changes in the composition of exports to USA and China. In the case of
India's exports to the USA, the share of exports of primary products has increased
while the share of manufactured goods in India's exports to the USA has fallen.
This decline has been mainly due to the fall in growth rates of exports of textiles
and gems and jewellery. In the case of India's exports to China, the share of
primary products has fallen due to the fall in share and growth rate of ores and
minerals. The share of manufactures in India's exports to China has increased
mainly due to the rise in share of engineering goods, textiles, and chemicals and
related products. In the case of India's exports to the EU, there has been a marginal

18
 rise in the share of primary products and petroleum products and a fall in the share
of manufactured goods.

18.6.1 Traditional Markets and Emerging Markets

It is convenient to divide the different market regions into two broad groups:
(i) Traditional markets’ comprising Australia and New Zealand,
Europe, Japan, and North America; and
(ii) Emerging markets which include south and Central America, the
Caribbean and the various regions of Asia and Africa.

The aggregate share of traditional markets in India's exports has declined steadily.
The emerging markets account for nearly two-thirds of India’s exports. India's
export shares to most of the countries in this group has increased over the years,
with the increase being particularly pronounced for the UAE and China.

With the country focusing on its Look-East policy since 2009 and exploring new
destinations, such as Latin America, Africa and Oceania, growth in exports has,
more or less, been steady, even as demand from traditional markets of the US and
the EU is on a decline. China continues to be the largest exporter to India followed
by USA, UAE and Saudi Arabia. There is need to diversify the markets.
Check Your Progress C
1. Write three importance of trade in services.
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2. Name five main items of exports and imports in trade in services.

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 ………………………………………………………………………………
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3. Describe the main trade partners of India for both exports and imports.
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4. Name three important emerging markets for Indian exports.
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5. Which of the following statements are True or False?
i) India has emerged among the fastest growing nations in global
services trade.
ii) India is now the world’s back-office.
iii) India has maintained trade surplus in all the major services.
iv) The share of manufactured goods in India's exports to the USA has
increased.
v) The Caribbean has been the traditional market for India’s exports.

18.7 INDIA'S FOREIGN TRADE POLICY

India used to be a protectionist state for a long time, but presently the country has
become progressively more open to international trade. Since July 1991, the
economy is largely driven by market dynamics. This is true for India’s foreign
trade. The Indian economy has been opened up to foreign participation for the first

20
 time, in an attempt to improve the efficiency and competitiveness of Indian
industries.
The outward looking trade policy measures announced in 1991 mark the initiation
of a new era in India’s foreign trade. India adopted export promotion strategy just
to promote its exports so as to increase its foreign exchange earnings. Post 1991,
the gradual liberalization of the Indian economy created a conducive environment
for India’s exports to flourish and evolve into an engine of social and economic
growth. Hence, the last three decades have witnessed India’s transformation from a
closed economy to a big player in the global market. Many pro-export policies
have been adopted after the reforms, which have a favorable impact on India’s
trade. The process of trade liberalization is still not completed.

18.7.1 Foreign Trade Policy 2015-20

The Foreign Trade Policy (FTP) 2015-20 was unveiled on April 1, 2015. India
aims to increase its export of merchandise and services from $ 465 billion in 2013-
14 to approximately $ 900 billion by the 2019-20 and to raise India’s share in the
world export from 2 percent to 3.5 percent. The focus of the policy is to support
both the manufacturing and services sectors, with a special emphasis on improving
the ‘ease of doing businesses’. It lays down a road map for India’s global trade
engagement in the coming years.
India’s Foreign Trade Policy (FTP) consists of schemes to support the domestic
exporting community. These include development policies that help set-up special
trade and economic zones in different parts of the country. The FTP is primarily
growth-oriented. Its main objective is to encourage exports. The government is
pitching India as a friendly destination for manufacturing and exporting goods, and
the policy is being seen as an important step towards realising that goal.

21
 The policy describes the market and product strategy and measures required for
trade promotion, infrastructure development and overall enhancement of the trade
eco system. It seeks to enable India to respond to the challenges of the external
environment, keeping in step with a rapidly evolving international trading
architecture and make trade a major contributor to the country’s economic growth
and development. Following are the salient features of the FTP :
(i) The policy provides a framework for increasing exports of goods
and services as well as generation of employment. The focus is on
increasing value addition in the country, in line with the ‘Make in
India’ programme.
(ii) It aims to enable India to respond to the challenges of the external
environment, keeping in step with a rapidly evolving international
trading architecture. It aims at making trade a major contributor to
the country’s economic growth and development.
(iii) It introduces two new schemes. The first is ‘Merchandise Exports
from India Scheme (MEIS)’ for export of specified goods to
specified markets. The second scheme is ‘Services Exports from
India Scheme (SEIS)’ for increasing exports of notified services.
(iv) In order to give a boost to exports from SEZs, the policy extends
benefits of both the reward schemes (MEIS and SEIS) to units
located in SEZs. It is hoped that this measure will give a new
impetus to development and growth of SEZs in the country. Duty
credit scrips issued under MEIS and SEIS and the goods imported
against these scrips are fully transferable.
(v) Measures have been adopted to nudge procurement of capital goods
from indigenous manufacturers under the EPCG scheme.
(vi) It provides boost to exports of defense and hi-tech items.

22
 (vii) A number of steps for encouraging manufacturing and exports under
100 percent EOU/EHTP/STPI/BTP Schemes has been taken.
(viii) 108 ‘MSME clusters’ have been identified for focused interventions
to boost exports. Accordingly, ‘Niryat Bandhu Scheme’ has been
galvanized and repositioned to achieve the objectives of ‘Skill
India’. Outreach activities will be organized in a structured way at
these clusters with the help of EPCs and other willing “Industry
Partners” and “Knowledge Partners”.
(ix) Trade facilitation and enhancing the ease of doing business are the
other major focus areas of FTP. Attention has been paid to simplify
various ‘Aayat Niryat’ Forms, bringing in clarity in different
provisions, removing ambiguities and enhancing electronic
governance.
The government has extended the existing foreign trade policy till March 2022
amid the outbreak of the coronavirus pandemic. Not with standing all the changes
and reforms, India’s trade regime and regulatory environment still remains
relatively restrictive.

18.8 FOREIGN TRADE MULTIPLIER

The concept: The foreign trade multiplier also known as the export multiplier
operates like the investment multiplier. It may be defined as the amount by
which the national income of a nation will be raised by a unit increase in
domestic investment on exports. As exports increase, there is an increase in the
income of all persons associated with export industries. These in turn create
demand for goods. But this is dependent upon their marginal propensity to save
(MPS) and the marginal propensity to import (MPM). The smaller the ratio of

23
 these two marginal propensities, the larger will be the value of multiplier and vice
versa resulting in increase in domestic product to an addition to exports. As for
example, if an increase in exports by `1000 crores has raised national income
through the foreign trade multiplier by `2000 crores, given the values of MPS and
MPM.

18.8.1 Assumptions

The foreign trade multiplier is based on the following assumptions:

(i) There is full employment in the domestic economy.

(ii) There is a direct link between domestic and foreign country in
exporting and importing goods.
(iii) It is on a fixed exchange rate system. The multiplier is based on
instantaneous process without time lag and the domestic
Investment (Id) remains invariable.
(iv) There is no accelerator and the analysis is applicable to only two
countries.
(v) There are no tariff barriers and exchange controls.
(vi) The government expenditure is constant.

18.8.2 It’s Working

The foreign trade multiplier process can be explained like this. Suppose the exports
of the country increase. To begin with, the exporters will sell their products to
foreign countries and receive more income. In order to meet the foreign demand,
they will engage more factors of production to produce more. This will raise the
income of the owners of factors of production. This process will continue and the
national income increases by the value of the multiplier. The value of the
multiplier depends on the value of marginal propensity to save (MPS) and

24
 marginal propensity to import (MPM). There has been an inverse relation between
the two propensities and the export multiplier.

Imports depend on the level of national income. As the national income increases,
so do domestic expenditures on imports. Thus, marginal propensity to import
(MPM) is defined as:
MPM = change in import/ change in income
Exports have no relationship with the level of domestic national income, thus they
are independent. Exports are dependent on national income of importing country.

Multiplier effect:
(i) Given the assumptions, an increase in exports tends to raise
domestic income. The increased income also encourages some
imports, which act as ‘leakages’. These tend to reduce the full
multiplier effect that would exist if imports remained constant.
Thus, MPM is the fraction of any increase in income that ‘leaks’
into imports.
(ii) Open economy’s allocation of income is MPC + MPS + MPM
= 1.
(iii) The foreign trade multiplier is defined as the reciprocal of all
the leakages, including imports.
Foreign trade multiplier= 1 / (MPS + MPM) = 1 / leakage
(iv) If MPS is constant then the MPM has an inverse relationship with MPC.
As more imports are consumed, there are smaller amounts to be
consumed for domestic goods.

18.8.3 Importance
The Foreign Trade multiplier brings about the effect of change in exports on
change in income. In the open economy exports are exogenous i.e., they do not
depend upon national income of an economy. It gets determined exogenously in
the external factors like taste and preferences of the residents of the foreign country
and the national income of the foreign countries. There is a direct and positive

25
 relationship between imports and national income. As total national income rises
imports rise too and vice versa.

In reality, countries are linked to each other indirectly also. A country’s exports or
imports affect the national income of the other country which, in turn, affects the
foreign trade and national income of the first country. The smaller the country is in
relation to other trading partner, the negligible is the foreign repercussion. But the
foreign repercussion will be high in the case of a large country because a change in
the national income of such a country will have significant foreign repercussions.
The policy implications are that the export promotion measures raise national
income via the simple foreign trade multiplier, whereas increases in domestic
investment policies raise national income many times in multiplier rounds via the
repercussion effects.

18.8.4 Shortcomings
The analysis of foreign trade multiplier is based on the unrealistic assumptions.
Exports and investment are not independent. A rise in exports does not always lead
to increase in national income. On the contrary, certain imports, of say capital
goods, have the effect of increasing national income. The foreign trade multiplier
is assumed to be an instantaneous process whereby it provides the final results.
Thus, it involves no lags and is unrealistic. The assumption of full employment is
not realistic. It is not applicable to more than two countries. The foreign trade
multiplier assumes that there are no tariff barriers and exchange controls. In reality,
such trade restrictions exist which restrict the operations of the foreign trade
multiplier. Governments always interfere through monetary and fiscal policies
which affect exports, imports and national income. However, despite these
shortcomings, the foreign trade multiplier is a powerful tool of economic analysis
which helps in formulating policy measures.

26
 Check Your Progress D

1. Distinguish between outward looking policy and import substitution

strategy.
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………

2. What do you mean by liberalized trade policy?

………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………

3. Point out six salient features of foreign trade policy (FTP) of 2015-20.

………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………

4. What is the concept of foreign trade multiplier?

………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………
………………………………………………………………………………

5. Which of the following statements are True or False?

i) India used to be a protectionist state for a long time.

ii) The focus of the foreign trade policy 2015-20 is to place special
emphasis on improving the ‘ease of doing businesses’.

27
 iii) The foreign trade multiplier is related to the domestic investment on
exports.

iv) In the open economy, exports depend upon national income of an

economy.

v) Governments interfere in exports and imports through monetary and

fiscal policies.

18.9 LET US SUM UP

It is significant to note the four important aspects of India’s foreign trade which
include huge growth in the value and volume of trade, higher growth of imports,
inadequate growth of exports, and mounting trade deficit.

Since independence, the composition of India’s foreign trade has changed as a

result of economic development and industrialization of the country. India's major
exports include manufacturing and engineering goods. It is no longer confined to a
few countries or few commodities. Presently India has trade relations with almost
all the countries of the world. India’s exports cover over 9300 commodities to
about 220 countries. Imports from about 180 countries accounts for over 8200
commodities. India is now importing intermediate goods and raw material so as to
make full use of its production capacity, known as maintenance imports.

India’s share in the world trade both in terms of imports and exports has been
increasing. The bulk of India’s trade is with the developed countries of the West,
the oil producing countries and China. However, there is a good scope for
expanding trade, particularly exports, with South-East Asia, Middle-East, and East
Africa.

28
 The government has been following a liberalised foreign trade policy since 1991
and has mainly concentrated on reforms on liberalization, openness and export
promotion activity.

The foreign trade multiplier may be defined as the amount by which the national

income of a nation will be raised by a unit increase in domestic investment on

exports. As exports increase, there is an increase in the income of all persons

associated with export industries. But the assumptions of foreign trade multiplier

are unrealistic.

18.10 KEY WORDS

Diversification of trade: A broadening of the range of products that a country

exports and imports. It is a key element which helps a country to move to a more
diverse production and trade structure. Diversification provides a more stable path
for growth of trade.

Globalization: The growing interdependence of the world’s economies, cultures,

and populations, brought about by cross-border trade in goods and services,
technology, and flows of investment, people, and information.

Import Substitution Strategy: It incorporates three main stages: (1) domestic

production of previously imported simple nondurable consumer goods, (2) the
extension of domestic production to a wider range of consumer durables and more-
complex manufactured products, and (3) the export of manufactured goods and

29
 continued industrial diversification. India adopted import substitution strategies for
its industrialization.

An outward-looking strategy: The stance of this strategy is vigorous promotion of

manufactured goods exports. It focuses on international trade reducing protection,
lifting subsidies and increasing FDI. The major characteristics of the outward
policy are: Deregulation, free trade, floating exchange rate, high competiveness
and increased flows of FDI.

Trade protectionism: Protectionist policy is a policy that protects domestic

industries from unfair competition from foreign ones for the benefit of a domestic

economy. The four basic tools are tariffs, subsidies, quotas, and currency

manipulation which a government can use under protectionism. It is a politically

motivated defensive measure.

18.11 ANSWERS TO CHECK YOUR PROGRESS

A 5 i) True, ii) False, iii) True, iv) True, v) False

B 5 i) True, ii) True, iii) False, iv) False, v) True

C 5 i) True, ii) True, iii) True, iv) False, v) False

D 5 i) True, ii) True, iii) True, iv) False, v) True

18.12 TERMINAL QUESTIONS

30
 1. Point out significance of foreign trade in Indian economy. Describe the
broad trends in India’s foreign trade since 1991.
2. Explain changes in the composition of India’s exports and imports.
Highlight the direction of trade in recent times.
3. What is services trade? Describe its importance in India’s foreign
trade.
4. What do you mean by liberalized foreign trade policy? Examine its
importance.
5. Analyse the salient features of India’s foreign trade policy of 2015-20.
How will it be of help in promoting India’s exports?
6. What is the meaning of foreign trade multiplier? Indicate its
importance.

SOME USEFUL REFERENCES

Ahluwalia, M.S., (2002), Economic Reforms in India since 1991: Has Gradualism
Worked? Journal of Economic Perspectives, Vol. 16, No. 3, pp. 64-88.

Datt, Gaurav and Mahajan, Ashwani (2020): Datt and Sundharam’s Indian
Economy, S. Chand Publishing, New Delhi

GoI (2020): Trends in India’s Foreign Trade, Department of Commerce, New

Delhi http://commerce.nic.in/publications/annual-report-pdf-2020

GoI (2021): Economic Survey 2020-21, Department of Economic Affairs,

Ministry of Finance, New Delhi.

Kapila Uma (2020): Indian Economy: Performance and Policies, Academic

Foundation, New Delhi

31
UNIT 19 BALANCE OF PAYMENTS (BOP) AND EXCHANGE RATE

Structure

19.0 Objectives
19.1 Introduction
19.2 Concept, Components and Importance of BOP
19.2.1 Components of BOP
19.2.2 Importance of BOP
19.2.3 Balance of Trade and Balance of Payments
19.3 BOP Disequilibrium
19.3.1 Causes of Disequilibrium
19.3.2 Policy Measures for Correcting Disequilibrium
19.4 Rate of Exchange: Concept, Types and Significance
19.4.1 Exchange Rate
19.4.2 Significance of Exchange Rate
19.5 Exchange Rage Regime / System
19.6 Fixed Exchange Rate
19.6.1 Advantages
19.6.2 Disadvantages
19.7 Floating Exchange Rates
19.7.1 Advantages
19.7.2 Disadvantages
19.8 Appreciation and Depreciation of Exchange Rate
19.9 Foreign exchange Rate and Impact on BOP
19.10 Determination of Exchange Rate
19.10.1 Purchasing Power Parity Theory
1
19.11 Let Us Sum Up
19.12 Key Words
19.13 Answers to Check Your Progress
19.14 Terminal Questions

19.0 OBJECTIVES

After going through this unit, you will be able to:

• describe the concept of BOP;

• identify the components of BOP;

(i) distinguish between: balance of trade and balance of payments;

and current and capital accounts of BOP;

• discuss the importance of BOP for an economy;

• identify the state of disequilibrium in BOP and explain the methods

required for correcting disequilibrium in BOP;

• state of exchange rate and its types;

• describe the purchasing power, parity theory of exchange rate

determination

19.1 INTRODUCTION

Balance of payments (BOP) is an accounting statement of all international

monetary transactions of a country. These transactions arise due to flow of

goods, services and capital between a nation’s residents and the residents of
2
 the rest of the world during a given period of time. BOP is a key to

understanding how people trade one country’s money for that of another

country. In addition, the transactions documented in the balance of payments

have major implications for macroeconomic concerns like growth, inflation

and unemployment. In this unit, you will learn various facets of BOP like its

concept, type, disequilibrium, corrective measures, exchange rates, types of

foreign exchange regime, its impact on BOP, and theory of purchasing power

parity.

19.2 CONCEPT, COMPONENTS AND IMPORTANCE OF BOP

Balance of payments of a country is a systematic record of all monetary

transactions during a period between residents of the reporting country and

residents of other countries. It is a summary of the money-value of all

exchanges and transfers of goods, services and evidences of debt or

ownership between the residents, business and government and other

institutions of one country and the rest of the world for a given period of

time, usually a year. The International Monetary Fund (IMF) has developed a

standardized BOP system and form of presentation. All transactions entering

the balance of payments can be grouped into three broad accounts –current,

capital and reserve account. In short, BOP:

(i) records all international monetary transactions;

3
 (ii) the type of economic transactions that dominate are: goods and
services, real assets, financial assets;
(iii) it is not a balance sheet;
(iv) it is a flow statement.
In a tabular form structure of BOP transactions may be presented as
under:

Balance of payments

Current Account Capital Account

Merchandise
Exports (X) Remittances and Asset Transactions, FDI,
Imports (M) Transfer Receipts External Borrowings
and Payments

(Balance of Trade = X – M)

As an illustration India’s BOP data is presented below in Table 19.1:

Table 19.1: Structure of India's Overall Balance Of Payments

(US $ million)

Item/Year 2019‐20*
Credit Debit Net
1 17 18 19
A. Current account
1. Merchandise 320431 477937 -157506
2. Invisibles (a+b+c) 321712 188862 132850
a) Services 213191 128269 84922
b) Transfers 83356 8147 75208
c) Income 25166 52446 -27281
Total Current account (1+2) 642143 666799 -24656

B. Capital account
1. Foreign investment 368534 324118 44417
2. Loans 94239 68553 25686
3. Banking capital 84716 90031 -5315
0 69 -69
4. Rupee debt service
5. Other capital 62549 44087 18462
Total capital account (1 to 5) 610038 526858 83180
C. Errors & omissions 1856 882 974
D. Overall balance (A+B+C) 1254037 1194539 59498

4
E. Monetary movements (i+ii) 0 59498 -59498
i) I.M.F. - - -
ii) Foreign exchange reserves (Increase- / Decrease+) 0 59498 -59498

* preliminary estimates

Look at Table 19.1 which shows India’s BOP account for the financial year

2019-20. It shows the main items of transactions with some simplifications.

19.2.1 Components of BOP

BOP components can be grouped into three broad categories: current

account, capital account, and reserves. Let us learn them in detail.

1. Current account: The current account consists of merchandise trade,

services, and unrequited transfers. Merchandise trade is typically the

first part of the current account. It receives more attention than any of

the other accounts. Merchandise trade transactions, where the imports

and exports of goods are reported, are often the largest single

component of all international transactions. Export receipts are treated

as credit entries, and imports payments as debits in current account.

The second type of transactions in the current account is those

payment and receipts for which there are no corresponding receipts or

payments. These are called unrequited payments and receipts. These

transactions are unilateral transfers.

5
 Services: The services category includes many payments such as

freight, banking and insurance on international shipments; tourist

travel; profits and income from overseas investment; personal

expenditures by government, civilians, and military personnel

overseas; and payments for management fees, royalties, film rental,

and construction services. Purchases of these services are recorded as

debits, while sales of these services are similar to exports and are

recorded as credits.

The net receipts from these transactions together with the net

transactions in the trade account constitute the balance of current

account. Here, it is important to note that positive net receipts imply a

current account surplus and negative net receipts imply a current

account deficit. The balance of current account is a larger concept as it

includes the balance of trade, the balance of services, and the balance

of unrequited transfers. The balance of current account need not be

equal but can show a surplus or a deficit.

2. Capital account: The capital account records all international

purchases and sales of assets such as money, stocks, bonds, etc.

Capital account items are transactions that involve claims in

ownership. It shows net change in foreign-asset-ownership of a nation.

6
 Foreign direct investment (FDI) involves managerial participation in a

foreign enterprise along with some degree of control. Foreign

portfolio investment (FPI) is investment designed to obtain income or

capital gains. Transactions in the capital account affect the

international debtor or creditor position of the country and the

distribution of wealth and debt. Capital account transactions give rise

to future claims such as acquiring foreign assets or share in companies

located abroad.

3. Reserves or the monetary movements: This refers to record of

transactions with the International Monetary Fund (IMF) and foreign

exchange reserves that mainly consist of holding of gold and foreign

currency assets. Drawings (treated as a kind of borrowing) from IMF

is a credit item, whereas repayments made to IMF are debit items.

Reserves are used for bringing BOP accounts into balance. When all

the components of balance of payments are taken together, the balance

of payments should be in balance. Credits should equal debits.

Net Errors and Omissions: You must have noticed that millions of

rupees in transactions are reported in BOP statements, it should come

as no surprise that the amount of recorded debits are never equal to the

amount of credits. This is why there is an entry in the reserve account

7
 for net errors and omissions. Net errors and omissions reflect the

imbalances resulting from imperfections in source data and

compilation of the balance of payments accounts.

19.2.2 Importance of BOP:

BOP highlights a country’s international economic status. It indicates a

country's position in international trade. Persistent disequilibrium in the

balance of payments, particularly the deficit balance, is undesirable because

it weakens the country's economic position at the international level. As a

result it affects the progress of the economy adversely.

BOP indicates a country's competitive strengths and weaknesses and helps in

achieving balanced economic growth. It can affect the economic policies of

a government significantly and also the economy itself. Capital receipts and

payments indicate the country’s external debt position and changes in it.

BOP data are of interest because they reveal demand for the country’s

currency, BOP trend helps to predict what sort of economic environment

may develop in the country and, in some cases, the likelihood of economic

crisis. International crises have occurred for as long as there have been

international trade and commerce. They may occur again. Each crisis has its

8
own unique characteristics, but all follow some of the economic

fundamentals.

19.2.3 Balance of Trade and Balance of Payments

For the sake of clarity, it is important to understand the distinction between

balance of trade and balance of payments. BOP transactions, as discussed

above, take the form of trade in goods and services, capital movements or

financial flows. These three forms of transactions give rise to a

compartmentalization of the balance of payments accounts. Balance of trade

refers to the transactions in visible items only. Import or export of goods is a

visible item because, it is an open trade among the countries and can be

easily certified ‘by the customs officials’. The net receipts from exports and

imports of merchandise constitute the balance of trade (BoT). A trade deficit

for a country arises in a particular year if the value of its exports is smaller

than the value of its imports. It is obvious that the balance of trade need not

always balance. The important point to remember is that there may be a

balance of trade deficit and still a balance of payment surplus-or vice versa.

BOT is just one part of balance of payments.

9
 BOP is more comprehensive than the balance of trade. Balance of payments

includes apart from balance of trade or merchandise account, the invisible

account. The visible account is composed of the services sector and gifts

and charities account comprising a variety of invisible items, plus

transactions on capital account. In short, balance of trade is a partial picture,

while balance of payments is a complete picture of the country’s

international economic relations. Further, in the accounting sense, balance

of trade may be deficit or surplus. It may, thus, be imbalanced. But balance

of payments as a whole must always balance. For that reason, there is an

item called ‘reserves or monetary movements’ in its structure.

Table 19.2 BALANCE OF PAYMENT V/S BALANCE OF TRADE

BOP BOT
1 It is a broad term. It is a narrow term.
2 It includes all transactions related to It includes only visible items.
visible, invisible and
capital transfers.
3 It is always balances itself. It can be favourable or unfavourable.
4 BOP = Current Account + Capital BOT = Net Earning on Export - Net
Account + or - Balancing item (Errors payment for imports.
and omissions)
5 Following are main factors which affect Following are main factors which
BOP affect BOT
a) Conditions of foreign lenders. a) cost of production
b)Economic policy of Government b) availability of raw materials
c) all the factors of BOT c) Exchange rate
d) Prices of goods manufactured at
home
10
19.2.2 Balance of Payments Always Balances:
The balance of payments is strictly an accounting term used to describe a
record of all monetary transactions between one country and rest of the
world. In practice, it is difficult to achieve a situation where receipts equal
payments. In reality, total receipts may diverge from total payments because
of:
(i) the difficulty of collecting accurate trade information;
(ii) the difference in the timing between the two sides of the balance;
and
(iii) a change in the exchange rates.

To say that the ‘balance of payments always balances’ is to say that a net

credit balance in one of these accounts must have a counterpart net debit

balance in one of the other accounts. The algebraic sum of the net credit and

debit balances of the three accounts must equal zero. It simply results from

the double-entry book-keeping procedure which is used to record the

transactions. Balance of payments balances only in an accounting sense and

not in economic sense.

Because of measurement problems, recourse is made to ‘balancing item’ that

intends to eliminate errors in measurement. The purpose of incorporating

this item in the BOP account is to adjust the difference between the sums of

the credit and the sums of the debit items in the BoP accounts so that they

add up to zero by construction. Hence the proposition: ‘the BOP always

11
 balances’. It is a truism. It only suggests that the two sides of the accounts

must always show the same total. It implies only equality. In this book-

keeping sense, BOP always balances. ‘Balance of payments always

balances’ has no economic significance.

Check Your Progress A

1. Define balance of payments.

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2. List the components of BOP.

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3. Write three differences between balance of payments and balance of trade.

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4. Distinguish between current and capital accounts of BOP.

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12
 ------------------------------------------------------------------------------------------------
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5. Which of the following statements are True or False?
i) BOP is an accounting statement of all international monetary
transactions of a country.
ii) BOP is a balance sheet.
iii) BOP highlights a country’s international economic status.
iv) The balance of payments always balances.
v) The balance of trade is more comprehensive than the balance of
payments.
19.3 BOP DISEQUILIBRIUM

A disequilibrium in the balance of payment implies a state of surplus or deficit. A

surplus in the BOP occurs when Total Receipts exceed Total Payments
(CREDIT>DEBIT). A Deficit in the BOP occurs when Total Payments exceed
Total Receipts (DEBIT>CREDIT).
In an equilibrium situation of BOP, there are neither surpluses nor deficits. When a
country’s current account is in a deficit or surplus, its balance of payments (BOP)
is said to be in disequilibrium. A significant deficit on the current account where
imports are greater than exports would result in a disequilibrium. Likewise, when
exports are greater than imports, creating a current account surplus, there is a
disequilibrium.
However, in general parlance, when BOP deficit or an unfavorable balance exists
whereby the value of debit items exceeds the value of credit items, such imbalance
is interpreted as BOP disequilibrium. Such disequilibrium is a matter of concern
which needs to be corrected.

19.3.1 Causes of Disequilibrium

Disequilibrium is caused by economic and non-economic factors. They are as

under:

13
 a) When there is an imbalance between domestic savings and domestic
investments. A deficit in the current account balance will result if domestic
investments are higher than domestic savings, since the excess investments
will be financed with capital from foreign sources.
b) When the trade agreement between two countries affects the level of import
or export activities, a balance of payments disequilibrium will surface.
c) Changes in an exchange rate when a country’s currency
is revalued or devalued; it can cause disequilibrium.
d) Other factors, such as inflation or deflation, changes in the foreign exchange
reserves, population growth, increase in developmental expenditure, political
instability, etc. may result in disequilibrium.

19.3.2 Policy Measures for Correcting Disequilibrium

There are a number of policies that can be introduced to achieve an improvement

in a country’s BOP. The measures are:
(i) Adjustment through exchange depreciation.
(ii) Devaluation or expenditure-switching policy.
(iii) Direct controls.
(iv) Adjustment through capital movements.
(v) Adjustment through income changes.
(vi) Stimulation of exports and import substitutes.
(vii) Expenditure-reducing policies.

Some of these measures focus on changing the growth of demand, and

others look to improve the supply-side competitiveness of an economy. The
effective policies are those that target the underlying causes which
emphasise earning more foreign exchange through additional exports or
reducing imports. Quantitative changes in exports and imports require
policy changes. Such policy steps are in the form of monetary, fiscal and
non-monetary measures. Non-monetary methods are more effective than
monetary methods and are normally applicable in correcting an adverse
balance of payments.
In practice, governments generally undertake the following measures:
1. Monetary Measures:
(a) The Central Bank by its monetary policy may expand or contract the
money supply in the economy through appropriate measures which
will affect the prices.
(b) Depending upon the situation government’s expenditure may be
14
 increased or decreased.
(c) Exchange rate depreciation reduces the value of home currency in
relation to foreign currency. As a result, imports become costlier and
exports become cheaper. It also leads to inflationary trends in the
country. Depreciation leads to fall in external purchasing power of
home currency. Depreciation occurs in a free market system wherein
demand for foreign exchange far exceeds the supply of foreign
exchange market of a country. When a country devalues its currency,
exports become cheaper and imports become expensive which causes
a reduction in the BOP deficit. It is important to remember that
devaluation is done in fixed exchange rate system.
(d) Deflation is the reduction in the quantity of money to reduce prices
and incomes. In the domestic market, when the currency is deflated,
there is a decrease in the income of the people. This puts curb on
consumption and government can increase exports and earn more
foreign exchange.
(e) Under exchange control, all exporters are directed by the monetary
authority to surrender their foreign exchange earnings, and the total
available foreign exchange is rationed among the licensed importers.
The license-holder can import any good but amount is fixed by
monetary authority.
2. Non-monetary measures: A deficit country may also adopt the following
non-monetary measures which will either restrict imports or promote
exports.
(a) Export Promotion: A country may adopt measures to stimulate
exports. Export duties may be reduced to boost exports. Cash
assistance, subsidies can be given to exporters to increase exports.
Goods meant for exports can be exempted from all types of taxes.
(b) Import Substitution: Steps may be taken to encourage the production
of import substitutes. This will save foreign exchange in the short run
by replacing the use of imports by these import substitutes.
(c) Import Control: Imports may be kept in check through the adoption
of a wide variety of measures like quotas and tariffs. Under the quota
system, the government fixes the maximum quantity of goods and
services that can be imported during a particular time period. Tariffs
are duties (taxes) imposed on imports. When tariffs are imposed, the
prices of imports would increase to the extent of tariff. The increased
prices will reduce the demand for imported goods and at the same
time induce domestic producers to produce more of import
substitutes.

15
Check Your Progress B

1. What do you mean by disequilibrium in BOP?

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2. List any four causes of disequilibrium in BOP.
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3. What is meant by deflation?

4. How is exchange control achieved?
5. Which of the following statements are True or False?
i) A disequilibrium in the balance of payment implies a state of surplus
or deficit.
ii) A surplus in the BOP occurs when Total Receipts are less than the
Total Payments.
iii) Devaluation is an important measure to achieve an improvement in a
country’s BOP.
iv) Under exchange control, all exporters are directed by the monetary
authority to surrender their foreign exchange earnings.
v) Export duties are hiked to boost exports.

19.4 RATE OF EXCHANGE: CONCEPT, TYPES AND SIGNIFICANCE

‘Foreign exchange’ refers to money denominated in a currency other than the

domestic currency. Foreign exchange can be in form of cash, funds available
on credit cards and debit cards, and banks’ deposits.

19.4.1 Exchange Rate

The rate at which a currency of one country exchanges for a currency of
another country is called the ‘exchange rate’ or the rate of exchange. The
16
exchange rate can either be expressed in terms of number of units of
domestic currency per unit of foreign currency (direct quotation) as in the
case of most currencies such as the Indian rupee. For example, if the
exchange rate between the rupee and the US dollar (USD) is quoted at Rs.74,
this means that Rs.74 is required to purchase US$1.00. When the value of
the domestic currency increases in terms of another currency, it is referred to
as a nominal appreciation of the domestic currency. In contrast, a decrease in
the value of the domestic currency in terms of a foreign currency is known as
a nominal depreciation.

19.4.2 Significance of Exchange Rate

The exchange rate performs the same type of functions as other prices do in a
market of mixed economy. It provides information and incentives to guide
decisions about what to produce and what to consume. Considered as a price,
however, the exchange rate has special qualities. It is probably the single
most important price in the economy. It affects numerous other prices and
touches the interests of many people. This makes it the centre of controversy
with major changes in the exchange rate exciting much popular attention. The
exchange rate has the further quality of linking together the general level of
prices in the national economy with prices in other countries.
It is worthwhile to remember that the exchange rate is a key financial
variable that affects decisions made by foreign exchange investors, exporters,
importers, bankers, businesses, financial institutions, policymakers and
tourists in the developed as well as developing world. Exchange rate
fluctuations affect the value of international investment portfolios,
competitiveness of exports and imports, value of international reserves,
currency value of debt payments, and the cost to tourists in terms of the value
of their currency. Movements in exchange rates thus have important
implications for the economy’s business cycle, trade and capital flows and
are therefore crucial for understanding financial developments and changes in
economic policy.

19.5 EXCHANGE RATE REGIME/SYSTEM

17
 Exchange rate system is also called a currency system which establishes the
way in which the exchange rate is determined. There are two basic systems
that can be used to determine the exchange rate between one country’s
currency and another’s. These are: a floating exchange rate system and a
fixed exchange rate system. Between these there are a number of
combinations of the two. The choice of an appropriate exchange rate
regime—floating, managed or fixed arrangements—for individual countries
is important. It is a pivotal element of the economic policy adopted by a
country’s government. However, it remains true that there is no single
exchange rate regime that is best for all countries in all circumstances.

19.6 FIXED EXCHANGE RATE

In a Fixed exchange rate system the price of a currency is “fixed” with
respect to another currency, a pool of currencies, or a precious metal such as
gold. A country’s monetary authority agrees to manage its affairs so as to
maintain a fixed ratio between the value of its own currency and that of other
currencies. A country’s currency, therefore, has a definite objective value in
terms of the other currencies into which it can be freely converted. The
central bank intervenes in the foreign exchange market to ensure that the
exchange rate stays close to a predetermined target.

In a fixed exchange rate system, a rise in the exchange rate of the domestic
currency vis-à-vis another foreign currency is called a devaluation. For
example, a government’s policy decision to devalue the domestic currency
vis-à-vis the US dollar from Rs.65 to Rs.75. This means that in order to buy
1 unit of a given foreign currency more of the domestic currency is needed.
On the other hand, when the exchange rate falls it is termed as a revaluation.
These terms imply a deliberate decision on the part of the government to
change the exchange rate.
It is important to realize that fixity cannot be achieved by simple
government decree because there are powerful economic forces at work in
18
 the foreign exchange markets. The fixing of an exchange rate very rarely
involves the establishment of a single point away from which a currency is
not permitted to move. The usual approach is to define a target zone for the
currency. The authorities then respond with appropriate measures when
market forces threaten to move the currency above or below the zone.
19.6.1 Advantages of Fixed Exchange Rate: These are as follows:
(i) Provides greater certainty for exporters and importers as there are no
exchange rate risks. Hence, it promotes long-term capital flows.
(ii) There is no fear of adverse effect of speculation on the exchange rate.
(iii) Businesses have the knowledge that the price is fixed and therefore,
not going to change, it is relatively easier for them to plan ahead.
(iv) Encourages international trade by making prices of goods involved in
trade more predictable. It leads to low inflation.
(v) Imposes the discipline necessary for exchange rate stability; in
particular monetary policy must be coordinated.
Keynes was a chief architect of IMF and a strong proponent of fixed rates.
Many Keynesians agree that government intervention is necessary to
promote exchange rate stability. However, the question remains how to
attain a stable exchange rate system.

19.6.2 Disadvantages are:

(i) Entails a high administration cost. Needs complicated exchange
control mechanism which may lead to misallocation of resources.
(ii) A significant gap between the official rate and that determined by the
market can promote black markets. In a black market the bulk of
foreign exchange transactions are carried out outside the banking
system.
19
 (iii) This may force government to draw down on reserves to meet
its obligations and cause scarcity of foreign exchange.
(iv) Restricts the ability of countries to conduct policy
autonomously.
(v) Inimical to the very desirable objective of free trade.
(vi) May achieve exchange rate stability but at the expense of
domestic economic stability.
Fixed exchange rates prevail around the world; the IMF regulated this
system. However, since the collapse of the IMF system in 1973, floating
exchange rates predominate. Nonetheless, many countries continue to use
some variant of fixed exchange rates even today.

19.7 FLOATING EXCHANGE RATES

Under the system of floating exchange rates the price of a currency with
respect to other currencies is set by the market demand and supply forces. A
flexible system is one that follows free markets principles. Exchange rate
determination is left entirely to the processes of currency supply and
demand, and governments do not attempt to manipulate the market in order
to have particular exchange rate outcomes. In this case, the exchange rate is
said to have a clean float (variability in price). All the major countries have
adopted the system of floating exchange rates since 1973. Under the
floating exchange rate system, there are no fixed par values of currencies.
That is, exchange rates of currencies are not determined by governments or
central banks but by the market forces of supply and demand. The exchange
rates can float freely, i.e., these can move up and down; and unlike the fixed
exchange rate system, central banks are not obliged to intervene in the
market at any particular point. In reality, central banks intervene in the
20
exchange markets even under floating rate system to support the rate, though
the points of intervention are not predetermined. This is because government
and central banks are concerned about the social consequences of a decline
or improvement in the exchange rate together with its effects on the prices of
imports and exports. Floating rate influenced by the indirect intervention of
central banks is known as managed floating.

19.7.1 Advantages
A flexible exchange rate system confers a number of advantages upon
economies that adopt it:
(i) Continuous changes are easier to adjust.
(ii) Less likely to permit a payments crisis to develop. Any early or
‘incipient’ deficit or surplus that might arise will be swiftly
dissipated by appropriate corrective exchange rate movements.
This system automatically provides for balance of payments
stability without the need for any action whatsoever by policy-
makers.
(iii) Less politicized and authorities do not intervene in the foreign
exchange market.
(iv) Provides fewer incentives for destabilizing speculation. Financial
instruments are available to hedge the risks posed by a
fluctuating exchange rate.
(v) Allows nations to pursue their own independent economic goals
in respect of the other objectives of macro policy. Gives the
monetary authorities’ flexibility in determining interest rates.
This is because interest rates do not have to be set to keep the
value of the exchange rate within pre-determined bands.
21
(vi) Offers the most appropriate framework for the international
allocation of resources through the trade process.

19.7.2 Disadvantages

Market forces may fail to determine the appropriate exchange rate and
hence floating exchange rate regime may not provide the desired
results. It also lead to misallocation of resources.

(i) It is impossible to have an exchange rate system without official

intervention. Government may not intervene. However, domestic
monetary policy and fiscal policy would definitely influence the
exchange rate.
(ii) Volatile exchange rate introduces considerable uncertainty in
export and import prices and consequently to economic
development. At the same time, abolition of exchange controls
causes capital flight.

Managed floating: A system of managed floating exchange rate is being

practiced by many countries at present. The management of a floating rate
sometimes referred to as a ‘dirty float’. It is unlikely that the authorities in
any country could remain completely indifferent to the behavior of the
exchange rate. In practice, a managed float permits the authorities to
intervene in the foreign exchange markets.

19.8 APPRECIATION AND DEPRECIATION OF EXCHANGE

RATE

Since the exchange rate is basically determined by market forces, the upward
and downward movement in the value of rupee are appreciation and
depreciation respectively. Depreciation of the rupee refers to the decrease in
the external value of the domestic currency caused by the operation of market

22
forces. Appreciation of the rupee refers to the increase in the external value
of the domestic currency caused by the operation of market forces. The
exchange rate is determined in the open market through the pressure of
buying and selling of foreign currencies.

19.9 FOREIGN EXCHANGE RATE AND IMPACT ON BOP

The balance of trade influences currency exchange rates through its effect on
the supply and demand for foreign exchange. When a country's trade account
does not net to zero—that is, when exports are not equal to imports. There is
relatively more supply, or demand, for a country's currency, which influences
the price of that currency on the world market. The currency exchange rate is
one of the most important determinants of a country's relative level of
economic health. Exchange rates play a vital role in a country's level of trade.

These relative values are influenced by the demand for currency, which is in
turn influenced by trade. If a country exports more than it imports, there is a
high demand for its goods, and thus, for its currency. The economics
of supply and demand dictate that when demand is high, prices rise and the
currency appreciates in value. In contrast, if a country imports more than it
exports, there is relatively less demand for its currency, so prices should
decline. In the case of currency, it depreciates or loses value.

For example, let us say that tea is the only product on the market and U.S.
imports more tea from India than it exports, so it needs to buy more dollars
relative to rupees sold. When India imports more than exports, India’s
demand for dollars outstrips U.S. demand for rupee, meaning that the value
of the rupee falls.

The relative attractiveness of exports from India also grows as a currency

depreciates. India might start buying fewer dollars because American goods
have become quite expensive, and Americans might start buying more rupee
because Indian goods are now cheaper. This, in turn, begins to affect the
balance of trade. India would then start exporting more and importing less,
reducing the trade deficit.

23
 In sum, the balance of trade impacts currency exchange rates as supply and
demand can lead to an appreciation or depreciation of currencies. A country
with a high demand for its goods tends to export more than it imports,
increasing demand for its currency. A county that imports more than it
exports will have less demand for its currency. Trade balances, and as a
result, currencies can swing back and forth, assuming each are floating
currencies. If one or both currencies are fixed or pegged, the currencies do
not move as easily in response to a trade imbalance.

Check Your Progress C

1. Define Exchange Rate.

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2. Why do exchange rates exist?
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3. Write any three advantages of fixed exchange rate.
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4. Write three advantages of the flexible exchange rate.

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 --------------------------------------------------------------------------------------------
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5. Which of the following statements are True or False?
i) The exchange rate affects decisions made by foreign exchange investors.
ii) When the exchange rate falls, it is termed as a revaluation.
iii) Volatile exchange rate is helpful in promoting exports.
iv) Depreciation of the rupee refers to the decrease in its external value.
v) The balance of trade influences currency exchange rate.
19.10 DETERMINATION OF EXCHANGE RATE

Purchasing power parity (PPP) was created after World War I. Before then,
most countries relied on the gold standard. A country's exchange rate
reflected how much gold the currency was worth. Most countries abandoned
the gold standard to pay for the war. They printed all the money they
needed, creating inflation.
After the war, the Swedish economist Gustav Cassel suggested multiplying
each currency's pre-war value by its inflation rate to get the new parity. That
formed the basis for today's PPP. When making comparisons between
countries which use paper currencies having no intrinsic value, it becomes
necessary to convert values. Economists use a tool known as purchasing
power parity (PPP) to smooth out some of the differences between
currencies and countries. Purchasing power parity theory allows reasonable
comparisons, even across widely variable conditions. Comparing economies
and currencies based on purchasing power parity theory is an important tool
for international finance.

25
19.10.1 Purchasing Power Parity Theory

Purchasing power parity (PPP) is an economic theory that allows the

comparison of the purchasing power of various world currencies to one
another. It is a theoretical exchange rate that allows to buy the same amount
of goods and services in every country. The theory aims to determine the
adjustments needed to be made in the exchange rates of two currencies to
make them at par with the purchasing power of each other. In other words,
the expenditure on a similar commodity must be same in both currencies
when accounted for exchange rate. The purchasing power of each currency
is determined in the process. As for example, let us say that a pair of shoes
costs Rs.2500 in India. Then it should cost $50 in America when the
exchange rate is $1= Rs.50 between the dollar and the rupee. Another
example is if the price of a Coca Cola can in India is Rs.50, and it is $2 in
the US, then the Rupee/USD exchange rate should be $2 (the US price
divided by the India’s) according to the PPP theory. This means that goods
in each country will cost the same once the currencies have been exchanged.

The purchasing power of a currency refers to the quantity of the currency

needed to purchase a given unit of a good, or common basket of goods and
services. It states that the price levels between two countries should be
equal. Purchasing power parity means equalising the purchasing power of
two currencies by taking into account cost of living and inflation differences.

The PPP theory is often broken down into two main concepts: Absolute
purchasing power parity and Relative purchasing power parity.

Absolute purchasing power parity (APPP) is the basic PPP theory, which
states that once two currencies have been exchanged, a basket of goods
should have the same value. Usually, the theory is based on converting other
world currencies into the US dollar. For example, if the price of a can of
Coca Cola was $2, APPP would suggest that a can of Coca Cola in any other
country should cost $2 after converting USD into the local currency. If this
does not hold true, then APPP suggests that the currency exchange rate will
26
change over time until the goods are of equal value – as without any barriers
to trade, there should be an equilibrium in the price of goods. This is a
completely price-level theory, which only looks at the exact same basket of
goods in each country, with no other factors included. However, the theory
ignores the existence of inflation and consumer spending, as well as
transportation costs and tariffs, which can impact the short-term exchange
rate. Without these inclusions, a currency’s power is not properly
represented.

Relative purchasing power parity (RPPP) is an extension of APPP and can

be used in tandem with the first concept. While it maintains that the value of
the same good in different countries should equal out over time. RPPP
suggests that there is a correlation between price inflation and currency
exchange rates. It looks at the amount of a good or service that one unit of
currency can buy, which can change over time as inflation rates alter. The
theory suggests that inflation will reduce the real purchasing power of a
currency, so in order to properly adjust the PPP, inflation must be taken into
account. For example, if India had an annual inflation rate of 5 per cent, then
one unit of rupee would be able to purchase 5 per cent less per year.

Once we add this concept onto APPP, we can see that inflation rates will
account for part of the change in the power of currencies. So suppose that
the India has a 5 per cent inflation rate, while US has a 2 per cent inflation
rate. This means that after one year, the price of a basket of goods in US has
increased by 2 per cent, while the same price of the basket of goods in India
has increased by 5 per cent. When a country's domestic price level is
increasing (i.e., a country experiences inflation), that country's exchange rate
must depreciate in order to return to PPP. The basis for PPP is the ‘law of
one price’. In the absence of transportation and other transaction costs,
competitive markets will equalize the price of an identical good in two
countries when the prices are expressed in the same currency.

27
How to calculate PPP: The PPP formula calculation will vary depending on
what we are trying to achieve and which PPP we want to use. The absolute
PPP calculation is calculated by dividing the cost of a good in one currency,
by the cost of a good in another currency (usually the US dollar).

Then, to calculate the relative PPP rate, we would simply assume that the
ratio of price levels was equal to the exchange rate from one currency to
another, adjusted for the inflation rate. This would give us the rate of
depreciation for one currency compared to another, and an estimate of the
future exchange rate.

19.10.2 A Critique of Purchasing Power Parity Theory:

The purchasing power parity theory has been subject to the following
criticisms.

(i) There are differences in transportation costs, taxes, and tariffs. These
costs will raise prices in a country. Countries with many trade
agreements will have lower prices because they have fewer tariffs.
(ii) Non-Traded Services include items as insurance, utility costs,
and labor costs. These expenses are unlikely to be at parity
internationally. There are things, like real estate and haircuts, can not
be shipped.
(iii) Not everyone has the same access to international trade.

28
(iv) Goods might be deliberately priced higher in a country. In some cases,
higher prices may obtain due to the fact that a company may have
a competitive advantage over other sellers. The company may have a
monopoly or be part of a cartel of companies that manipulate prices,
keeping them artificially high.
(v) Import costs are subject to exchange rate fluctuations. The most
significant driver of changing exchange rate values is the foreign
exchange market. It creates wide swings in exchange rate values.

In reality, there are factors which prevent costs from equalising. The theory
also assumes that the basket of goods is completely identical, or at best very
similar goods. For a truly meaningful comparison, the basket would have to
contain a wide variety of goods and services. The amount of data that has to
be collected is huge, and it can be a complex process.

19.10.3 Significance of PPP theory

It is the principal virtue of the PPP approach that computations of
equilibrium exchange rates can be performed ‘on the back of an envelope’
without the need of sophisticated econometric or mathematical techniques.
The PPP approach may also be of value in forecasting floating exchange
rates.

It is the virtue of PPP theory to be simple; but the theory would have to be
rejected if it were simple-minded. The theory does have limitations. PPP is
used worldwide to compare the income levels in different countries. PPP
thus makes it easy to understand and interpret the data of each country. PPP
theory can be corrected by a simple alteration or extension of the theory. If
the PPP remains the more important explanatory variable, the PPP theory
has been amended but not eclipsed. Such techniques may be used to
incorporate speculation, trade restrictions, and other influences on a floating
exchange rate.

Purchasing power parity is a common tool used by traders to assess when an

asset is over or under-valued. It is mostly used to analyse forex pairs and
stocks. Traders can use any disparity between the PPP rate and exchange
rate to assess a currency’s long-term forecast and valuation. It is possible to

29
 use the rates to predict the direction of a currency pair and use it to
determine whether to buy or sell a currency pair. The PPP theory assumes
that a decline in the purchasing power of a currency, caused by factors such
as inflation, should equate to an equal fall in the exchange rate. While it is
not a perfect measurement metric, purchase power parity does allow for the
possibility of comparing pricing between countries that have differing
currencies.

Check Your Progress D

1. What is purchasing power parity?

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2. How is PPP formula used to calculate PPP?

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3. What is the criticism of PPP theory?

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4. How is purchasing power parity useful?

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19.11 LET US SUM UP

Balance of payments (BOP) is a record of values of all economic

transactions of a country with the rest of the world in a particular year. There
are two types of transactions that dominate the balance of payments. The one
is real assets like the exchange of goods and services and the other is
financial assets consisting of the exchange of financial claims (for example,
stock, bonds, loans, purchases or sales of companies) in exchange for other
financial claims or money. The Balance of Trade deals only with export and
import of merchandise or visible items. It is just one part of balance of
payments.
The current account of the balance of payments refers to the monetary value
of international flows associated with transactions in goods and services,
income flows and unilateral transfers. Capital transactions consist of capital
transfers and the acquisition and disposal of certain nonfinancial assets.
Under capital account there is only inflow and outflow of capital and the
difference between the two, represents a country’s capital account balance.
Balance of payments accounts are constructed using a double entry
accounting principle such that total credits equal total debits.
Disequilibrium is used to describe a deficit or surplus in a country’s balance
of payments. Disequilibrium in BOP must be settled. A way to settle is by a
transaction on the capital account. BOP is one of the major indicators of a
country's status in international trade. The BOP accounts do not tell what is
good or bad, nor do they tell what is causing what. But they do show what is
happening so that one can reach one’s conclusions. Disequilibrium in BOP
must be rectified by taking appropriate measures. There are many methods,
important among them are monetary and non- monetary measures.
Exchange rate is the process by which a country manages its currency in
respect to foreign currencies. There are basically three types of exchange
rate systems globally: flexible or floating exchange rate system, fixed
exchange rate system and managed floating (intermediate exchange rate
system).
31
Purchasing power parity (PPP) is based on an economic theory that states
the prices of goods and services should equalize among countries over time.
PPP suggests the prices of goods and services between two countries should
be equal, once their currencies have been exchanged. PPP was introduced to
be a more accurate and effective measure of a currency’s power. It is split
into two types: absolute PPP, which does not adjust for inflation, and
relative PPP, which is used to compare economic productivity and living
standards between countries. There are significant limitations to the theory,
such as its exclusion of other transactional costs, taxes and barriers to trade.
Purchasing power is broadly determined by the relative cost of living and
inflation rates in different countries.
19.12 Key Words

BOP account: Follows the double-entry book keeping method, which

balances both the credit and debit sides. By this accounting method, BOP of a
country is always in balance.
Counterpart items: Certain items in the balance of payments exist only as
counterpart items, introduced to balance the inclusion of other items that do
not fall naturally into the double-entry system. The allocation of Special
Drawing Rights (SDRs) is an example of an artificial counterpart item
introduced into the balance of payments to offset the corresponding increase
in SDRs holdings within official reserves (as SDRs are no one sector’s
liabilities).
Expenditure reduction policy: Involves a reduction in the level of aggregate
demand in the domestic economy in order to improve the balance of
payments position on the current account.
Expenditure-switching policy: Switches domestic and foreign demand away
from foreign goods and towards home produced goods.

19.13 ANSWERS TO CHECK YOUR PROGRESS

A 5 i) True, ii) False, iii) True, iv) True, v) False
B 5 i)True, ii)False, iii)True, iv)True, v)False
32
 C 5 i) True, ii) True, iii) False, iv) True, v) True.

19.14 TERMINAL QUESTIONS

1. Explain the concept of BOP. Describe its components.

2. Why is it necessary for a country to be concerned about its BoP

deficits? Give reasons.

3. What corrective measures are available to a country to rectify its BoP

disequilibrium? Explain.

4. What do you mean by exchange rate? Explain system of exchange rate

along with their merits and demerits.

5. How is exchange rate determined under purchasing power parity

theory?

SOME USEFUL BOOKS/REFERENCES

Acharyya, Rajat (2014): International Economics, Chapter 22, 1st

edition, Oxford University Press, New Delhi

Carbaugh, Robert J (2009): International Economics, 11th editions,

Cengage Learning Indian Pvt., Ltd., New Delhi

Hall, Mary (2020): What Is Purchasing Power Parity (PPP)?

https://www.investopedia.com/updates/purchasing-power-parity-
ppp/#:~:text=Purchasing%20power%20parity%20(PPP)%20is,standards%2
0of%20living%20between%20countries.

Lioudis, Nick (2019): How the Balance of Trade Affects Currency Exchange
Rates (https://www.investopedia.com/ask/answers/041515/how-does-
balance-trade-impact-currency-exchange-rates.asp) Jul 9.

Roy, Shyamal (2010): Macroeconomic Policy Environment, 2nd edition,

Tata McGraw-Hill Publication Company Ltd., New Delhi
33
Sodersten, Bo (1974): “International Economics”, Macmillan Press
Ltd., London, UK

Twin, Alexandra (2020): Factors That Influence Exchange Rates

(https://www.investopedia.com/trading/factors-influence-exchange-rates/)
April 03

34
 [1]

UNIT 20 WORLD TRADE ORGANIZATION (WTO)

Structure
20.0 Objectives

20.1 Introduction

20.2 General Agreement on Tariffs and Trade (GATT)

20.2.1 GATT and Trade Rounds of Negotiations

20.3 World Trade Organization (WTO) and Trade Agreements

20.3.1 Distinction between GATT and WTO

20.3.2 Principles of WTO

20.3.3 Objectives and Functions of WTO

20.3.4 Organizational Structure of WTO

20.4 WTO: Special Agreements: IPR, Agriculture and Trade in Services

20.4.1 WTO and Intellectual Property Rights (IPRs)

20.4.2 WTO and Agriculture

20.4.3 WTO and General Agreements on Trade in Services (GATS)

20.5 WTO and India’s Concern

20.6 Working of WTO (1995-2021)

20.6.1 Doha Round of Negotiations

20.7 Let Us Sum Up

20.8 Key Words

20.9 Answers To Check Your Progress

20.10 Terminal Exercises

 [2]

20.0 OBJECTIVES

After going through this unit, you will be able to:

• explain what is WTO and its importance in global trade;

• describe principles, objectives and functions of WTO;

• discuss different rounds of trade negotiations;

• relate Uruguay round and emergence of WTO;

• give a description of General Agreement on Tariffs and Trade (GATT);

• portray structure of WTO;

• discuss dispute settlement body of WTO;

• describe the significance of IPR, GATT and AOA and

• evaluate the working of WTO.

20.1 INTRODUCTION

The WTO has been the cornerstone of the multilateral rules-based global trading system since its

inception in 1995. The WTO is an international organization that deals with the global rules of trade. The

policies of the WTO impact all aspects of global society. WTO has evoked the entire spectrum of opinion

from being the saviour of the global economy to the destroyer of less developed countries. There is a

growing international backlash against the WTO. All three of the WTO’s functions – providing a

negotiation forum to liberalize trade and establish new rules, monitoring trade policies, and resolving

disputes between its 164 members are facing challenges. In this unit you will learn evolution and features

of WTO, summarizes the key features of the types of agreements of WTO along with its principles,

objectives, functions, structure and addresses questions and concerns of India regarding WTO and its
 [3]

working. With trade tensions getting increasingly politicized and Covid-19 creating huge economic

challenges, a modernized and fully functioning WTO is more essential than ever.

20.2 GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT)

It was in 1946 that a conference was organized in London where the tariff concession resulting from the

tariff negotiating conference were embodied in a multilateral contract called the GATT. The contract was

signed on October 30, 1947 at Geneva and became effective from January 1, 1948. GATT was essentially

a trade agreement. The GATT embodies a set of rules of conduct for international trade policy that are

monitored by a bureaucracy headquartered in Geneva.

FUNDAMENTAL PRINCIPLES OF GATT: GATT was a treaty that was collectively administered by

the contracting parties. Representatives of the contracting parties used to meet from time to time to discuss

matters of common interest and to give effect to the provisions of the Agreement requiring joint action.

The following were regarded as its four fundamental principles:

(i) Trade should be carried on the non-discriminatory basis.

(ii) Domestic industry should only be protected by means of customs tariffs and not through

other commercial measures.

(iii) The aims of consultations should be the avoidance of damage to member’s interests.

(iv) GATT served as a framework within which negotiations could be held to reduce tariffs and

other trade barriers.

Objectives of GATT: The objectives of the GATT were based on principles contained in the code

of International Trade Conduct. These principles are as follows:

 [4]

1. To follow unconditional Most Favoured Nation (MFN) principle.

2. To carry on trade on the principle of non-discrimination, reciprocity and transparency.

3. To grant protection to domestic industry through tariffs only.

4. To liberalise tariff and non-tariff measures through multilateral negotiations.

To achieve these objectives, the Agreement provided for:

(a) multilateral trade negotiations,

(b) consultation and settlement of disputes, and

(c) waivers to be granted in exceptional cases.

Criticisms of GATT: There had been large scale evasion of GATT rules by contracting parties over the

years which had made a mockery of the GATT. From the beginning of the GATT, agriculture was treated

as a special case where GATT rules hardly applied. Almost every developed country followed such

agricultural trade policies which were inconsistent with GATT rules. But trade liberalisation for

agricultural products had been much less than for manufacturers. The role of GATT was being

undermined by concluding bilateral, discriminatory and restrictive arrangements outside the GATT rules.

At the time of the conclusion of the Uruguay Round on December 15, 1993, over 100 bilateral agreements

were in force in the world which restricted exports of developing countries to the developed ones. The

GATT being a mandatory body did not possess any mechanism to get its rules implemented by

contracting parties.

20.2.1 GATT and Trade Rounds of Negotiations

Since its formation in 1947, eight rounds (conferences) of global trade negotiations were held under the

auspices of the GATT. The Eighth Round of GATT negotiations which began at Punta Del Esta in

Uruguay in September 1986 ought to have been concluded by the end of 1990. Indeed the Uruguay Round

concluded on December 15, 1993 marks the end of the longest debate in the history of the globe. The
 [5]

negotiators finally produced a basic document consisting of 400 pages of agreements, together with

supplementary documents detailing the specific commitments of member nations with regard to particular

markets and products. By the end of the Uruguay Round (1994), 123 countries joined hands. The

agreement was signed in Marrakesh, Morocco, in April 1994, and ratified by the major nations—after

bitter political controversy in some cases, including the United States—by the end of that year. The so-

called Uruguay Round was completed.

In short, one can have the conclusion of all the eight rounds at a glance in the shape of following Table:

GATT trade rounds

Year Place/name Subject covered Countries

1947 Geneva Tariffs 23

1949 Annecy Tariffs 13

1951 Torquay Tariffs 38

1956 Geneva Tariffs 26

1960-1961 Geneva Dillon Round Tariffs 26

1964-1967 Geneva Kennedy Round Tariffs and anti-dumping measures 62

1973-1979 Geneva Tokyo Round Tariffs, non-tariff measures, ‘framework’ 102

agreements

1986-1994 Geneva Uruguay Round Tariffs, non-tariff measures, rules, 123

services, intellectual property, dispute

settlement, textiles, agriculture, creation of

WTO, etc

Check Your Progress A

 [6]

1. What is GATT?
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2. What were fundamental principles of GATT?
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3. What are objectives of GATT.
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4. Point out criticisms of GATT.
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5. Which of the following statements are True or False?
i) The GATT embodied a set of rules of conduct for international trade policy.
ii) GATT served as a framework within which negotiations could be held to reduce tariffs and
other trade barriers.
iii) After inception of GATT, no bipartisan agreements were made. False
iv) GATT did not possess any mechanism to get its rules implemented by the contracting
parties.
v) The Eighth Round of GATT negotiations was held in Uruguay.

20.3 WORLD TRADE ORGANIZATION (WTO) AND TRADE AGREEMENTS

On the conclusion of the Uruguay Round, The WTO was setup on January 01, 1995, comprising 164

member States. It provides a common platform to negotiate trade agreements among member countries
 [7]

and to resolve any trade disputes. It manages 60 global and about 300 regional trade agreements. The 60

trade agreements are accorded the status of international law.

WTO Agreements cover goods, services, and intellectual property. It is a list of about 60 agreements,

annexes, decisions, and understandings. Agreements relate to both multilateral and plurilateral agreements.

Four annexes to the WTO define the substantive rights and obligations of members:

A. Annex 1 has three parts: Annex 1A, Multilateral Agreements on Trade in Goods,

which contains the GATT 1994. Annex 1B, which contains the GATS’ and Annex1C;

the TRIPS agreement.

B. Annex 2 contains the Understanding on Rules and Procedures Governing the

Settlement of Disputes (DSU) – the WTO’s common dispute settlement mechanism.

C. Annex 3 contains the Trade Policy Review Mechanism (TPRM), an instrument for

surveillance of members’ trade policies.

D. Annex 4 Plurilateral Trade Agreements, consists of Tokyo Round codes that were not

multilateralized in the Uruguay Round and that therefore bind only their signatories.

Together, Annexures 1 through 3 embody the multilateral trade agreements that are an integral part of the

WTO agreement and are binding on all members.

Multilateral Trade Agreements are on: 1. Agriculture: (i) Market Access, (ii) Domestic Support and (iii)

Reductions in Export Subsidies. 2. Sanitary and Phytosanitary Measures. 3. Textiles and Clothing 4.

Technical Barriers to Trade. 5. Trade Related Investment Measures (TRIMS). 6. Anti-dumping. 7.

Customs Valuation. 8. Pre-shipment Inspections. 9. Rules of Origin. 10. Import Licensing Procedures.

11. Subsidies and Countervailing Measures. 12. Safeguards. 14. General Agreement on Trade in
 [8]

Services (GATS). 15. Trade Related Intellectual Property (TRIPS). 16. Dispute Settlement. 17. Trade

Policy Review Mechanism (TPRM).

Plurilateral Trade Agreements: ‘Plurilateral Agreements’ were formally annexed to the Final Act of the

Uruguay Round and will be regulated and supervised by the WTO. These agreements will, however, only

be applicable (and thus enforceable) between their signatories. There are four Plurilateral Agreements

concerning:

(i) Public procurement;

(ii) Trade in civil aircraft;

(iii) International dairy products; and

(iv) International bovine and meat products.

Trade Liberalization: The most important results may be grouped under two headings, trade

liberalization and administrative reforms.

20.3.1 Distinction between GATT and WTO

The WTO differs in a number of important respects from the GATT. The differences are as follows:

(i) The WTO is a forum for international cooperation on trade-related policies–the creation

of codes of conduct for member governments.

(ii) The WTO contains a set of specific legal obligations regulating trade policies of

member states, and these are embodied in the GATT, the GATS, and the TRIPS

agreement. The WTO acts as an umbrella organization that encompasses the GATT

along with two new sister bodies, one services and the other on intellectual property.

(iii) The WTO’s GATS has taken the lead to extending free trade agreements to services. In

the same way, the TRIPS is an attempt to narrow the gaps in the way intellectual
 [9]

property rights are protected around the world and to bring them under common

international rules.

(iv) WTO has taken over responsibility for arbitrating trade disputes and monitoring the

trade policies of member countries. Countries that have been found by the arbitration

panel to violate GATT rules may appeal to a permanent appellate body, but its verdict

is binding. Every stage of the procedure is subject to strict time limits. Thus, the WTO

has something that the GATT never had – teeth.

(v) The clarification and strengthening of GATT rules and the creation of the WTO also

hold out the promise of more effective policing and enforcement of GATT rules. The

WTO is a distinctively as well as qualitatively an improvement upon the GATT.

20.3.2 Principles of WTO

Following principles of WTO are of particular importance:

(i) Nondiscrimination: Nondiscrimination has two major components: the most-favored-nation

(MFN) rule, and the national treatment principle. Nondiscrimination in the form of national

treatment and most favoured nation (MFN) treatment to our exports in the markets of other

WTO members. National treatment ensures that our exports to other member countries

would not be discriminated vis-a-vis their domestic products. MFN treatment likewise

ensures non-discrimination among various members in their tariff regimes and also other

rules and regulations.

(ii) Reciprocity: The principle of reciprocity refers to the ideal of mutual changes in

international trade policy. The granting of mutual concessions in tariff rates, quotas, or

other commercial restrictions. Reciprocity implies that these concessions are neither

intended nor expected to be generalized to other countries with which the contracting
 [10]

parties have commercial treaties. Reciprocity agreements may be made between individual

countries or groups of countries. Reciprocity is a fundamental element of the negotiating

process. Reciprocal concessions ensure that gains will materialize.

(iii)Binding and Enforceable Commitments: Liberalization commitments and agreements to

abide by certain rules of the game have little value if they cannot be enforced. Once tariff

commitments are bound, it is important that there be no resort to other, nontariff, measures

that have the effect of nullifying or impairing the value of the tariff concession.

(iv) Transparency: Transparency is a basic pillar of the WTO. Enforcement of commitments

requires access to information on the trade regimes that are maintained by members.

Transparency has a number of important benefits. With stability and predictability,

investment is encouraged, jobs are created and consumers can fully enjoy the

benefits of competition — choice and lower prices.

(v) Safety Valves: A final principle embodied in the WTO is that, in specific circumstances

governments should be able to restrict trade.

(vi) Freer Trade: Lowering trade barriers is one of the most obvious means of encouraging

trade gradually through negotiations more accurately. It is a system of rules dedicated

to open, fair and undistorted competition.

20.3.3 Objectives and Functions of WTO

WTO’s main objectives relate to the following:

(i) achieving ‘sustainable development’ in relation to the optimal use of the world’s

resources,
 [11]

(ii) ensuring the need to protect and preserve the environment in a manner consistent

with the various levels of national economic development;

(iii) safeguarding the interest of developing countries to secure a better share of the

growth in international trade;

The following are the functions of the WTO:

(i) Facilitates the implementation and operation of all the agreements and legal instruments

negotiated in connection with the Uruguay Round, including the Plurilateral Trade

Agreements; for the fulfilment of their obligations.

(ii) Provides a forum for all negotiations and also facilitates implementation of the

results of the negotiations as decided by the Ministerial Conference.

(iii) The WTO is responsible for administration of the Trade Policy Review Mechanisms

(TPRM).

(iv) It is also the organ for establishing co-ordination with other wings of the UNO such as the

International Monetary Fund (IMF) and World Bank and its affiliated agencies.

Decisions will be taken by a majority of the votes cast, on the basis of ‘one country, one vote.’ This

system of decision making by consensus is a major improvement as it seeks to ensure security,

predictability and participation.

20.3.4 Organizational Structure of WTO

The structure of the WTO is dominated by its highest authority, the Ministerial Conference, composed of

representatives of all WTO members. It can take decisions on all matters under any of the multilateral

trade agreements.
 [12]

The Ministerial Conference of the WTO meets every two years to make important decisions about existing

trade agreements. The Ministerial Conference holds the authority to make decisions on any aspects of all

multilateral agreements made under the WTO. The Conference includes representatives from all members

of the WTO. It gives equal representation to all its members regardless of the size of their economy or

share in international trade. It can be thought of as the legislative branch of the WTO.

The WTO is headed by the Ministerial Conference, while the daily operations are carried out by three

administrative bodies:

1. General Council: The General Council comprises the representatives of all member countries. Its job is

to carry out the implementation and monitoring function of the WTO. The General Council is further

divided into multiple councils and committees that focus on specific topics. Examples of such bodies

include the Council on Goods, the Councils on Services, the Committee on Textiles under the Council on

Goods, etc.

2. Dispute Settlement Body (DSB): The DSB is responsible for settling trade disputes between member

states. The purpose of DSB is to resolve such disputes by a rule-based system rather than through

unilateral retaliatory action by those complaining. There is now a time-table laid down for dispute

settlement. The amount of time each stage of the process should take has been indicated, though there is

some flexibility in the time-frames laid down. The DSB can reject the findings of a panel or of an appeals

report – only by consensus. The dispute settlement system is undoubtedly the jewel in the WTO's crown.

The consensus is certainly leaning in favour of preserving and strengthening the dispute settlement

function of the WTO. There is also an Appellate Body, where member states can appeal any decisions

made against them during a dispute settlement.

3. Trade Policy Review Body: The Trade Policy Review Body is also a part of the General Council and is

responsible for ensuring the trade policies of member states are in line with the goals of the WTO.
 [13]

Member countries are required to inform the WTO about changes in their laws and trade policies. The

body undertakes regular reviews of the policies to ensure they conform to the rules of the WTO. This is

part of the monitoring function of the WTO, and it helps the WTO to adapt to the changing economic

landscape.

In the WTO, power is not delegated to a board of directors or the organization’s head. The WTO is a

member-driven, consensus-based organization.

Check Your Progress B

1. What is WTO?

‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
 [14]

‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐

2. Name any three agreements under WTO?

‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐

3. Give three points of distinction between GATT and WTO.

‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐

4. List any three objectives of WTO.

‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐

5. Which of the following statements are True or False?

i) The WTO was setup on January 01, 1995.

ii) The WTO is responsible for administration of the Trade Policy Review Mechanisms.
iii) The GATT came into being after the failure of WTO.
iv) The WTO gives equal representation to all its members regardless of the size of their
economy or share in international trade.
v) The WTO is a member-driven, consensus-based organization.

20.4 WTO: SPECIAL AGREEMENTS: IPR, AGRICULTURE AND TRADE IN SERVICES

20.4.1 WTO and Intellectual Property Rights (IPRS)

Intellectual Property Rights (IPRs): Intellectual property rights are knowledge that belongs to the citizens

or firms of one country in the form of patents, copyrights, trademarks, industrial designs or geographical

indications. If these are copied by firms in another country without the permission of the owner and

without making a payment to the owner for use of the know-how, the property rights of the owners are
 [15]

infringed. According to the WTO, intellectual property rights are the rights given to persons over the

creations of their minds. They usually give the creator an exclusive right over the use of his/her creation

for a certain period of time. In relation to intellectual property the Uruguay settlement provides for the

following:

(a) Patent protection for 20 years regardless of where an item is invented or whether it is

imported or locally produced.

(b) Limitations on the use of compulsory licensing for patented products (licences are easily

obtained in some underdeveloped countries).

(c) Copyright protection for at least 50 years from the creator’s death. This is to include

computer software and compiled databases.

(d) All countries will have to introduce laws to prevent the unauthorized disclosure of trade

secrets.

(e) Provision of equal treatment for domestic and foreign intellectual property holders.

Protection of intellectual property rights has become an issue of wide and serious discussion. As a member

of the WTO, India is obliged to comply with the standards of the TRIPs. Indian laws are substantially in

accordance with the TRIPs standards on copyright and related rights, trademarks, geographical design and

undisclosed information. The greatest challenge, however, is posed by patents. TRIPs agreement goes

against the Patent Act of India, 1970 in almost all important areas. Patents in all the three fields

(agriculture, pharmaceuticals and industrial biotechnology) linked to microorganisms are either already

with the multinational companies or are likely to be acquired at a much faster rate vis-à-vis the developing

countries.
 [16]

Patent rights in respect of trade relates to: (a) copy rights; (b) designs; (c) trade-marks; (d) trade-secrets;

or any other species of intellectual property. The Government of India enacted a new law, the Patents

(Amendment) Act, 2005, wherein product patent was extended to all fields of technology including food,

drugs, chemicals and micro-organisms to take advantage of the provisions of TRIPs agreement in respect

of plant varieties. A decision has been taken to put in place a sui generis (special) system as it is perceived

to be in India’s national interest. A major area of concern for India is the protection of the biodiversity.

It is pertinent to note that economists of repute who otherwise are fully supportive of the free trade theory

and the WTO (Jagdish Bhagwati, Dani Rodrik, Michael Finger) have, of late, recognized the inequity of

the TRIPS agreement from the point of view of developing countries.

20.4.2 WTO and Agreement on Agriculture (AOA)

The AOA aims at removing the distortions in world trade in agriculture arising from excessive protection

and subsidization of agriculture. AOA is highly complicated and controversial; it is often criticized as a

tool in hands of developed countries to exploit weak countries. Agreement on agriculture stands on 3

pillars:

1. Domestic Support – It refers to subsidies like minimum price or input subsidies which are

direct and product specific. Under this, subsidies are categorized into 3 boxes –

a) Green Box – Subsidies which are no or least market distorting.

b) Blue Box – Only ‘Production limiting Subsidies’ under this are allowed. They

cover payments based on acreage, yield, or number of livestock in a base year.

c) Amber Box – Those subsidies which are trade distorting and need to be curbed.

The Amber Box contains category of domestic support that is scheduled for
 [17]

reduction based on a formula called the “Aggregate Measure of Support” (AMS).

The AMS is the amount of money spent by governments on agricultural

production, except for those contained in the Blue Box, Green Box and ‘de

minimis’.

Existing non-tariff barriers in agriculture, which are considered trade-distorting, are to be abolished and

converted into tariffs so as to provide the same level of protection and subsequently the tariffs are to be

progressively reduced.

It must be recognised that globally the policy environment is becoming increasingly complex. The

dilemma most governments face, whether of developed or developing countries, is how to reconcile the

conflict arising out of their international commitment under the WTO and domestic compulsions,

economic, political and social. Agriculture holds the key to progress in future trade negotiations. And

these issues affect different countries differently, depending on the competitiveness of their agriculture.

Market access is viewed as the most important issue.

20.4.3 WTO and General Agreement on Trade in Services (GATS)

General Agreement on Trade in Services (GATS): The growing role of international services and their

implications have come to be recognized in the General Agreement on Trade in Services (GATS). The

WTO rules on services trade, as embodied in the GATS are the first ever set of multilateral, legally

enforceable rules covering international trade in services. The economic significance of services has

increased substantially since the GATS entered into force in 1995. A WTO council of services oversees

the operation of agreement. The GATS did not directly remove any important barriers to trade in services.

It did, however, set up a legal framework under which future negotiations to liberalize service trade could

proceed.
 [18]

Modes of supply of services: There are four different ways in which services can be provided

internationally are:

(i) Cross-border supply (Mode 1) is when the service is provided from one country to another

(like international phone calls. Business Process Outsourcing, KPO or LPO services).

(ii) Consumption abroad (Mode 2) this mode covers supply of a service of one country to

the service consumer of any other country, e.g. telecommunication, tourism.

(iii) Commercial presence (Mode 3) is when a firm sets up a subsidiary/branch in an export

market, e. g branch of a foreign bank, subsidiary of a telecom firm and the like. This opens

door of relevant sector in one country to investments from another country. Accordingly, it

is in west’s interest to push for liberalization in India. There has been sustained pressure to

open up higher education sector, insurance sector, medical sector etc. through this mode.

(iv) Movement of Natural Persons (Mode 4) which covers services provided by a service

supplier of one country through the presence of natural persons in the territory of

any other country. e. g. Infosys or TCS sending its engineers for onsite work in

US/Europe or Australia. Here again, it’s in India’s interest to push for liberalization.

Negotiations in services under GATS are classified in these 4 modes, interests of different countries

depend upon this classification.

20.5 WTO AND INDIA’S CONCERN

WTO and India’s Trade-in-Services: From India’s point of view, services present a different picture from

agriculture and industrial tariffs. As an emerging global power in IT and business services, the country is,

in fact, a demander in the WTO talks on services. India seeks more liberal commitments on the part of its

trading partners for cross-border supply of services, including the movement of ‘natural persons’ (human
 [19]

beings) to developed countries, or what is termed as Mode 4 for the supply of services. With respect to

Mode 2, which requires consumption of services abroad, India has an offensive interest.

In sharp contrast, the interest of the EU and the US is more in Mode 3 of supply, which requires the

establishment of a commercial presence in developing countries. Accordingly, requests for more liberal

policies on foreign direct investment in sectors like insurance have been received. These developed

countries are lukewarm to demands for a more liberal regime for the movement of natural persons.

Among the different modes of services of supply, India is most interested in movement of natural persons

(mode 4) and has also submitted a proposal at the WTO Council for trade in services. India has an obvious

interest in the liberalisation of services trade and wants commercially meaningful access to be provided by

the developed countries.

WTO and Indian Agriculture: India’s domestic support to agriculture is well below the limit of 10 per

cent of the value of agricultural produce and therefore India is not required to make any reduction in it at

present. India’s food security law subsidized food supply as an integral part of its welfare programmes.

The problem is unlike the rich countries, because with limited financial means India is not able to give

income support to farmers.

Agreement on agriculture is facing issues due to food security and development requirements for

developing countries like India. India should attempt to bring its domestic food legislation in line with

WTO rules. Efficient internal policies are the best weapon against an unfair external market. But India’s

farm exports are fundamentally supply-constrained. India cannot ignore the wide-ranging provisions of the

AOA covering domestic support, export subsidies, and market access, besides sanitary and phyto-sanitary

measures.

India strongly favours extension of higher levels of protection to geographical indications for products

like Basmati rice, Darjeeling tea, and Alphonso mangoes at par with that provided to wines and
 [20]

spirits under the Trade-related Aspects of Intellectual Property Rights (TRIPS) agreement. India is

against any inclusion of non-trade issues that are directed in the long run at enforcing protectionist

measures, particularly against developing countries.

India should worry about the multilateral trading system and integrate rapidly with the world economy.

There is the need to align national economic policies with its WTO commitments.

20.6 WORKING OF WTO (1995-2021)

By 2021, the WTO has 164 members and 25 observer governments. Since its formation, the WTO has

been under scrutiny. The WTO has remained at the forefront of efforts to promote global free trade. The

predictable market conditions fostered by the WTO have combined with improved communications to

enable the rise of global value chains (GVCs). The way the world trade has changed since the WTO was

established, fewer goods and services originate from any one supplier or country. Components and

intermediate services are increasingly sourced and assembled from specialist suppliers around the world.

The establishment of the WTO changed the character of the trading system. It is playing a crucial role in:

1 The international trade and global economies.

2 The political and legal issues arising in the international business because of globalization.

3 Establishing coordination between its member countries through negotiations,

consultations and mediations.

4 Countries are using the WTO represents an important vote of confidence in the organization’s

dispute resolution procedures.

 [21]

5 The WTO has proven exceedingly useful is monitoring. The most prominent of which is the

Trade Policy Review Mechanism, which subjects all WTO members to a periodic review of

their trade regimes and their compliance with WTO rules.

Challenges before WTO: Misunderstandings about the WTO are pervasive. The WTO faces a number of

challenges today. A number of questions have been raised about the future direction of the WTO. “Not all

disputes were resolved so smoothly. As ever, agriculture was the sorest subject. Not only is the WTO

theoretically in search of a permanent substitute for India’s waiver on subsidies; it also pledged long ago

to scrap rich countries’ farm-export subsidies. Big groups or small, sweeping deals or narrow, trade

liberalisation is never easy” (The Economist, December 16, 2013).

A major challenge to WTO is the proliferation of free and preferential regional/bilateral trading

arrangements. More than half of the existing 300 regional/bilateral trading arrangements have emerged in

the past 30 years. But a regrettable fact is that some of these regional/bilateral arrangements are crafted

not for promoting trade, but for political and economic diplomacy, “cartel” for negotiations, etc. The issue

of abuse of the anti-dumping procedure the problems of rules of origin criteria, technical barriers to trade,

etc., are also being considered at various levels in the WTO.

Decision-making process at the WTO has never been above board. Little wonder that critics of the

global trading system describe WTO as ‘Whose Trade Organisation?’ The WTO increasingly looks like a

toothless tiger.

It is important to remember that since the WTO is consensus-based, with a near-universal membership of

164 countries, big, small and all sizes in-between, the organisation simply turned unwieldy. It became

increasingly impossible to negotiate one common trade rule on the basis of the consensus that applied

equally to all WTO members. However, there is little doubt that WTO is needed more than ever now
 [22]

when the Covid-19 has wrought havoc with global trade. The post-Covid-19 world needs WTO more than

ever if only to provide security and predictability to international trade. But for that to happen, the WTO

members must get their act together. What is needed is the identification of areas that need improvement

for greater credibility, more confidence and larger commitment for meaningful progress in trade

liberalisation. The success of WTO’s ministerial round of conference would depend entirely on the

political will expressed by developed and developing countries.

20.6.1 Doha Round of Negotiations

To address various contentious issued, the Doha Round of Negotiations (also known as the Doha

Development Round) Commenced in November 2001. Its major objective was to lower trade barriers

around the world, and thus facilitate increased global trade.

The aim was to put less developed countries’ priorities at heart. The needs of the developing countries

were the core reason for the meeting. The major factors discussed include trade facilitation, services, rules

of origin and dispute settlement. Special and differential treatment for the developing countries were also

discussed as a major concern.

The most significant differences are between developed nations led by the European Union, the US,

Canada and Japan and the major developing countries led and represented mainly by India, Brazil, China

and South Africa. There is also considerable contention against and between the EU and the US over their

maintenance of agricultural subsidies seen to operate effectively as trade barriers.

This round has so far, after 20 years of negotiations, failed to make any progress.

Check your progress C

 [23]

1. Define intellectual property right (IPR).

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2. What are Green Box subsidies?
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3. What are the four modes of supply of services?
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4. Write two achievements of WTO?
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5. Write two challenges of WTO?
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20.7 LET US SUM UP

WTO was born out of the General Agreement on Tariffs and Trade (GATT), which was established in

1947. The WTO came into existence on January 1, 1995. It is a global organization made up of 164
 [24]

member countries that deals with the rules of trade between nations. The goal of the WTO is to ensure that

trade flows as smoothly and predictably as possible.

From 1948 to 1994, the GATT provided the rules for much of world trade and presided over periods

that saw some of the highest growth rates in international commerce. The eighth, the Uruguay

Round of 1986-94, was the last and most extensive of all. It led to the WTO and a new set of

agreements. It took seven and a half years, almost twice the original schedule.

WTO’s main function is to ensure that trade flows as smoothly, predictably, and freely as possible. It is

designed to play the role of a watchdog in the spheres of trade in goods, trade in services, foreign

investment, intellectual property rights, etc. WTO administers the understanding on rules and procedures

governing the settlement of disputes and the Trade Policy Review Mechanism (TPRM). The WTO

remains the only forum in which developing countries are on an equal footing with their rich-country

counterparts. All WTO members may participate in all councils, committee, etc, except appellate Body.

WTO is different from the GATT. The former GATT was not really an organisation; it was merely a legal

arrangement. On the other hand, the WTO is a new international organisation set up as a permanent body.

It is expected that the enforcement mechanisms granted to the WTO would make it more effective at

policing global trade rules than the GATT had been.

Dispute settlement is the central pillar of the multilateral trading system, and the WTO’s unique

contribution to the stability of the global economy.

Talking of distorted global agricultural markets, whether developed or developing, all countries face the

same dilemma: How best to reconcile domestic priorities with international obligations. WTO has not

been able to ensure abolition of non-trade barriers being imposed on labour and environmental

considerations.
 [25]

20.8 KEY WORDS

Amber Box: Trade-distorting support which is to be reduced. For instance minimum support price or

counter-cyclical payments in the US.

Anti-dumping duties: The WTO rules permit a country to impose these duties if a product from a

particular country is imported at less than the “normal” price. Both the developed and developing

countries are increasingly levying these duties among themselves and at each other.

Blue Box: Support linked to production which is subject to production limits. It is seen as minimally

trade-distorting. For example, compensation paid to farmers in the US for keeping land fallow.

Green Box: Non-trade distorting support which is permitted without a ceiling. For instance, payments for

infrastructure development.

Intellectual Property Rights: Ownership rights to intangible assets, such as patents, copyrights, etc.

Most Favoured Nation status (MFN): MFN status – expresses the primary GATT/WTO principle that

any country signing up for membership must treat all trading partners in the WTO in the same way and

not give special terms to any or discriminate against any.

Multilateral Agreement: An agreement involving more than two governments.

Sanitary and Phytosanitary (SPS) Measures: The agreement on the application of SPS measures sets

out the basic rules for food safety and animal and plant health standards. It allows countries to set their

own standards. But it also says regulations must be based on science. They should be applied only to the

extent necessary to protect human, animal or plant life or health. And they should not arbitrarily or

unjustifiably discriminate between countries where identical or similar conditions prevail.

20.9 ANSWERS TO CHECK YOUR PROGRESS

A 5 i) True, ii) True, iii) False, iv) True, v) True

 [26]

B 5 i) True, ii) True, iii) False, iv) True, v) True

20.10 TERMINAL QUESTIONS

1. Describe the principles and functions of WTO. Explain the importance of WTO.

2. What are the issues of concern for India, arising out of WTO agreements?

3. Explain the organizational structure of WTO. What is the role of trade policy review committee?

4. What is GATT? Compare GATT with its successor WTO. How WTO is considered an

improvement over GATT?

5. What are the main features of following agreements:

(a) Agreement on agriculture (AOA).

(b) General agreement on trade in services (GATS).

(c) Agreement on trade related intellectual property rights (TRIPS).

6. Write notes on the following:

(a) Dispute settlement body of WTO.

(b) 25 years of working of WTO.

SOME USEFUL REFERENCES

Anderson, Kym : World Trade Organization https://www.britannica.com/topic/World-Trade-Organization

Collins, David (2015): The WTO: A Beginner's Guide – December 8 https://www.amazon.in/World-

Trade-Organization-Beginners-Guides/dp/1780745788
 [27]

Felbermayr, Gabriel (2019): 25 years of the WTOPage | 27Causes of Decay and Reform Proposals for the

Future, https://www.ifw-kiel.de/publications/kiel-focus/2019/25-years-of-the-wto-causes-of-decay-and-

reform-proposals-for-the-future-13610/

Joshi, Rakesh Mohan (2009): International Business, Oxford University Press, New Delhi

Ravikanth (2014): WTO Upside Down: Trade Facilitation vs Agriculture, Economic and Political Weekly,

Vol - XLIX No. 36, September 06

WTO (2013): World Trade Report: Factors shaping the future of world trade, Geneva
BLOCK 7 Fiscal & Monetary Policy
In this block you will learn about monetary policy and its goals and instruments, monetary
policy framework, overview of monetary policy in India,monetary policy rule, monetary
policy transmission, fiscal policy and its various instruments, objectives of fiscal policy and
its limitations, different sources of revenue and expenditure of a government, public debt and
government budget,main aspects of fiscal federalism, role of government in federal
economics, economic rationale for central-state transfer of grants, fiscal decentralisation and
local governance, emerging issues and challenges and redefining of fiscal architecture in
India. This block has three units.
Unit-21 deals in ‘Monetary Policy’. The unit begins with the introduction of monetary
policy. Instruments and goals of Monetary Policy are given. Monetary Policy framework and
an overview of Monetary Policy in India are clearly explained. Various monetary policy rules
are provided and monetary policy transmission process is discussed in the last.
Unit-22 deals in ‘Fiscal Policy’. The unit begins with the meaning and instruments of fiscal
policy. Concept of public revenue, its type and sources are given. Different heads of taxare
explained. Concept and main heads of public expenditure is described. Need of public debt
and methods of redemption of public debt are provided. Meaning, components and types of
government budget are elaborated in the last.
Unit-23 deals in ‘Fiscal Federalization in India’. The unit begins with the introduction and
main aspects of fiscal federalism. Role of government in federal economics and economic
rationale for centre-state transfer of grants is presented. Fiscal decentralisation and local
governance is elaborated. Emerging issues and challenges in India’s fiscal federalism are
highlighted. The chapter ended with redefining the fiscal architecture in India.

1
Unit 21 MONETARY POLICY

Structure
21.0 Objectives
21.1 Introduction
21.2 What is Monetary Policy?
21.3 Instruments of Monetary Policy
21.4 Goals of Monetary Policy
21.5 Monetary Policy Framework
21.6 An Overview of Monetary Policy in India
21.7 Monetary Policy Rule
21.7.1 Taylor Rule
21.7.2 Flexible Inflation Targeting
21.7.3 Monetary Policy Committee
21.8 Monetary Policy Transmission
21.9 Let Us Sum Up
21.10 Key Words
21.10 Terminal Questions

21.0 Objectives
After studying this unit, you should be able to:
• Describe the concept of monetary policy
• Discuss the instruments of monetary policy
• State the objective of monetary policy
• Explain the monetary policy framework
• Describe the overview of monetary policy in India
• Discuss the monetary policy rule
• Explain the monetary policy transmission

21.2 What is monetary policy?

Monetary policy is the macroeconomic policy laid down by the central bank of an economy.
The policy involves an operational framework which uses certain instruments and targeting

2
mechanisms to achieve macroeconomic objectives like price stability, reviving consumption,
growth and liquidity. The Reserve Bank of India (RBI) is vested with the responsibility of
conducting monetary policy. This responsibility is explicitly mandated under the Reserve
Bank of India Act, 1934.Monetary policy thus involves the use of monetary instruments
under the control of the central bank to regulate magnitudes such as interest rates, money
supply and availability of credit with a view to achieve certain objectives of economic policy.
Expansionary Monetary Policy vs. Contractionary Monetary Policy
The monetary policy response depends on the economic state of affairs of the economy.
Based on which, themonetary policy may be categorized in one of two ways: expansionary
monetary policy or contractionary monetary policy.
a) Expansionary Monetary Policy: This is known as loose monetary policy,
expansionary policy increases the supply of money and credit to generate economic
growth. A central bank may deploy an expansionist monetary policy to reduce
unemployment and boost growth and investment during hard economic times.The
overall goal of any expansionary policy is to encourage spending and borrowing. This
is done by reducing the interest rate, subsequently providing easier and cheaper loans
to the borrowers. According to economic theory, more money available to individuals
and businesses at lower cost will result in the increased purchase of goods and
services, thus stimulating growth.
b) Contractionary Monetary Policy: Tight or contractionary monetary policy is used to
prevent inflation due to economy growing too fast (over-heating). It aims at reducing
the money supply, raising the interest rates and therefore, discouragingborrowing in
the economy. Business investment will decline because it is less attractive for firms to
borrow money.In addition, higher interest rates will also discourage consumer
borrowing for big-ticket items like houses and cars.
Figure 2 gives a schematic representation of how the above two policies change the output
and price level in an economy:
Figure 2 Change in Monetary policy and its influence on output and price level

Note- M- Money supply, r- rate of interest, I – Investment, C- Consumption demand, P

- Prices

RULE-BASED VS. DISCRETIONARY MONETARY POLICY

3
Academics and policymakers debate whether central banks should follow a predetermined,
fixed rule or should have discretion in monetary policy. Supporters of central bank discretion
argue that a simple monetary policy rule is incompatible with the complexity of an economy.
A rules-based approach can be considered reliable on account of the following reasons:
1. A good monetary policy rule specifies a plan of action which the central bank cannot
later ignore, while discretion allows central bankers to react—and often overreact—to
economic indicators as they see appropriate.
2. The rules-based approach has been criticized for being too rigid, but it provides
certainty in the market that the central bank will not sacrifice long-term stability for
short-term gain.
In sum, a simple and easily communicated rule is better able to manage the
complexity of the economy than a central bank operating with discretion.

21.3Instruments of Monetary Policy

There are several direct and indirect instruments that are used for implementing monetary
policy.

1. Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of
exchange or other commercial papers.
2. Cash Reserve Ratio (CRR): The average daily balance that a bank is required to
maintain with the Reserve Bank as a share of such per cent of its Net demand and time
liabilities (NDTL).The Reserve Bank may notify CRR from time to time in the Gazette
of India.
3. Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to
maintain in safe and liquid assets, such as, government securities, cash and gold. Changes in
SLR often influence the availability of resources in the banking system for lending to the
private sector.
4. Open Market Operations (OMOs): These include both, outright purchase and sale of
government securities, for injection and absorption of durable liquidity, respectively.
5. Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight
liquidity to banks against the collateral of government and other approved securities
under the liquidity adjustment facility (LAF).
6. Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs
liquidity, on an overnight basis, from banks against the collateral of eligible government
securities under the LAF.
7. Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term
repo auctions. It is used to make temporary and swift adjustments in liquidity within the
banking system mainly using the repo and reverse repo rates.
8. Marginal Standing Facility (MSF): A facility under which scheduled commercial banks
can borrow additional amount of overnight money from the Reserve Bank. This provides
a safety valve against unanticipated liquidity shocks to the banking system.
9. Corridor: The MSF rate and reverse repo rate determine the corridor for the daily
movement in the weighted average call money rate.

4
10. Market Stabilisation Scheme (MSS): This instrument for monetary management was
introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital
inflows is absorbed through sale of short-dated government securities and treasury bills.

We have so far discussed the conventional monetary policy instruments.However

sometimes there may be problems in the monetary policy transmission mechanism
(discussed later) or if policy rate cannot be reduced further then the central banks may
employ unconventional monetary policy tools. For example, large scale asset
purchases,lending operations, forward guidance, and negative interest rate.The objective
of unconventional tools is to supplement the conventional monetary policy tools
especially in the easing cycle to boost economic growth.More recently, with the
slowdown in 2019 followed by the extraordinary collapse in economic activity due to
COVID-19 pandemic, unconventional monetary policy tools supplemented the
conventional monetary policy measures to stimulate growth in the economy.

Goals of Monetary Policy

Goals refer to the final policy objectives of the monetary policy.In any monetary policy
framework, a key ingredient is the enunciation of its objectives as its actions are guided
foremost by the objectives. These may include: price stability, economic growth and
financial stability. Let us learn them.

1. Price Stability: The primary objective of monetary policy is to maintain price

stability while keeping in mind the objective of growth. Price stability is a necessary
precondition to sustainable growth.In May 2016, the Reserve Bank of India (RBI)
Act, 1934 was amended to provide a statutory basis for the implementation of the
flexible inflation targeting framework.

2. Economic Growth:One of the most important objectives of monetary policy in recent

years has been the rapid economic growth of an economy. The RBI, by keeping the
prices steady and maintaining overall financial stability, has the ability to promote
economic growth, leading to prosperity over time.

3. Financial Stability:Financial system stability means the effective functioning of the

financial system (financial institutions and markets) and the absence of banking,
currency, balance of payments andexchange rate crisis.By forestalling or mitigating
the consequences of financial instability for the economy, the central banks help
alleviate liquidity pressures and boost public confidence. Formulatingappropriate
financial regulations, implementing effective bank supervision, and operatingor
overseeing efficient payment systems are few ways through which central banks help
to offset the risks offinancial instability.

The choice of a dominant objective arises essentially because of the multiplicity of

objectives and the inherent conflict among such objectives.The fundamental reason to
adopt price stability as the dominant objective is that inflation is economically and
socially costly.It is also important to observe that the objective of control of inflation

5
 iss not indepeendent of thee objective of growth. For
F examplee, the amenddment Act of o
2016 relatingg to RBI sayys (GoI, 20116) “Whereaas the primaary objectivee of monetarry
policy is to maintain
m pricee stability w
while keeping
g in mind thee objective of
o growth”.

21.5 M
Monetary Po
olicy Frameework

Monetary y Policy is conducted

c th
hrough speciification of the
t Monetaryy Policy Fraamework. Thhe
Monetary y policy fraamework in India has evolved overr the past feew decades owing to thhe
changingg macroeconomic conditions and finaancial developments in the t economyy. Instrumennts
and targgeting mechhanisms thatt ensure sm mooth operaation of thee monetary policy havve
undergonne significannt changes.T
The overall fr
framework inncludes welll-defined obj bjectives/goaals
of monettary policy along
a with instruments, operating taargets and inntermediate targets. Theey
ensure prroper implemmentation off monetary ppolicy and reealization off the definitee objectives.A
A
schematic representaation of a moonetary policcy frameworrk is shown iin Figure 2
Fig. 2

Source: Dua
D (2020)

Instruments are toolls that the central

c bankk has contro ol over and are used to o achieve thhe
operationnal target.EExamples off instrumennts include open marrket operatiions, reservve
requiremments, repo rate etc.Opperational taargets are the t financiaal variables that can be b
controlled by the cen ntral bank to
o a large exttent through the monetarry policy insstruments annd
guide thee day-to-dayy operationss of the cenntral bank.T These can innfluence thee intermediate
target annd thus helpp in the delivery of thhe final goaal of monetaary policy. Examples of o
operationnal targets include reserve monney and short-term s money maarket intereest
rates.Inteermediate targets, on the other handd, are variabbles that aree closely rellated with thhe
final goaals of monetary policy and
a can be aaffected by monetary
m poolicy. Intermmediate targeets
may inclu ude monetarry aggregates and short-tterm and lon ng-term interrest rates.

21.6 A Overview
An w of Monetaary Policy in
n India

The storyy of contemmporary Indiaan Monetaryy policy cann be understoood by goinng back to thhe
history of
o how this policy
p has undergone
u trransformatioons over a pperiod of tim
me.The 19700s
and 19800s were markked by fiscall dominancee, wherein monetary
m poliicy almost enntirely playeed
a supportting role in financing
f fisscal needs.Tiill about the mid-1980s,, monetary policy
p in Inddia
was moree suitablyconnsidered as “credit plannning”. The key k objectivee was to chaannel credit at
cheap addministered rates
r for thee developmeental pursuits, with publlic sector baanks acting as a
the mainn intermeddiaries.Moneetary policyy formulatioon from thhe mid-19880s to 19998
functioneedon the linees of the recommendatioons of Chakrravarty Com mmittee (1985). In view of o
that,moneetary targeting was adoopted, whereein the targeeted path of monetary ex xpansion waas
designed to fund the ‘desired growth of GDP in nominal terms’, i.e., growth after accounting
for tolerable inflation.
In the wake of challenges posed by financial liberalization and increasing complexities of
monetary management, the Reserve Bank of India switched to a multiple indicator approach
in 1998-1999.Under this approach Broad money (M3) continued to remain a primary
variable; however, focus was also placed on rate channels in monetary policy formulation.
Many macroeconomic variables like interest rate along with other indicators like credit flows,
inflation rate, exchange rate, foreign exchange reserves etc. were juxtaposed with output data
for drawing policy outlooks. In June 2000, the Reserve Bank also introduced a Liquidity
Management Facility (LAF) to manage liquidity on a daily basis through reverse repo and
repo rates in order to convey interest rate signals to the market.Monetary reformscontinued
thereafter, eventually freeing the central bank from fiscal dominance. This paved way for
greaterdependence on market-oriented, price-based, indirect instruments as against the direct
measures used earlier on. These changes marked the adoption of a multiple indicator
approachby RBIwhich lasted till 2016.
Another imperative footstep towards an independent and proficient monetary policy
framework and its operations was to cut the liability of swelling fiscal deficit. It was
attempted in the form of a Fiscal Responsibility and Budget Management Act, 2003. Under
it, the automatic monetization of fiscal deficit of Government of India was to be phased out
completely and the RBI was to be relieved of the burden of subscribing government securities
in the primary market. This assisted in giving more independence and autonomy to RBI in
outlining a balanced monetary policy subject to its goals.
The most important development between 1998 and 2016 has been the emergence of interest
rates as the chief tool of monetary intervention. This was a noticeable shift from the prior
reliance on bank rate and cash reserve ratio (CRR) by the RBI. Liquidity adjustment facility
(LAF), a cornerstone of monetary policy over this period, was used extensively. This was
used to make temporary and swift adjustments in liquidity within the banking system mainly
using the repo and reverse repo rates. This process culminated in the evolution of the repo
rate as the benchmark policy rate, determining the baseline cost of borrowing in the economy
today.
The Report of the Committee on Financial Sector Reforms, 2009 under the chairmanship of
the then Governor, Raghuram Rajan and headed by the then Deputy Governor Urjit Patel,
proposed that RBI can take care of the growth objective in the medium-run only if it focuses
on controlling inflation. It would also help serve the purpose of inclusive growth since the
poorer sections are least hedged against inflation. Following this, an Expert Committee to
Revise and Strengthen the Monetary Policy Framework was appointed on September 12,
2013. The main objectives of the Committee were: i) to devise and redefine the objectives
and conduct of monetary policy framework in an open economy environment; ii) to
recommend an appropriate nominal anchor for conduct of monetary policy; iii) to review the
operating framework and instruments of the monetary policy including the multiple-indicator
approach; and iv) to identify the impediments both fiscal and others in the smooth
functioning of monetary policy.

7
The main recommendations of this committee that submitted its report in January 2014
include the following:
(a) The Choice of Nominal Anchor: Inflation should be the nominal anchor for the
monetary policy framework. This nominal anchor should be set by the RBI as its
predominant objective of monetary policy in its policy statements. The nominal anchor
should be communicated without ambiguity, so as to ensure a monetary policy regime shift
away from the current approach to one that is centered around the nominal anchor. Subject to
the establishment and achievement of the nominal anchor, monetary policy conduct should be
consistent with a sustainable growth trajectory and financial stability.
(b) The Choice of Inflation Metric: The RBI should adopt the new CPI (combined) as the
measure of the nominal anchor for policy communication. The nominal anchor should be
defined in terms of headline CPI inflation, which closely reflects the cost of living and
influences inflation expectations relative to other available metrics
(c) Numerical Target and Precision:The nominal anchor or the target for inflation should
be set at 4 per cent with a band of +/- 2 per cent around this target should be set in the frame
of a two-year horizon.
(d) Institutional Requirements of the Monetary Policy Framework: Consistent with the
Fiscal Responsibility and Budget Management (Amendment) Rules, the Central Government
needs to ensure that its fiscal deficit as a ratio to GDP is brought down to 3.0 per cent by
2016-17.
The Expert Committee also recommended that decision-making should be vested in a
Monetary Policy Committee (MPC).The above recommendations were accepted and from
2016 the monetary authority shifted to flexible inflation targeting with repo rate as its
instrument of control.
Thus, the progression of monetary policy was swayed not only by the changing prototype in
monetary economics but also by the advances in the financial markets and macroeconomic
outcomes.
Check your Progress A
1. What is the difference between Expansionary Monetary Policy and Contractionary
Monetary Policy.
…………………………………………………………………………………………………
…………………………………………………………………………………………………
……………………………………………………………………….........................................
2. Write at least five instruments that are used for implementing monetary policy.
…………………………………………………………………………………………
…………………………………………………………………………………………
………………………………………………………………………………………….
3. Write the major goals of monetary policy.

8
 …………………………………………………………………………………………
…………………………………………………………………………………………
……………………………………………………………………………………….....

21.7Monetary Policy Rule

Monetary policy and its implementation in India has seen a steady, fundamental shift from
the pre-1990s regime of administered interest rates to a market-based system today. The repo
rate has emerged as the primary tool of monetary intervention.The theoretical underpinning
of the recent policy stance of the RBI can be traced back to the influential Taylor rule. This
captured the way forward-looking central banks frame interest rate policies, by taking into
account inflationary expectations (based on the Phillips Curve) and the impact of real interest
rates on output (based on dynamic IS curve).
21.7.1 Taylor Rule
Taylor rule is a monetary policy rule, which explains its stance of changing the nominal
policy interest rate in response to its objectives, viz. inflation, output and other economic
conditions.
According to the original version of Taylor rule as per Taylor (1993), the nominal interest
rate should respond to divergences of actual inflation from target rates and actual output from
the potential output.

𝒊 𝛑 𝒓∗ 𝜷𝟏 𝝅 𝝅∗ 𝜷𝟐 𝒚 𝒚 ∗ …………………………….(1)
In the above equation, i is the nominal interest rate set by the central bank; r* is the
equilibrium real rate of interest; π and π* are the actual and target rates of inflation,
respectively; and y and y* are logarithms of actual and potential output levels, respectively.
According to the Taylor Rule, the coefficient values β1 and β2 should be positive and as a
rule of thumb, β1and β2 must be equal to 0.5. The rule thus proposes a higher interest rate,
when either inflation is above its target or when output is above its potential or full
employment level. In other words, a tight monetary policy, when inflation or output gap is
positive and an easy monetary policy, when the gap is negative. During times when an
economy experiences conflicting goals such as low growth and high inflation, such as
stagflation, the rule recommends, giving relative weights to stimulate output and lower
inflation. The magnitude of the weights assigned to the inflation gap and output gap
essentiallyindicate central banks’ tolerance for deviations of output vis-à-vis inflation from
respective targets.
21.7.2 Flexible Inflation Targeting
While India formally adopted an inflation target of 4% (within a 2% point range of 2–6%) in
2016.In practice, monetary policy seems to have broadly followed the Taylor rule right
through the 2000s decade.With the signing of the Monetary Policy Framework Agreement
(MPFA) between the Government of India and the RBI on Feb 20, 2015, Flexible Inflation
Targeting (FIT) was formally adopted in India. In May 2016, the Reserve Bank of India
(RBI) Act, 1934 was amended to provide a statutory basis for the implementation of the FIT

9
framework. The ameended RBI Act,A 1934 alsso provided that the Cenntral Governnment shall, ini
consultattion with thee Bank, dettermine the inflation tarrget in term
ms of the Coonsumer Pricce
Index, onnce in every 5 years.
In 2016, India thus joined seveeral developped and em merging markket econom mies that havve
implemennted inflatio on targetingg. Figure 3 shows thee timeline ffor adoptionn of inflatioon
targeting regime starrting with Neew Zealand in 1990 and most recenttly Argentina and India in
i
2016.

F
Fig. 3
Source: Dua
D (2020)

21.7.3 Monetary
M Po
olicy Comm
mittee (MPC
C)
The Monnetary Policyy Committeee (MPC) is one of the main comm mittees of thhe RBI and is
responsibble for settinng the monetary policy sstance (settin
ng the repo rate). In foormulating thhe
monetaryy policy direection, MPC C makes asssessments annd policy deecisions bassed upon data
providedd by the RBI. Under the amended RB BI Act, the MPC
M is requuired to meeet at least fouur
times in a year.
The miniimum numbber for the meeting
m of thhe MPC is four
f membeers. Currently as of 2021,
MPC is a 6 member committee. Each membber of the MPC M has one vote, and inn the event of
o
an equaliity of votes, the Governoor has a secoond or castinng vote. The resolution adopted
a by thhe
MPC is published after
a conclussion of everry meeting of the MPC C in accordaance with thhe
provisionns of Chapteer III F of thee Reserve Baank of India Act, 1934.
On the 144th day, the minutes of the
t proceedinngs of the MPC
M are publlished whichh include:
a. the ressolution adoppted by the MPC;
M
b. the votte of each member
m on th
he resolutionn, ascribed to
o such membber; and
c. the statement of eaach member on the resollution adopteed.
Once in every six months,
m the Reserve
R Bannk is requirred to publissh a documeent called thhe
Monetary
y Policy Repport to explaain:
a. the sou
urces of inflaation; and
b. the forecast of inflation for 6-18 months ahead.

21. 8 Monetary Policy Transmission

The transmission mechanism of monetary policy is a process through which monetary actions
affect the twin objective of growth with stable inflation. There are various monetary policy
tools which are used for achieving the same, but in the recent past interest rate has been
predominantly and frequently used.Changes in monetary policy affect the economic activity
in general and price level in particular through the following five channels of monetary
transmission:
1. The interest rate channel:The change in the policy rate affects directly money-
market interest rates and, indirectly, lending and deposit rates, which are set by banks
to their customers.A reduction in interest rates (an ‘easing’ of monetary
policy)reduces the cost of capital thus triggering aggregate demand by motivating
business investment and consumption decisions. A tightening in monetary policy has
the opposite effect on demand and inflation.

Source:
https://www.bot.or.th/English/MonetaryPolicy/MonetPolicyKnowledge/Pages/Trans
missionMechanism.aspx

2. The exchange rate channel: Lower domestic interest rates could lead to a
depreciation of the domesticcurrency.On the one hand making exports more
competitive in the global market and addingto domestic demand and economic
activity. On the other hand, could also have a directupward impact on the rupee prices
of imported inputs, making imports (forexample, crude oil) costlier.

11
 Source:
https://www.bot.or.th/English/MonetaryPolicy/MonetPolicyKnowledge/Pages/Trans
missionMechanism.aspx

3. The credit channel: Through this channel an expansionary monetary policy leads to
higher deposits.Consequently, the banks disburse higher credit, which in turn
increases the investment and output in the economy. Further, debt obligations of
businesses may also change due to a change in the interest rate. For instance, if the
policy rate falls, debt obligations of firms may decrease, strengthening their balance
sheets. As a result, financial institutions may be more willing to lend to businesses,
thus increasing investment spending.

Source:
https://www.bot.or.th/English/MonetaryPolicy/MonetPolicyKnowledge/Pages/Trans
missionMechanism.aspx

12
4. The asset price channel: Asset prices and people's wealth influence how much they
can borrow and how much they spend in the economy. The asset prices and wealth
channel typically affects consumption and investment.Lower interest rates support
asset prices (such as housing and equities) by encouraging demand for assets. Higher
asset prices also increase the equity (collateral) of an asset that is available for banks
to lend against. This can make it easier for households and businesses to borrow.An
increase in asset prices increases people's wealth. This can lead to higher consumption
and housing investment as households generally spend some share of any increase in
their wealth.

Source:
https://www.bot.or.th/English/MonetaryPolicy/MonetPolicyKnowledge/Pages/Trans
missionMechanism.aspx

5. The expectations channel:Inflation expectations also matter for the transmission of

monetary policy. By having an inflation target, the central bank can anchor inflation
expectations. In this case, economic agents do not have to increase their prices for fear
of higher inflation or reduce them for fear of deflation. This should increase the
confidence of households and businesses in making decisions about saving and
investment because uncertainty about the economy is reduced.

13
 Check your Progress B
1. What do you mean by Taylor Rule.
………………………………………………………………………………………
………………………………………………………………………………………
………………………………………………………………………………………
2. What is meant by monetary policy transmission?
………………………………………………………………………………………
………………………………………………………………………………………
……………………………………………………………………………………....
3 What do you mean by Flexible Inflation Targeting ?
………………………………………………………………………………………
………………………………………………………………………………………
……………………………………………………………………………………....

21.9 Let Us Sum Up

Monetary policy refers to the use of monetary instruments under the controlof the central
bank to regulate magnitudes such as interest rates, moneysupply and availability of credit
with a view to achieving the ultimate objective of economic policy.The primary objective of
monetary policy in India is to maintain price stability while keeping in mind the objective of
growth. Price stability is a necessary precondition to sustainable growth.

14
The monetary policy framework aims at setting the policy (repo) rate based on an assessment
of the current and evolving macroeconomic situation; and modulation of liquidity conditions
to anchor money market rates at or around the repo rate. Repo rate changes transmit through
the money market to the entire financial system. This in turn, influences aggregate demand –
a key determinant of inflation and growth.The MPC determines the policy interest rate
required to achieve the inflation target.The monetary policy framework adopted by India and
many other countries is correctly described as ‘flexible inflation targeting’. Most of these
countries set not only an inflation target but also provide a range within which it can
fluctuate. This flexibility is extremely important because it emphasizes the uncertainties
against which central bank have to operate.Monetary policy, therefore, has an important role
in flattening the recession curve by ensuring easy and sufficient liquidity in the economy, so
that people have money to spend even if they are unemployed. Lastly, a healthy monetary-
fiscal policy co-ordination is essential to achieve macroeconomic stability and prevent any
future growth impairment in India.

21.10 Key Words

Expansionary Monetary Policy: This is known as loose monetary policy, expansionary

policy increases the supply of money and credit to generate economic growth.
Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of
exchange or other commercial papers.
Repo Rate: The (fixed) interest rate at which the Reserve Bank provides overnight liquidity
to banks against the collateral of government and other approved securities under the
liquidity adjustment facility (LAF).
Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity, on
an overnight basis, from banks against the collateral of eligible government securities under
the LAF.

21.11 Terminal Questions

Q1. Write down the major instruments of monetary policy?

Q2. What do you mean by monetary policy framework?
Q3. What all are the monetary policy committee formed for the purpose of monetary policy
rule.

15
Unit 22 FISCAL POLICY: MEANING AND INSTRUMENTS

Structure
22.0 Objectives
22.1 Introduction
22.1.1 Meaning and Instruments of Fiscal Policy
22.2 Public Revenue
22.2.1 Current Receipts and Capital Receipts
22.2.2 Sources of Revenue of State Governments
22.2.3 Tax Revenue
22.2.4 Sources of Non-Tax Revenue for the State Government
22.3 Tax
22.3.1 Direct Tax and Indirect Tax
22.4 Progressive, Proportional, Regressive and Digressive Taxation
22.5 Public Expenditure
22.5.1 Revenue Expenditure and Capital Expenditures
22.5.2 Main Heads of Public Expenditure
22.5.3 Developmental and Non Developmental Expenditure
22.5.4. Importance of Public Expenditure
22.6 Public Debt
22.6.1 Need for Public Debt
22.6.2 Method of Redemption of Public Debt
22.7 Government Budget: Meaning and Components
22.7.1 Components of Union Budget
22.7.2 Types of Budget
22.8 Government Budget: Meaning and Components
22.8.1 Components of Union Budget and State Budget
22.8.2 Types of Budget
22.9 Let Us Sum Up
22.10 Key Words
22.11 Terminal Questions

22.0 Objectives
After studying this unit, you will be able to:
1
 1. State the meaning of fiscal policy and its various instruments
2. Identify the different sources of revenue and different heads of expenditure of a
government
3. Explain the objectives of fiscal policy and the limitations thereof.

22.1 Introduction
Every government seeks to control and give direction to economic activities. For this purpose
it has at its disposal a number of instruments. Among these,the most important is the fiscal
policy or what is also known as the budgetary policy.
The fiscal policy, or budgetary policy,operates through the financial operations of the
government. Every government performs a large number of functions to carry out its
responsibilities. The functions that government has to carry and perform has been continually
rising.
Generally, fiscal policy to achieve different objectives.

Meaning and Instruments of Fiscal Policy

Fiscal policy is concerned with the finance of government,i.e., with the revenue and
expenditure of government. Studied earlier, a government mobilizes financial resources
through different means that include taxation and various non-tax sources. In addition, a
government can and does raise financial resources by way of loan and printing of new
currency.Likewise, a government undertakes various functions that involve expenditure.
By bringing out changes in structure of taxation, borrowing, etc., and by changing the size
and pattern of public expenditure, government can see to bring about desired change in the
economy. Thus, (i) public revenue, (ii) public expenditure and (iii) public debt form
important instrument of fiscal policy.
All the instruments of fiscal policy operate simultaneously. Changes in public revenue,
expenditure and debt implement each other.
Fiscal policy is defined as the policy under which a government uses the instruments of
taxation, public expenditure and public borrowing to achieve various objectivesof economic
policy

22.2Public Revenue
The responsibilities of a government all over the world have been steadily increasing.
Government is responsible for the national defence and also for maintenance of law and
order. Besides, government is also responsible for promoting social and economic welfare of
the people. All these responsibilities imply that a government has to discharge large number
of functions. These require money. A government has to mobilize more and more money in
order to finance its function and the money mobilized by the government is called public
revenue.
The various sources of public revenue can be broadly presented as shown in fig. 22.1:

2
 Fig. 22.1

22.2.1 Current Receipts and Capital Receipts

(i) Current receipts (also called revenue received) are those sources of inflows of money
which do not create any liability of repayment on the government. For example:A
government collects revenue by way of taxes. Revenue so raised is not to be ever returned to
the taxpayers.Similarly, a government owns many production enterprises which are known as
Public Sector Undertaking (PSUs). The profit earned by theseenterprises from part of the
income of a government. These are not to be returned to PSUs.
Current receipts of government take to forms, viz., (a) tax revenue, and (b) non tax revenue.
(a) Tax Revenue:Every government has the power to impose a number of taxes and every
government makes use of this power.
In India a number of taxes are imposed on goods,service,income and wealth etc.
These include: goods and service tax (GST), income tax, wealth tax, customs
duties,etc. The government mobilizes large sums of money by the way of these taxes
is constituted the tax revenue of the government.
(b) Non-tax revenue:Revenue mobilized by the government from all sources other than
taxes constitutes non tax revenue.
Of the two sources of revenue, tax revenue is generally more important than non-tax revenue.
The major source of non-tax revenue receipts can be conveniently tabulated as shown in Fig.
22.2. Let us learn them in detail.

22.2
(a) Commercial revenue:It is the revenue received by a government in the form of prices
paid for the government-supplied commodities and services. This includes payment
for postage, railways, electricity, toll,interest on funds borrowedfrom the government,
etc.
(b) Dividends:These are paid out by public sector enterprises out of the surplus income
3
 generated by them.
(c) Administrative revenue:It is the revenue that arises on account of the administrative
functions of a government. Some of the different forms of administrative revenue are
as follows:
– Fees:These are the charges imposed by government to defray the cost of each
recurring service.
– License Fees:These are paid in those instances where are government authorities
invoked simply to confer a permission or privilege. No service as such is provided
by the government.
– Fines and Penalties:These are levied for infringement of law.
– Forfeitures:Theseare in the form of penalties imposed by courts for non-
compliance with orders on non-fulfillment of contract etc.
– Escheat:It refers to the claim of the government on the property of a person who
dies without having any legal Heirs or without leaving a will.
(d) Grants from abroad:Occasionally, a country receives grants and donation from
governments and philanthropic organisations situated abroad.
Capital receipts, on the other hand constituted those sources of money for a government
which involve either of the following two:
• A liability of prepayment is created for the government.
• An asset owned by the government is to be sold.
For example, when a government receives money by way of loans and borrowings, a liability
of repayment of loans arises.
Similarly, when a government raises money by way of disinvestment of equity of government-
owned enterprises, assets gets sold out to private Enterprises.
The major sources of capital receipts of a government can be conveniently presented as
shown in Fig. 22.3.

4
 Fig. 22.3.
(a) Recoveries of Loans: a government extends loan to the households, business unit and
also in other countries. These loans constitute asset of the government. When these
loans are paid back to the government, it gets its money back. Government’sreceipts
increase but its assetsfall. Hence, these are known as capital receipts.
(b) Loans and borrowings:A government can borrow from different sources.By way of
loans a government gets money. But every loan is to be paid back. Till the loan is
paid back the government carries the liability of repayment.
(c) Disinvestment:The government establishes a number of Industrial and business units
which are the assets of the government.The government may sell a unit or more units
in part of whole,to private sector enterprises.This sale is known as disinvestment.By
this method moneyflows to the government.But in the process the role of government
gets reduced.

22.2.2 Sources of Revenue of State Governments

State Government have their own independent source of revenue the different source of
revenue can be classified into three parts A. Tax revenue, B. Non tax revenue, C. Central
transfers.

A. Sources of tax revenue for the state government

In our Constitution, the states have been given independent tax powers. There is no work
lapping of tax jurisdiction.
The underlying principle which determines this division is as follows:
• Taxes which have an interstate base are levied by the central government.
Examples:Income Tax,Corporation tax, Custom duties, etc.
• Local taxes levied by the State Government.
The state list contains 19 items like land revenue, tax on agricultural income, GST
5
 etc.

22.2.3 Tax Revenue

The tax revenue of the State Government can be divided into two parts, vis., (a) revenue from
the taxes levied by the State Government,such as taxes on income, tax on property and taxes
on commodities and services,and (b) revenue from taxes shared with the Central Government
such as income tax, GST etc.
The main sources of tax revenue of states are:
(i) Taxes on income:The state government get revenue from taxes on income mainly in
three ways: (a) Shareof the states in the income tax imposed by the Central
Government is the most important source of taxes on income. (b) Some of the states
have imposedagriculturalincome tax (c) Professional tax,i.e., taxes is imposed on
people involved in various profession.
(ii) Tax on property:The State Governments receive income from taxes on property and
capital transactions.The main type of such taxes are: (a) Land revenue (b) Stamp
duties and registration fee and (c)Taxes on urban immovable property.
(iii) Taxes on commodities and services:The State Governments impose taxes on
commodities and services mainly in the following ways: (a) General sales tax has
been the most important source of revenue for the states from the commodity taxes. It
is imposed on the commodities (selected for sales tax), which are sold within the
country.Sales tax has been replaced by VAT now in all states, (b) Share of states in
the Union excise duties,(c) State excise duty is levied on liquid, opium and other
narcotics,(d) Motor vehicle tax, (e) Entertainment tax (on cinemas,theatre
performance,game etc.)including tax on betting and gambling, and(f) Electricity
duties.

22.2.4 Sources of Non-Tax Revenue for the State Government

The main source of non-tax revenue for the State Governments are: (i) Fees taken in all
courts except the Supreme Court. (ii) Income from undertakings owned, partly or fully, by
the State Governments.(iii) Income from property owned by the State Government. (iv)
Borrowings from within the country. (v) Royalty from mines, forest, treasure troves, etc. (vi)
Grant-in-aid from the Central Government.(vii) Other grants from the Central Government.

C. Resource Transfer from the Central Government to the State Government

The basic principle of federal finance is that all the constituent unit should have adequate
sources of revenue.
It has further been realised that the states, left to themselves,cannot raise sufficient revenues
to meet their function and needs.
Moreover, wide interstate disparities exist. An important objective of development effort is to
remove these regional disparities.
A consideration of these different factors points to the need of a balancing factor. Such a
balancing factor is provided by the principle of transference.
Our financial system has provided for the transfer of resources from the centre of the states.

6
The important means of resource transfer are:
(i) Tax sharing: 42.0% of the total tax revenue collected by the Central Government is
distributed among the State Governments.
(ii) Grants-in-aid:The central government extends different type of grants to state
government.
These grants are made on the recommendations of the Finance Commission.
(iii) Loans:The Central Government is authorised to give loans to State Government,
subject to such condition as may be laid down by or under any law made by the
Parliament.
(iv) Other transfer:these include:
– Central assistance to an externally aided projects.
– loans, comprising mainly net small savings collection by the states.
– Grants and loans to the states for implementing Central schemes.
– Grants and loans for centrally-sponsored schemes.
– Grants and loans to the case of natural disasters.
– Loans to settle overdraft from the RBI.
– Special loans.
These transfers are made at the recommendations of the union Finance Ministry.
Apart from these direct transfer through sources also flow to the states through:
• The establishment / expansion of Central public undertakings, and
• The distribution of credit by the financial institution.
Check Your Progress 1
1. What do you mean by budgetary policy?
…………………………………………………………………………………………
…………………………………………………………………………………………
…………………………………………………………………………………………
2. What do you mean by public revenue?
…………………………………………………………………………………………
…………………………………………………………………………………………
…………………………………………………………………………………………
3. What are direct taxes?
…………………………………………………………………………………………
…………………………………………………………………………………………
…………………………………………………………………………………………
4. What are indirect taxes?
…………………………………………………………………………………………
…………………………………………………………………………………………
7
 …………………………………………………………………………………………

22.3Tax
A tax is a compulsory contribution levied on the wealth of an individual by the government
of a country without reference to any benefit.
From this definition following important characteristics of tax can be observed:
1. A tax is a compulsory payment. All those who act as to pay tax have to make the
payment. Otherwise, they are liable to fine or punishment.
2. The rate of tax is decided by the government. The taxpayer cannot bargain with the
government.
3. Tax must be paid whether the individual derives any special benefit or not.
4. A tax is paid for the general or common benefits extended by the government to all
the taxpayers.
5. No individual can claim any special service for himself in exchange for the tax paid to
the government.

22.3.1 Direct Tax and Indirect Tax

(i) Direct tax is a tax which is expected to be paid out of the income or wealth of the
same person on whom it has been imposed.
In other words the same person is expected to be the burden of the tax on whom the
tax has been imposed.
In more technical language we say that the impact and the incidence of the tax are on
the same person. By impact we mean the responsibility to pay the tax. By incidence,
we mean the burden of the tax. For example:If a person earns ₹5 lakh a year, he is
liable to pay income tax. The tax is to be paid out of his income.The tax burden
cannot be shifted to any other person not given the employer.
Similarly, if a company earns Profit during a year it is liable to pay corporation tax
out of its income.The company cannot shift this on anyone else.
(ii) Indirect tax is a tax whose burden can be shifted to another person. The person who is
made responsible to pay the tax is expected to charge the amount of tax from another
person.
In other words, the tax burden is not borne by the person on whom the tax has been
imposed. Technically, we say that the impact and incidence of an indirect tax fall on
different persons.
Example:Government levies GST on production of Pepsi. the company easily
includes the amount of tax in the price of Pepsi and charge the same from the buyer.
Similarly, if an import duty has been imposed on an imported camera, the seller includes that
duty in the price of camera. The burden (incidents) of the tax is borne by the consumer and
not the seller.
Your shopkeeper charges GST from you. He is responsible to deposit the tax money with the
government treasury. But he is authorised to charge the amount from you.
More generally, direct tax is levied on the income of an individual, while indirect tax is levied

8
on expenditure.

Advantages of Direct Taxes

Direct taxes are paid out of the income or wealth of the person on whom the tax has been
imposed. Direct taxes have certain merits. These can be briefly identified as:
(i) Equity:Burden of taxation is distributed on different people and institutions in just or
equitable manner.The tax rates can be progressively raised as a level of income go up.
(ii) Certainty:Direct taxes satisfy the principle of certainty.The taxpayer knows well in
advance in certain terms as to how much he is expected to pay.
(iii) Elasticity:With an increase in income and wealth of the people, the revenue from
direct taxes also increases. Similarly,a government can raise more revenue simply by
raising the tax rate.
(iv) Civic consciousness:The taxpayers are always aware of the fact that a part of their
income has been transferred to the government. They begin to show more interest in
the affairs of the government they work like watchdogs.
(v) Reducing inequalities:Direct taxes are generally progressive in nature. Higher
incomes are taxed at higher rates.
(vi) Simplicity:Direct taxes are generally simple. They are normally understood clearly by
ordinary taxpayers.

Disadvantages of Direct Taxes

(i) Arbitrary:Direct taxes tend to be arbitrary. It is indeed difficult to have objectively
just on the basis of ability. The tax rates are often dictated by political compulsions of
the government.
(ii) Tax evasion: Direct taxes tempt people to evade them by hiding their income and
wealth.
(iii) Inconvenient:Taxpayers have to file returns of their income, these returns are
scrutinised by the tax authorities. All these involved inconvenience and expenses
besides time and energy.
(iv) High cost of collection:Direct taxes are often regarded as expensive to collect.
(v) Adverse effect on will to work and save:Taxpayers always do not positively react to
direct taxes. Taxes work as a disincentive to work more and earn more income since a
part of the additional income is to be surrendered to the government.

Advantages of Indirect Taxes

The tax burden of indirect taxes is expected to be shifted to others
The major advantages of indirect taxes can be summed up as :
(i) Convenience:Indirect taxes are convenient to pay and collect. The government finds it
convenient to collect indirect taxes as they are paid in lump sum by the producer.
(ii) Difficult to evade:Indirect taxes are included in the price of the commodity. Evasion
of an indirect tax will mean giving up the satisfaction of a given want.
(iii) Elasticity:As the consumption level increases, tax revenue mobilized by way of
indirect taxes also increases.
(iv) Ability:Indirect taxes can serve the principle of ability. High rates of taxes may be
9
 imposed on those goods and services which are generally consumed by high income
groups.
(v) Social benefit:Indirect taxes enable everyone, even the poorest citizen, to contribute
something towards the expenses of the state.
(vi) Equity: Indirect taxes can be made equitable by imposing heavy taxes on luxury
goods that are generally considered by the richer section of the society.Consumption
of lower income group may be exempted.
(vii) Promote production and investment: Indirect taxes can be so levied that the
production of goods by high-priority industries is increased and low priority
Industries is discouraged.

Disadvantages of Indirect Taxes

Indirect taxes has certain disadvantages also among these the more important ones are :
(i) Unjust and inequitable:They fall alike on all the persons irrespective of their ability to
pay.
(ii) Uncertain:Neither the taxpayer nor the government can be sure about the amount of
tax involved.
(iii) Lack of social consciousness:Taxpayers fail to feel the pinch of tax immediately.
These tax fail to evoke social consciousness among the taxpayers.
(iv) Inflationary impact:An indirect tax gets added up in the price of a product.Prices of
commodities go up and this may be registered by the consumers.
Advantages of Direct Taxes Disadvantages of Direct Taxes
• Equity • Arbitrary
• Certainty • Tax evasion
• Elasticity • Inconvenient
• Civil consciousness • High cost of collection
• Reducing inequalities • Adverse effects on Will to Work and
• Simplicity Save
Advantages of Indirect Taxes Disadvantages of Indirect Taxes
• Convenience • Unjust and inequitable
• Difficult to evade • Uncertain
• Elasticity • Lack of social consciousness
• Ability • Inflationary impact
• Social benefits
• Equity
• Promote production and investment
Check Your Progress 2
1. What do you mean by public expenditure?
…………………………………………………………………………………………
…………………………………………………………………………………………
…………………………………………………………………………………………
10
 2. Define regressive tax.
…………………………………………………………………………………………
…………………………………………………………………………………………
……………………………………………………………………………………………….
3. Define Degressive tax.
…………………………………………………………………………………………
…………………………………………………………………………………………
…………………………………………………………………………………………

22.4Progressive Taxation, Proportional Taxation, Regressive Taxation and Degressive

Taxation
As stated earlier, different types of taxes are imposed by a government. We have already
classified the different taxes into two categories as (i)direct tax and (ii) indirect tax.
Different taxes are imposed by the government because a government has to pursue different
objectives. For example, at times a government may need to encourage production and
consumption of some commodities. Redistribution of income among different section of the
society may be another objective of taxation. In pursuance of these objectives, a government
imposes taxes at different rates on different commodities and different groups of persons. For
example, a person who earns ₹3 lakh a year pays income tax at the rate of 10% of his taxable
income. On the other hand a person who earns ₹10 lakh a year pays income tax at the rate of
30% of his taxable income.
On the basis of the rate of taxation the different taxes can be classified into four categories
as:(A) Progressive taxation, (B) Proportional taxation, (C) Progressive taxation, and (D)
Degressive taxation.

(A). Progressive taxation

In a progressive tax system the rate of tax increases as the tax base increases. That is, persons
with higher income of wealth not only pay more tax, they pay tax at a higher rate.
This is illustrated below:
Suppose the tax rates at different slabs of income are as follows:
Amount of Income (₹) Rate of Tax (₹)
0–1 lakh 10
1 lakh – 2 lakh 20
2 lakh – 3 lakh 30

From this, we calculate the tax liability of A, B and C who have annual incomes of ₹1 lakh
₹2 lakh and ₹3 lakh respectively this is shown below:
Persons Income (₹) Tax liability (₹)

11
 A 1 lakh 10,000
B 2 lakh 10,000 + 20,000 = 30,000
C 3 lakh 10,000 + 20,000 + 30,000 = 60,000

Thus, A pays a total tax of ₹10,000 on an income of ₹1 lakh, whereas C pays a tax of ₹60,000
on an income of ₹3 lakh.

B. Proportional taxation
In a proportional tax system the rate of tax remains the same at different tax bases.
Suppose, India adopt a proportional income tax system.Every individual is required to pay
tax at the rate of 10% of his income. We estimate the tax liability at different levels of income
as follows:
Income (₹) Income of Tax (₹)
10 1
1,000 100
10,000 1,000
10,00,000 1,00,000

We notice the amount of tax to be paid goes on increasing but the rate at which the tax is paid
remained unchanged.
C. Regressive Taxation
In a regressive tax system, the rate of tax Falls as the tax base increases.
Level of income (₹) Tax rate(%) Tax amount (₹)
10,000 10 1,000
20,000 8 1,600
30,000 7 2,100

In this case we find that

• the amount of tax to be paid increases and
• the rate at which tax is to be paid falls.
A regressive tax is one in which the rate of taxation decreases as the taxpayer’s income
increases.

D. Degressive Taxation
In a degressive tax system, the tax increases with an increase in tax base but the rate of
increase of tax diminishes with every increase in the tax base.
This can be illustrated as follows:
Taxable income (₹) Rate of tax (%) Rate of increase in tax Amount of tax (₹)

12
 rate (% of point)
100 5 – 5
200 10 5 20
300 14 4 42
400 17 3 68
500 19 2 95
600 20 1 120

Thus, it would be seen that with an increase in the tax base :

• Rate of tax increases.
• Amount of tax increases.
• Rate of increase in tax rate falls.
Progressive taxation is based on the principle of ‘ability’-to-pay, i.e., those who earn more
should pay more to the government. It helps the government in redistribution of income from
rich to poor.

22.5 Public Expenditure

Public expenditure refers to the expenses of the public authorities—Central Government,
State Government and Local Government—either in protecting the citizens or in promoting
the economic social welfare.
Public expenditure, broadly speaking, includes expenditure incurred by a government under
the following heads:
• Defence expenditure:It includes expenses on equipment, payment as wages for army
personnel, etc. Defence expenditure corresponds to the ‘first duty of sovereign’, viz.,
defending the society from the violence of other independent societies.
• Civil expenditure or administrative expenditure:It is incurred for the maintenance of
law and Justice, viz., securing internal justice between citizens.
• Economic expenditure, (i. e., government expenditure for economic ends):It includes
provision of direct services to private enterprises in the form of subsidies and
provision of benefits through its own industries.
• Social expenditure:It includes expenditure on education, public health, social
Insurance scheme, etc.
Each one of the above broad headings includes many subsidiary functions.

22.5.1 Revenue Expenditure and Capital Expenditure

Government expenditure can be divided into two heads:
(i) Revenue expenditure and,
(ii) Capital expenditure.
Let us learn them in detail.
(i) Revenue expenditure of a government is in the form of consumption expenditure.It does

13
not directly create any capital asset for the economy.
Example: LPG cylinders are made available to domestic consumers at a price which is less
than theper unit cost of production of a cylinder. The difference is borne by the government
and is known as subsidy. Expenditure on subsidies is a part of the government expenditure it
does not lead to creation of any effect.
The other characteristic of revenue expenditure is that it does not cause any reduction in the
liability of the government.
Example:Expenditure incurred on the defence forces of a country does not cause any
reduction in the liability of the government.
The major items on which a government increase revenue expenditure include:
(a) subsidies,
(b) interest on government loans,
(c) public administration,
(d) defence, and
(e) other economic and social services.
(ii) Capital expenditure is in the form of investment expenditure. It results in creation of
assets in the economy. The more the capital expenditure, the larger the quantity of assets that
are created.
Examples:Construction of roads, dams bridges,flyovers, hospitals, schools, canals, etc.,
involves government expenditure this expenditure creates more assets.
The other characteristic of capital expenditure is that it causes a reduction in the liabilities of
the government.
Example:If the government incurs expenditure towards repayment of loans, its liabilities get
reduced.

22.5.2 Main Heads of Public Expenditure

Main heads under which expenditure is incurred in India by the Central Government are as
follows:
(i) Central scheme: Ours is a planned economy. For this purpose five year plans are
formulated. Within each plan, development programmes are formulated and
implemented as a part of each five year plan. On each of development programmes
and schemes government expenditure is included. A provision for this expenditure is
made each year in the budget for the year.
(ii) Central assistance to States:In our federal set-up, the State Governments receive
financial assistance for the central government. The financial assistant is granted both
for plan and non plan expenditure of the states. This is extended both on Revenue
account and Capital account.
(iii) Interest payment:It has not been possible for the government to meet its rising
expenditure from its own financial resources. it has been resorting to use borrowing
both domestically and externally. Any loan, by definition, carries the application to
14
 pay interest. Same is the situation of the Government of India. With rising public debt
the burden of interest payment has been rising in the economy.
(iv) Defence: Defence expenditure constitutes a big share of total expenditure on the
economy. Defence expenditure is included both on maintenance of armed forces, as
also on creation of Defence assets.The former constitutes revenue expenditure,
whereas the latter constitute capital expenditure.
(v) Public Administration and services:The government is responsible for provision of
various social,economic and administrative services in the economy. To run these
services, a comprehensive government machinery has been built up at all levels. Huge
sums of money are required to be spent on the maintenance and running of this
machinery.
The main heads of public expenditure can be illustrated in the form of Table 22.1 which
relates with a recent Union budget.
Table 22.1: Heads of Public Expenditure in Union Budget
Heads of expenditure ₹ in crore
A. Revenue expenditure 18,36,934
of which
(i) Interest payment 1,90,807
(ii) Defence 57,593
(iii) Subsidies 71,431
(iv) Economic, social and other services 40,870
B. Capital expenditure 3,09,801
C. Expenditure on central schemes 9,45,078
D. Total expenditure (A + B + C) 30,91,813

Recent Change: 2017 onwards

This 12th five-year plan came to an end on March 31st 2017. With this the era of five-year
plans which began with the first five year plan on April 1, 1951, has ended. The planning
commission has been disbanded. in view of this distinction between plan expenditure and non
plan expenditure has lost its relevance. Hence, with budget 2017-18 onwards, this distinction
has been removed from the budget papers.
Two other changes in budget provisions may be noted as follows:
(i) Till the year 2016-17, the railway budget was presented to Parliament separately.
From 2017-18 the Railway budget has been merged in the union budget, and it is
presented as part of the union budget.
(ii) Till the 2016 17 budget the Union Budget was presented on the last working day of
February every year.
From 2017-18, the practice has changed and it is now presented on the first working
day of February every year.

22.5.3 Development Expenditure and Non-development Expenditure

Development expenditure relates to growth and development activities of the government. It
includes expenditure incurred under such head as social and community service and
15
economic services.
Non-development expenditure relates to non-development activities of the government. It is
incurred under such head as defence, interest payments, subsidies,public administration, etc.
Further, it should be noted that development schemes are included in both revenue and
capital budgets.

22.5.4 Importance of Public Expenditure in an Economy

Public expenditure is of great significance in the context of a welfare state like India. This
can be seen from the following points:
(i) Public expenditure increases economic growth:It accelerate the process of economic
growth.
(a) New industries can be set up.
(b) infrastructure like roads,dams, bridges,canals, flyover, etc., can be constructed.
(c) Research and innovation are encouraged.
(d) Rate of investment and capital formation is increased.
(ii) It increases economic welfare:This happens when public expenditure is directed
towards programmes of poverty eradication, health and education of the poorer
sections of the society etc.
(iii) It corrects depression and checks unemployment:Depression in an economy is the
result of the fact that there is an inadequate aggregate demand for goods and services.
This causes unemployment and further fall in incomes. A government can create
more employment opportunities for increasing its own expenditure. Once more
employment is created, it generates more income and increase demand for goods and
services.
(iv) It leads to reduction in inequalities:Public expenditure can be used to
(a) reduce inequalities in income distribution, and
(b) remove regional disparities in growth.
It is largely because of the above operations, the public expenditure has been continuously
rising almost in all countries.

Is increasing Public Expenditure Necessary Good or Evil?

It is difficult to take sights on this issue. This is, however, clear that as an economy grows
and the sphere of government activity expands, the size of public expenditure will keep on
increasing.
It is difficult to determine any common yardstick for all the nations of the world. The proper
level of Expenditure would depend upon a number of factors, among these, the more
important ones are:
1. Designers and needs of the community.
2. Effects of government spending and the revenue supporting the spending.
3. Willingness of the population to be taxed.
4. Resources and population of a community.

16
5. Distribution of wealth and income.
6. Stage of economic development,etc.
Check Your Progress 3
1. Distinguish between revenue expenditure and capital expenditure.
…………………………………………………………………………………………
…………………………………………………………………………………………
…………………………………………………………………………………………
2. Distinguish between developmental expenditure and non-developmental expenditure.
…………………………………………………………………………………………
…………………………………………………………………………………………
………………………………………………………………………………………….
3. What do you mean by social expenditure?
…………………………………………………………………………………………
…………………………………………………………………………………………
…………………………………………………………………………………………

22.6 Public Debt

Government borrow money from different sources to meet their budgetary needs.
Governments may borrow from sources within the country of resources outside the country.
Every loan, by definition, is contracted for a fixed period of time. During this period, the
borrower is under a contractual obligation to pay interest on the borrowed capital. On the
maturity of the loan period, the borrower is under a contractual obligation to return the
principal.
A borrower may raise a fresh loan to pay of the earlier loan.
This process may be repeated any number of times. as a result, the debt burden of the
borrower goes on increasing. Public debt refers to the debt burden of a government at any
point of time.

22.6.1 Need for Public Debt

Government normally borrowed in difficult situations as explained below:
(i) To meet budgetary deficit: Modern Government do not have any last accumulated
balance to meet a budget deficit.Governments may face any of the following
situations:
(a) the revenue from taxation and other sources may not be equal to the actual
expenditure, and
(b) there may be unplanned and unexpected emergency situation like major fires,
floods and famines.
It may not be possible to mobilise fund through taxation to meet the situations.
17
 Government may Resort to borrowing.
(ii) War finance:A factor which necessitates public loans is war. Modern Warfare is so
costly that the normal income through taxation falls short of the actual war
expenditure. A republic loan is a better and easy method of collecting revenue than
taxation.
(iii) To check recession:Public borrowing is considered very useful as a remedy for
slowdown in economy. Loans enabled the government to make use of idle and
unutilised points of the public in this way the government can create demand for
goods and services. This will provide a much needed push to the economic activity.
(iv) To accelerate development activity:Public loans are also made for development
purposes. These loans can be made to buildinfrastructure and capital projects.
(v) To meet contingencies:Government may be required to undertake any unexpected
expenditure. This expenditure might not have been budgeted for. The government
may raise loans to this type of expenditure.
(vi) Short revenue option:Taxation is a difficult choice, high taxation is generally
resisted.High taxation also adversely affect the ability and willingness to work and
save. Borrowing offers of a soft option to the government. It does not attract any
adverse reaction. At times, people may even appreciate when a government plots new
scheme of borrowing, more so, if the scheme of was any added incentives.

22.6.2 Methods of Redemption of Public Debt

Various methods available to a government to pay off its debts are:
(i) Repudiation of debt:It simply means that government refuses to pay the interest as
well as the principal. It does not recognise its debt obligation. A government can
repudiate both its internal debt and external debt. Generally, no government like to
repudiate its debt as this will shake the confidence of the general public in the
government.
(ii) Conversion of loans (Debt conversion):An old loan may be converted into a new
loan.Conversion may be resorted to:
– when at the time of redemption of a loan the government does not have the
necessary funds,or
– when the current rate of interest is lower than the rate at which the government is
paying for its existing debt, so that the government can reduce its debt obligations.
(iii) Serial bond Redemption:Government may decide to repay every year a certain
portion of the bonds issued previously. This enables a portion of the debt being paid
off every year.
(iv) Buying up loans:A government may redeem it step to buying up loans from the
market. Whenever it has surplus income, it may spend the amount of pay off
government loan bonds from the market where they are bought and sold.
(v) Sinking fund:It refers to the creation and the gradual accumulation of a point which
will be sufficient to pay of public debt.
(vi) Capital levy:It may be levied once in a while with the special objective of redeeming
public debt.
(vii) Redemption of external debt:It can be done only through accumulating the necessary
18
 foreign exchange to pay for it.
(viii) Refunding:The simple and transparent method through which government buys back
the bonds as and when they mature and stand due for payment in cash.

22.7GOVERNMENT BUDGET: MEANING AND COMPONENTS

Budgetary policy of fiscal policy:It implies the use of various components of budget as a
means to achieve different set goals.
Capital expenditure:The expenditure incurred on creation of capital assets.
Capital receipts:All money mobilized by a government that either creates a liability or
repayment or involves the sale of an asset.
Direct tax:It is a tax whose liability and burden is borne by the same person.
Fiscal:It refers to the finances of the government
Indirect tax:Liability to pay and the burden of this tax is borne by different persons.
Non tax revenue:Total financial resources faced by a government by way of different sources
other than all types of taxes.
Public debt:It refers to the value of loans that a government owes to others.
Public expenditure:The expenditure incurred by a government under different heads.
Public Finance:Study of public revenue, public expenditure and public debt.
Public revenue:The amount of money collected by a government from different sources.
Social sector expenditure:Comprises expenditure on social services,rural development and
food subsidy.

22.8 Government Budget: Meaning and Components

A budget is an annual financial statement of a government. It gives out details of total
receipts and total expenditure for a year. Till now, in India, budget of the Union Government,
known as the Union Budget, used to be presented on the last working day of the month of
February. This practice has been changed now beginning with 2017-18 budget, it will be
presented on the first day of the month of February. Similarly, each of the state government
presents annual budget for the respective state. This is known as State Budget. For example,
Haryana State budget, Maharashtra State budget etc.
Along with the budget for the next year, the set of figures relating to government receipts and
expenditure pertaining to the preceding two years are also presented.

22.8.1 Components of Union Budget and State Budget

The various components of a budget can be divided into two parts, viz., (i) revenue budget
and (ii) capital budget
A revenue budget contains the details of revenue expenditure and revenue receipts of the
government. These are in the nature of current expenditure and current income of the
government.
19
A capital budget is a statement of capital receipts and capital expenditure of the government.
The sum total of the revenue budget and capital budget that contribute to the overall budget
of the government. Thus, the sum of revenue receipts and capital receipts constituted total
receipts of the government. The sum of revenue expenditure and capital expenditure
constitute the total expenditure of the government.

The different components can be tabulated and illustrated with the help of data from a recent
Union Budget as follows:
Components of budget (₹ in crore)
A. Revenue budget
A1 Revenue receipt 6,02,935
A2 Revenue expenditure 6,58,119
Revenue surplus/(deficit) = (A1 – A2) –55,184
B. Capital budget
B1 Revenue receipt 1,47,949
B2 Revenue expenditure 92,765
Capital surplus/(deficit) = (B1 – B2) +55,184
C. Overall budget = (A + B)
C1 Overall receipt (A1 + B1) 7,50,884
C2 Overall expenditure (A2 + B2) 7,50,884
Overall surplus/(deficit) = (C1 – C2) 0

The state budget also follows the same pattern. However, a state government does not have
the privilege of running a fiscal deficit. The state government can borrow money from the
unknown government. This is in addition to the resources transferred by the union
government to state governments.

22.8.2 Types of Budget

Balanced Budget, Surplus Budget, and Deficit Budget

During a year, government’s overall receipts may be equal to, less than, or more than
government’s overall expenditure.
• If overall receipts are equal to overall expenditure, we call it a balance budget.
• If overall receipts are more than overall expenditure, we call it a surplus budget.
• If overall receipts are less than overall expenditure, we call it a deficit budget.
We know receipts and expenditure of two forms, viz., (i) Revenue receipts and (ii) Capital
receipts and (i) Revenue expenditure and (ii) Capital expenditure.

We have different concept of deficits (and surplus) in government budget.

Among these concepts, more important ones are: (A) revenue deficit, (B) budget deficit, (C)
fiscal deficit, (D) primary deficit, gross primary deficit, and primary deficit.

20
A. Revenue Deficit
Revenue deficit obtains when the revenue expenditure of the government exceed the
revenue receipt.

Revenue deficit = Revenue expenditure – Revenue receipts.

This is shown in the following tabular data from the Union Budget for a recent year:

Financial statement (₹ in crore)

A. Revenue receipts 6,02,935
B. Revenue expenditure 6,58,119
Revenue deficit = (B – A) 55,184

Implications of Revenue Deficit

The golden rule laid down for any budget is that it should have a revenue surplus,i.e., the
current expenditure of the government should be less than its current income. The difference
on this account known as revenue surplus. The revenue surplus can be used to finance
capital projects in the country. The capital project represent capital formation. These add to
the production potential of the economy and thus create conditions for rapid growth.

Conversely, if a government incurs revenue deficit, it implies that its current expenditure
exceeds its current revenue. To plug this difference, it will have to find additional sources of
money. For example, it may borrow within the economy; it can also borrow externally. It
may even decide to sell the assets owned by it.The money so realised may be used to finance
the deficit. It is obvious that in this situation the economy would not be in a position to
strengthen its resource-base. After all, it is bad economics to sell off family’s jewel to
celebrate a wedding at home. What is true for a family is true for the government also.

In short, the accepted wisdom is that a government should have a revenue surplus (and not
revenue deficit); it may have an overall balanced budget or deficit budget. That is a separate
question to be considered as given below.

Methods to Plug Revenue Deficit

The government may attempt to plug revenue deficit. for this purpose, it may have to:
• increase its current receipts and /or
• reduce its current expenditure
But the government comes again serious fraud block on either of these two fronts. The major
source of current receipt of a government are taxes. But taxation as an instrument of resource
mobilization suffers from serious limitations. Taxation beyond the limit may adversely affect
people’s capacity and willingness to work and save. Therefore, no government can report to
raise tax rates on the taxable capacity of the people.

Similarly, a government can make serious items to cut down its current expenditure. But
many items of the current expenditure are in the form of committed expenditure. These have
to be incurred and cannot be cut down. If these are cut down they may adversely affect either
the security of the nation on authority of the government or the Welfare of the people.
21
Given these limitations, government may have to leave with revenue deficit, although it is
presented by everyone.

B. Budgetary Deficit
Budgetary deficit will be obtained when the overall expenditure of the government, i.e., the
sum total of revenue expenditure and capital expenditure exceeds the overall receipts, i.e., the
sum total of revenue receipts and capital receipts. If total receipts equal total expenditure, it
will be called a balanced budget. Budgetary deficit will be zero.

Budgetary deficit = Total expenditure – Total receipts.

= (Revenue expenditure + Capital expenditure) – (Revenue receipts + Capital
receipts )

For example, in a recent Union Budget we have:

Financial statement (₹ in crore)

A. Revenue receipt 6,02,935
B. Capital receipt 1,47,949
Total receipts = (A + B) 7,50,884
C. Revenue expenditure 6,58,119
D. Capital expenditure 92,765
Total expenditure = (C + D) 7,50,884

It would be seen that in the given Union Budget, overall expenditure is equal to overall
receipt. It is a balanced budget in this sense.

But in case the overall expenditure were to be more than the overall receipts, the difference
between the overall expenditure and the overall receipt constitutes budgetary deficit.

A budgetary deficit is always financed by printing new currency.

In a developing economy, it is always necessary to print new currency. New currency is

required to meet increasing transaction in goods and services arising out of increased
production of goods and services.

But if new currency is printed in a greater proportion than the proportion in which supply of
goods and services has increased, there would be more money available in the economy than
what is required. There would be too much money chasing too little goods. This would prove
inflationary. An unchecked inflation can have serious adverse effect on the growth process in
an economy. It can adversely affect both savings and investment, which are fountainhead of
capital formation.

Thus, no government can go for uncontrolled printing of new currency to meet its financial
needs.

C. Fiscal Deficit
Fiscal deficit is calculated as follows:

22
Financial statement (₹ in crore)
A. Revenue expenditure 6,58,119
B. Capital expenditure 92,765
C. Revenue receipts 602,935
D. Recoveries of loans by the government 4,497
E. Non-debt creating capital receipts 10,165
Fiscal deficit = (A + B) – (C + D + E) 1,33,287

In other words,

The fiscal deficit equals a sum of total of revenue expenditure and capital expenditure minus
the sum total of the revenue receipts and the recovery of loan by government and the non-
debt creating capital receipts.

Fiscal deficit = Total expenditure – Total receipts (Except borrowings )

= Total expenditure – (Revenue receipts + Non-debt creating capitalreceipts)

Gross Fiscal Deficit and Net Fiscal Deficit

Fiscal deficit as defined above is known as gross fiscal deficit. The net fiscal deficit is the
difference between gross fiscal deficit and net lending by the government (net lending equals
to gross loans extended by the government minus recoveries of loans).

The difference can be illustrated as :

Financial statement (₹ in crore)

A. Gross fiscal deficit 1,33,287
B. Gross loans extended by the government 1,614
C. Recoveries of loans 4,497
Fiscal deficit = (A + B) – (C + D + E) 1,27,176

Significance of Fiscal Deficit

Fiscal deficit is the barometer of the financial health of the government.

A small amount of fiscal deficit is considered good for economic growth, especially if it is
financed by printing of new currency.

Fiscal deficit implies that the injections by the government are more than the leakage from
the circular flow of income. If an economy is in a position to absorb additional money, it
would stimulate aggregate demand. As the result, level of employment and income will
increase.

But a large amount of fiscal deficit proves counter-productive and acts as a check on growth.
A large part of it is to be financed by borrowing. Some of the adverse effects may be briefly
stated as follows:

(i) Rise in rate of interest and adverse effects on private investment: When government
borrows large amount of money from the market, rates of interest go up in
23
 consequence private investments suffers.
(ii) Increase in public debt with increase in borrowings: The burden of public debt keep
on increasing. Interest payments keep increasing at compound rates. As a result,
government’s ability to undertake development activities seriously suffers.
(iii) Inflationary pressures: High fiscal deficits cause inflationary pressures. Once
inflation set in, non development expenditure of the government begins to grow fast.
In view of this consideration, it is important to keep fiscal deficit under check.

22.9 Let Us Sum Up

Public finance is a study of the financial aspects of the government. It is similar to private
Finance in as much as both of these have broadly the same objectives, i.e.,
satisfaction of human wants. But on many points, public finance and private finance
differ from each other.Public revenue consists of money receipt of the government.
These receipts are general divided into two groups, viz., (i) current receipts (or
revenue receipt), and (ii) capital receipts.Among the revenue receipts tax is
constituted the most important sources of public revenue Non-tax revenue is collected
from varied sources.Taxes are of different kind these can be classified as(i) direct and
indirect tax, (ii) progressive,proportional,regressive and digressive taxes.Each kind of
tax has its own merits and demerits.Public expenditure refers to the expenses incurred
by government in the course of performing its various duties.Public expenditure is
variously classified as (i) revenue expenditure and capital expenditure, (ii)
developmental expenditure and non-development expenditure.Expenditure by the
government has been regularly increasing in all the countries throughout the world. it
is indicative of the fact that the governments have been assuming more and more
responsibilities their sphere of activities has been expanding.The government borrow
money from different sources to meet their budgetary needs.Like a government, and
individual also borrows to meet his/her financial need however there are some
fundamental differences between public debt and private debt.The government can
borrow from different sources both internal and external. Borrowing from domestic
sources results in internal debt,while borrowing from external sources results in
external debt.
22.10 Key Words

Fiscal policy is defined as the policy under which a government uses the instruments of
taxation, public expenditure and public borrowing to achieve various objectives of economic
policy
Current receipts (also called revenue received) are those sources of inflows of money which
do not create any liability of repayment on the government.
Tax is a compulsory contribution levied on the wealth of an individual by the government of
a country without reference to any benefit.
Direct tax is a tax which is expected to be paid out of the income or wealth of the same
person on whom it has been imposed.
Indirect tax is a tax whose burden can be shifted to another person. The person who is made

24
responsible to pay the tax is expected to charge the amount of tax from another person.
Regressive tax is one in which the rate of taxation decreases as the taxpayer’s income
increases.
Public expenditure refers to the expenses of the public authorities—Central Government,
State Government and Local Government—either in protecting the citizens or in promoting
the economic social welfare.
Revenue budget contains the details of revenue expenditure and revenue receipts of the
government. These are in the nature of current expenditure and current income of the
government.
Capital budget is a statement of capital receipts and capital expenditure of the government.

22.11 Terminal Questions

1. Discuss the important sources of revenue receipts and capital receipts of the
government of India.
2. Distinguish between direct and indirect taxes.Which of these are more important in
India’s tax structure.
3. What do you mean by public expenditure?Describe its constituents?
4. Describe the important heads of expenditure of the Government of India.
5. Examine the reasons responsible for rapid growth of public expenditure in recent
years.
6. Explain the importance of public expenditure in an economy. Is increasing public
expenditure a necessary good or evil?
7. Identify the different sources of public borrowings.

25
Unit 23 FISCAL FEDERALISM

Structure

23.0 Objectives
23.1 Introduction
23.2 Main Aspects of Fiscal Federalism
23.3 Role of government in federal federalism
23.4 Economic Rationale for Central-State & Transfer of Grants
23.5 Fiscal Decentralization and Local Governance
23.5.1 Features of Well-Functioning Intergovernmental System in India
23.5.2 Importance of Fiscal Decentralization
23.5.3 Fiscal Decentralization in India
23.5.4 Criteria for Fiscal Devolution
23.6 Emerging Issues and Challenges in India’s Fiscal Federalism
23.7 Redefining the Fiscal Architecture in India
23.8 Let Us Sum Up
23.9 Key Words
23.10 Terminal Questions

23.0 Objectives
After studying this chapter, you will be able to:
• Explain main aspects of fiscal federalism
• Identify role of Government in federal economics
• Describe economic rationale for transfer of grants
• Discuss fiscal decentralization in local governance
• State issues and challenges in India’s fiscal federalism
• Redefine the fiscal architecture in India

23.1 Introduction

Fiscalfederalismisdefinedasfinancialrelationsbetweenunitsofgovernmentsinafederalgovernmen
tsystem.Fiscalfederalismispartofbroaderpublicfinancediscipline.WallaceE.Oakes,in1999,define
ditas,“FiscalFederalismisconcernedwithunderstandingwhichfunctionsandinstrumentsarebestcen
tralisedandwhicharebestplacedinthesphereofdecentralisedlevelsofgovernment.Thisconceptappli
estoallformsofgovernment:unitary,federalandconfederal”.Fiscalfederalismdealswiththedivision
ofgovernmentalfunctionsandfinancialrelationsamonglevelsofgovernment.Musgravearguedthatf
ederalgovernmentsystemshavetheabilitytosolvemanyoftheissueslocalgovernmentsfacebyprovidi
ngthebalanceandstabilityneededtoovercomedisruptiveissueslikeunevendistributionofwealthandl
ackofwidelyavailableresources.Musgravefurthertheorizedthatfederalgovernmentsshouldmanage
anation'smoneyfromthetopand give it to states,who can distribute it locally as needed.
Thetheoryoffiscalfederalismassumesthatafederalsystemofgovernmentcanbeefficientandeffecti
veatsolvingproblemsgovernmentsfacetoday,suchasdistributionofincome,efficientandeffectivea
llocationofresources,andeconomicstability.Economicstabilityanddistributionofincomecanbedo
 nebyfederalgovernmentbecauseofitsflexibilityindealingwiththeseproblems.Becausestatesandlo
calitiesarenotequalintheirincome,federalgovernmentinterventionisneeded.Allocationofresource
scanbedoneeffectivelybystatesandlocalgovernments.Musgravearguedthatthefederalorcentralgo
vernmentshouldberesponsiblefortheeconomicstabilizationandincomeredistributionbutthealloca
tionofresources should bethe responsibility of stateandlocalgovernments.
Afederationissimplyamultilevelsystemofgovernmentinwhichdifferentlevelsofgovernmentexist.
Eachof whichhassomeindependentauthoritytomake
economicdecisionswithinitsjurisdiction.Byeconomicdecisions,weincludeavarietyofthings.Gov
ernmentscanacquireresourcestoprovidepublicgoodsandservices.Expendituresforthesepurposes
canbeofacurrentnature(e.g.,hiringemployees,purchasingmaterials)andacapitalnature(e.g.,buildi
ngs,infrastructure).Governmentscanraiserevenuesinordertofinanceservicesprovidedbytheprivat
eornon-
profitsectors,suchashospitals,universities,orinsurance.Theycanarrangetohaveresourcesredistrib
utedamonghouseholdsintheeconomy.Theycanintroduce regulations in the markets of the
privatesector so as to influence resource
allocationthere.Theycaninterferewiththepricingmechanismasanalternativewayofachievingreso
urceallocationorredistributiveeffects,suchasthroughsubsidizingortaxingcertainactivities.Theyc
analsoattempttoinfluencetheaggregateamountofactivitythatoccursintheeconomyboththroughbu
dgetaryactionsandthroughchangesintheamountofmoneyandcreditcirculating in the economy.

23.2 Mainaspects of fiscalfederalism:

Division of Functions:
ThefiscalpowersandfunctionalresponsibilitiesinIndiahavebeendividedbetweentheCentralandStat
egovernmentfollowingtheprinciplesoffederalfinance.ThedivisionoffunctionsisspecifiedintheSev
enthScheduleoftheConstitutioninthreelistsviztheUnionList, the StateListandthe Concurrent List.

TheUnionListcontains97subjectsofnationalimportance,suchasdefence,railways,nationalhighwa
ys,navigation,atomicenergy,andpostsandtelegraphs.66itemsofStateandlocalinterest,suchaslawa
ndorder,publichealth,agriculture,irrigation,power,ruralandcommunitydevelopment,etc.havebee
nentrustedtotheStategovernments.47itemssuchasindustrialandcommercialmonopolies,economi
candsocialplanning,labourwelfareandjustice,etc.havebeenenumeratedintheConcurrentList.The
concurrentlistisoneinwhichbothstateandthecentrecanmakelegislations.However,incaseofaconfl
ictortie,federallawsprevail.

Revenue Powers ofthe Centre:

TheCentralgovernmenthasbeengivenpowersinrespectoftaxesonincomeotherthanagriculturalinc
ome,customsduties,and.excisedutiesontobaccoandothergoodsmanufacturedorproducedinIndia,
corporation,tax,taxesoncapitalvalues,estatedutyinrespectofproperty other than
agriculturalland,terminaltaxeson goods or railwaypassengerscarried by railway,
seaorair,taxesotherthan stamp duties on transactions in
stockexchangesandfutures,markets,stampsdutyinrespectofland,etc.;taxesonsaleorpurchaseofne
wspapersandonadvertisementspublishedtherein;andsale,purchaseandconsignmentofgoodsinvol
vinginter-Statetradeorcommerce.Infact,theCentralgovernmentdoesnotgetrevenuefrom all
theabove taxes.
 Revenue Powers oftheState: TheStategovernmentshavebeengivenexclusive
taxpowersinrespectoflandrevenue;taxesonagriculturalincome;dutiesinrespectofsuccessiontoagr
iculturalland;estatedutyinrespectofagriculturalland;taxesonlandandbuildings;excisedutiesongo
odscontainingalcoholic liquors forhumanconsumption; opium,Indian hemp and othernarcotic
drugs;taxesontheentryofgoodsintolocalareas;taxesonthesaleorpurchaseofgoodsotherthannewsp
apers;taxesonvehicles,tolls;taxesonprofessions,trades,callingsandemployment;capitationtaxes,t
axesonluxuriesincludingtaxesonentertainment,amusements,bettingandgambling.

Divisionof BorrowingPowers:
TheborrowingpowershavealsobeenclearlymentionedintheConstitution.UnderArticle292,thecen
tralgovernmentisempoweredtoborrowfundsfromwithinandoutsidethecountryasperthelimitsimp
osedbytheParliament.AccordingtoArticle293(3),theStatescanborrowfundswithintheCountry.Ar
ticle293(2)empowerstheCentretoprovideloanstoStatesubjectto conditions laid down by
Parliament.

Fiscal Imbalances:
Fiscalimbalanceisamismatchintherevenuepowersandexpenditureresponsibilitiesofagovernment.
Whentherevenuepowersaredividedbetweentwoormoretiersofgovernmentinafederation,ingeneral,t
heCentralgovernmentisentrustedwithmorefinancialresources.Thisisbecauseduetoitsfunctionalres
ponsibilitieslikedefence,spaceresearch,etc.thereisalways agreater demandforits
expenditurerequirement vis-a-vis its revenue resources.

Thisistosaysomeofitsfunctionsarerequiredtobedischargedmoreinthenationalinterestthan the
interest of aregional dimension, whichwarrants greater revenue powers for it.

Thus,thefiscalimbalanceamongthestateswouldarisebecauseofinadequaterevenueresourcesinco
mparisontotheirrespectiveexpenditurecommitments.Suchnon-
correspondencebetweentherevenueresourcesandexpenditurerequirementsamongthestatesin a
federation is known asfiscalimbalance.

23.3 Roleof GovernmentinFederal Economies

The instruments
oractivitiesthatgovernmentsincorporatetoundertaketheireconomicactivitiesinclude
thefollowing:
Expenditures on goodsand services:
Governmentsmaypurchaselabour,capital,goods,andservicesfromtheprivatesectorinordertoprovi
degoodsandservicestotheirconstituents.Suchmajorexpenditurecategoriesasdefencespending,tran
sportation,schools,andhospitalsareincludedintheirmenuofgoodsandservicesexpenditures.Insom
ecases,thepublicsectoractuallyproducesthegoodsorservices.Inothers,itmerelyfinancestheirprovis
ionbyprivateproducersorthenon-profitsector.Transfers to individuals or households.
Government spending alsoincludestransferpayments:
Thesecanbeprovidedtohouseholdsintheeconomy,forexample,intheformofwelfarepayments,paym
entsfordisability,andpaymentstotheelderly.Thesetransfersmightbe
administeredthroughthetaxsystemorthroughanagencyresponsiblefordeliveringthemtotheir
intendedrecipients.
Subsidies to firms:
Aparticularformoftransferisasubsidytofirmsintheprivatesector,whosepurposeistypicallytoassistt
hefirm’sparticipationintheprivatesectorinwaysthatfacilitategovernmentobjectives.
Transfers to other levels of government:
Inafederation,transferscanalsobefromonelevelofgovernmenttoanother.Mostcommonly,intergove
rnmentaltransfersgofromhigher-leveltolower-levelgovernments,butinsomecases they go
theother way.
Taxation: Governments can, and do, useawideassortmentoftaxes to raise
revenues,suchasindividualandcorporateincometaxes,generalsalestaxes,payrolltaxes,excisetaxes,
importandexportduties,andpropertyandwealthtaxes,tonamethemainones.Differentlevelsofgover
nmentmay have access to differenttaxesand may sharesome taxbases.
Userfees: Revenues mayberaisedfromcharges that arerelated to servicesprovided.Examples
includewater,garbage,andsewagecharges;roadtolls;licensesofvarioussortsimposedonindividuals
andlegislationofalower-levelgovernment.Itmayalsobeabletoimposemandatesonthelowerlevel of
government, forcing it to providecertaintypes of services for its constituents.

Publiccorporations: Governmentsmayalsoengagedirectlyinbusiness-
likeactivities,operatingpublicfirmsthatproducegoodsandservicesforsaletothepublicinindustriesth
atmightbeconsideredofnationalimportanceorinwhichitisfeltthatprivatecompetitivemarketswould
notprevail.Someexamplesofsuchindustriesincludetransportation,communications,utilities,andair
craftproduction.
Theultimateconcerninstudyingtheeconomicsoffederationsishowthesevariouspublic-
sectoractivitiesaretobedividedamong,orassignedto,governments.Whichonesshouldbedecentrali
zedtolowerlevels?Whichonesshouldberetainedatthecenter?Whichactivitiesshouldbejointlyunde
rtaken?Howshouldthedivisionofresponsibilitiesbewrittenintotheconstitution?Whatinfluence,ifa
ny,shouldonelevelofgovernmentbe
abletoexertonotherlevels?Whatinstitutionalarrangementsshouldbeusedtofacilitatetheinteraction
amonglevelsofgovernment?Thesearethesortsofquestionsthatencompasswhatinfiscalfederalisma
rereferredtoastheassignmentproblem–
theassignmentoftaxation,expenditure,andregulatoryresponsibilitiestovariouslevelsofgovernme
nt–andthefiscalarrangements–
thedesignofintergovernmentalfiscalrelations.Thekeyissuehereconcernstheoptimaldegreeofdece
ntralization ofvarious public-sectordecisions.

Check Your Progress A

1. Write four main aspects of Fiscal Federalism.

………………………………………………………………………………………………
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2. Describe the role of Government in Federal Economics.
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 ………………………………………………………………………………………………
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3. What do you mean by Fiscal Federalism?
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23.4Economic Rationale for Central-State Transfer of Grants

We canidentifyfive broadeconomic argumentsforcentral-state
transferseachofwhichisbasedoneitherefficiencyorequity,andeach ofwhichmay
applytovaryingdegreesinactualfederal economies.

i. The fiscal gap: Animbalancebetweentherevenue-

raisingabilityofsubnationalgovernmentsandtheirexpenditureresponsibilities(the"verticalimba
lance") might arisefor
tworeasons.First,theremaybe(ofteninappropriate)assignmentoftaxingandspendingresponsibili
tiessuchthatexpenditureneedsofsubnationalgovernmentsexceedtheirrevenuemeans.Second,m
anytaxesaremoreefficientlycollectedatthecentrallevelresponsibilitiestoavoidtaxcompetitionan
dinterstatetax distortions, so transfersarenecessary to enablelocal levels to carry out
theirexpenditureresponsibilities.

ii. Fiscal inequity:

Acountrywhichvalueshorizontalequity(i.e.,theequaltreatmentofallcitizensnationwide)willne
edtocorrectthefiscalinequitywhichnaturallyarisesinadecentralizedcountry.Subnationalgover
nments with theirown expenditureandtaxation responsibilities willbe
abletoprovidetheirresidentsdifferentlevelsofservicesforthesamefiscaleffortowingtotheirdiffe
ringfiscalcapacities.Ifdesired,thesedifferencesmaybereducedoreliminatedifthetransferstoeac
hjurisdictiondependuponitstaxcapacityrelativetoothers,andupontherelativeneed for
andcostof providing public services.

iii. Fiscalinefficiency:
Theargumentforsuchtransfersisreinforcedbythefactthatthesamedifferentialswhichgiveriseto
fiscalinequity also cause fiscal inefficiency.

iv. Interstate spillovers:

Thisisthetraditionalargumentformatchingconditionalgrants.Normally,subnationalgovernme
nts will not havetheproper incentive toprovidethecorrectlevelsof
serviceswhichyieldspilloveracrossjurisdictions.Intheory,asystemofmatchinggrantsbasedont
heexpendituresgivingrisetothespilloverswillprovidetheincentivetoincreaseexpenditures.Inpr
actice,theextentofthespillover willbedifficulttomeasuresothecorrectmatchingrateto use will
be somewhatarbitrary.

v. Fiscal harmonization:
Totheextentthatthecentralgovernmentisinterestedinredistributionasagoal,thereisanationalinte
restinredistributionthatoccursviatheprovisionofpublicservicesbythesubnationalgovernments.
 Expenditureharmonizationcanbeaccomplishedbytheuseof(non-
matching)conditionalgrants,providedtheconditionsreflectnationalefficiencyandequityconcer
ns,andwherethereisafinancialpenaltyassociatedwithfailuretocomplywithanyoftheconditions.I
nchoosingsuchpoliciestherewillalwaysbeatrade-
offbetweenuniformity,whichmayencouragethefreeflowofgoodsandfactors,anddecentralizatio
nwhichmayencourage innovation, efficiencyandaccountability.

Revenue Sharing
Manycountriesattempttoachievevariousoftheobjectivesascribedabovetotransfersthroughsystem
svariouslydescribedas"taxsharing"or"revenuesharing."Whilethereareawidevarietyofsuchsyste
ms,mostofthem-perhapsmostmarkedlyinthetransitionalcountries-
sufferfromseveralcommonproblems.First,iftheyarepartial,thatis,donotapplytoallnationaltaxesb
utonlytoasubsetofsuchtaxes,theymaybiasnationaltaxpolicy.Second,if-asisoftenthecase-
theysharetherevenuesfromorigin-
based(production)taxestothejurisdictionsfromwhichtherevenuesarecollected,theybreakthedesir
ablelinkbetweenbenefitsandcostsatthelocallevelandhencereduceaccountabilityandtheefficiency
ofdecentralization.Third,sinceinsuchsystemstaxratesareinvariablysetbythecentralgovernment,a
ndinadditionsincethesharingrateisoftenapplieduniformlythroughoutthecountry,onceagaintheac
countabilitylinkisbrokenandsubnationalgovernmentshavenoincentive to ensurethat the
amountand pattern oftheir spending is efficient. Inaddition, if,
asinsomeofthetransitionalcountries,suchtaxesarecollectedbylocalgovernmentsandthensupposed
lysharedwithnationalgovernments-
andinthiscaseperhapsespeciallyifthesharingratesarehigher(moreflowsupwards)forricherareas-
eitheranundesirabledisincentiveforcollectioneffortiscreatedor,moreusually,thetemptationto"co
okthebooks"islikelytobeoverwhelming.

Criteria for the designof intergovernmental fiscal arrangements

• Autonomy
Subnationalgovernmentsshouldhavecompleteindependenceandflexibilityinsettingpriori
ties,andshouldnotbeconstrainedbythecategoricalstructureofprogramsanduncertaintyass
ociated with decisionmaking at the center.Tax basesharing—
allowingsubnationalgovernmentstointroducetheirowntaxratesoncentralbases,formula-
basedrevenue sharing, orblock grants—is consistent with this objective.
• Revenue adequacy
Subnationalgovernmentsshouldhaveadequaterevenuestodischargedesignatedresponsibi
lities.
• Equity
Allocatedfundsshouldvarydirectlywithfiscalneedfactorsandinverselywiththetaxablecap
acity ofeachprovince.
• Predictability
Thegrantmechanismshouldensurepredictabilityofsubnationalgovernments’sharesby
publishing five-yearprojections of funding availability.
• Efficiency
Thegrantdesignshouldbeneutralwithrespecttosubnationalgovernmentchoicesofresource
allocationtodifferentsectorsordifferenttypesofactivity.Thecurrentsystemoftransfersinco
 untriessuchasIndonesiaandSriLankatofinancelowerlevelpublicsectorwagescontravenest
his criterion.
• Simplicity
Thesubnationalgovernment’sallocationshouldbebasedonobjectivefactorsoverwhichindi
vidualunitshavelittlecontrol.Theformulashouldbeeasytocomprehend
sothat"grantsmanship"isnotrewarded,asappearstooccurwithplanassistanceinIndiaandPa
kistan.
• Incentive
Theproposeddesignshouldprovideincentivesforsoundfiscalmanagementanddiscouragei
nefficientpractices.Thereshouldbenospecifictransferstofinancethedeficits of
subnationalgovernments.
• Safeguard of grantor’s objectives
Thegrantdesignshouldensurethatcertainwell-
definedobjectivesofthegrantorareproperlyadheredtobythegrantrecipients.Thisisaccompl
ishedbypropermonitoring,jointprogressreviews,andprovidingtechnicalassistance,orbyd
esigningaselectivematchingtransfer program.

Thevariouscriteriaspecifiedabovecouldbeinconflictwitheachotherandthereforeagrantormay
have to assign priorities to variousfactors incomparing policy alternatives.

23.5FiscalDecentralizationand LocalGovernance

Infederalstates,fiscaldecentralizationmeansthatrevenueandexpenditureresponsibilities(therightt
oimposeandcollecttaxandindependentlydeterminethefocusareasofexpenses)aretransferredfromt
hefederaltotheregionalandlocallevels.Fiscalfederalismisamoregeneralconceptthat
representsaverticalfinancial
structureofthepublicsector(Oates,1999),withrevenueandexpenditureassignmentamongdifferent
levelsofgovernmentandasystem
ofintergovernmentaltransfers.Thus,fiscaldecentralizationisamechanismoffiscalfederalismandca
nbeconsideredasanecessaryconditionofthelatterbecausethereisnopointinaverticalfinancialstruct
ureofthepublicsectorwithoutacertainlevelofdecentralization(in this
case,allresources,authorityand responsibilities areconcentratedat the federal level).
Howacountryorganisesitsfinances,formsthebasisforhowlocalauthoritiesgoverntheircities,towns
andvillages.Throughfiscaldecentralisation,localgovernmentshavemoreauthoritytodecidehowan
dwheretospendtheirresources.Thisenablesthemtobemoreresponsive to citizens’ needs.

Forsuccessfuldecentralisation,nationalgovernmentsneedtodesignandsuperviseclearfiscalarrang
ementsthatsupportlocalservicedelivery.Atthesametime,localauthoritiesarechallengedtostrength
entheirfinancialcapacitiesandusetheirlimitedresourcesinaneffectiveandefficientway.

Theworldwidetrendtowardsdecentralizationhasbeenaccompanied by
animateddiscussionsaboutitsbenefitsandcosts.Perceivedbenefitsrangefrombetterservicedeliver
ytopopularinvolvementingovernancetorevenuemobilization.Theperceivedcostsincludereduced
centralabilitytoimplementmacroeconomicstabilizationprogramsandefficiencylossesbecauseofp
oorlocalcapacity.Regardlessofpossiblecosts,mostcountrieshaveplacedthestrengtheningoflocalg
overnments–ordecentralization–
ontheirdevelopmentpolicyagenda.Actiontoendowlocalgovernmentswithsignificanttaxingpower
sandincreasedexpenditureautonomyhas,however,notmatchedplans.Infact,theshareofexpenditur
eofsub-nationalgovernments in developing countrieshas not increased in the past two decades.

GivenIndia’ssizeanddiversity,itisnoteasytoachieveeffectiverepresentation.Butfromthefirstcentr
alinitiativetoestablishlocal governments in 1957to
the73rdConstitutionalAmendmentin1993,therehavebeenadvancesinthisdirection.Therehaveals
obeen,ateverystep,administrativeandlegalproblems,orincompleteunderstandingoftheconceptsin
volved.Overall,decentralizationinIndiaisunfinished:ithasputlocalgovernmentsinplacebutnotend
owed them with themeans to deliverresults.

23.5.1 Features of Well-FunctioningIntergovernmentalSystemin India

Theeffectivenessofdecentralizationrequiresthecalibrationoftheadministrative,politicalandfiscal
dimensions.Withoutpoliticaldecentralization,participatorydecision-makingisnotpossible.
Administrativedecentralization is necessary to
implementpoliticaldecisions,andanimportantprecondition for fiscaldecentralization.Efficiency
in the delivery ofpublic
servicesdependsonadministrativeefficiencyandaccountability.Toassessrurallocalgovernmentfin
ancein India,itisusefultocomparethesystem withcurrent thinkingon awell-
functioningintergovernmentalfiscalsystem.

1. Addressingallkeycomponentsofadecentralizedfiscalsystem:Grampanchayatcouncilsareelect
ed,thegrampanchayatsaresmallenoughtobecloseto thepeople,andthereissome
localtaxingpower.Thelowexpenditureofgrampanchayatstogetherwithlimitedcontrolhaveunder
mined institutions–suchas the gram sabha –set up to enablelocal participation.

2. Financeshouldfollowfunction:Thestategovernmentsmaytreatthe29expenditurefunctionsofl
ocalgovernmentnamedintheConstitutionasexclusiveorconcurrentlocalgovernmentfunctions.Bo
thKarnatakaandKeralahavechosenthelatter.Tocomplicatematters,expendituresforcentralscheme
sandforMPdevelopmentprojectsaremadeoutsidethelocalgovernmentsystem.Thisconfusestheser
vicedeliveryroleoflocal governmentsandthe estimation of theirfinancingrequirements.

3. Strongabilitytomonitorandevaluatetheintergovernmentalfiscalsystem:Bothstatesprovidefo
rperiodicstatefinancecommissions,butthesehaveinadequatestaff.Also,neitherstate has adata
systemthat helps track local government finances.

4. Astructurethattreatstheurbanandruralsectorsdifferently:TheIndiansystemdoesdifferentiat
ebetweentheurbanandrurallocalgovernmentsinitssystemoffiscalfederalism,and the statesappear
to treatthese sectors differently.

5. Assignmentofrevenuepowerstolocalgovernments:Thegrampanchayatshaveindependentrev
enueraisingpowersforlandandpropertytaxesforanumberofminorlevies,andforanumberofusercha
rges.Butthelocalgovernmentsinthetwo statesdonotusetheirrate-
settingpowersfully.Propertytaxcollectionratesarenothigh,andinsomecases,collectioncostsappro
achedrevenue levels.

6. Higher-
levelgovernmentsfollowingtherulestheymakeforrurallocalgovernments:Bothstatesfall short
in this aspect.Inparticular, thefailureof thestatetreasuries to release full andtimely funds
forintergovernmentaltransferscompromiseslocalgovernmentfiscaloperations.

7. Asimplesystem:TheIndiansystemofrurallocalgovernmentfinancesisanythingbutsimple.Thein
tergovernmentaltransferssysteminKarnatakacomprisesover400differentgrantstolocalgovernme
nts,eachwithadifferent
setofearmarksandmanagement.Theresultisthedifficultyofunderstandingthesystemandholdingeit
herlocalorhigher-levelgovernmentaccountableforthe effectiveness of these programs.

8. Intergovernmentaltransferstomatchclearlyspecifiedobjectives:Thesystemofintergovernme
ntaltransfersfallsshortofthisgoal,atleast
inKarnataka.ThegrampanchayatsinKeralareceiveblockgrantsandaregivensomediscretionindeci
dinghowthemoneyisspent.Buttheamountallocatedtothegrampanchayatsisonlyaboutfourpercent
oftotaltransfers to rurallocalgovernments.

9. Policiesthatconsiderimpactonallthreelevelsofgovernment:ThestatedeficitsinbothKeralaand
Karnatakahaveledtoexpenditurereductionprograms,whichhavebeentranslatedinto
reducedintergovernmentaltransfers to rural local governments.

10.Hardbudgetconstraintonlocalgovernments:Thedatasetgatheredforthisstudyshowthat most
gram panchayats in Karnatakaand Keralarun deficits on currentaccount.

11.Recognizingthechangingnatureofsystems:TheIndiansystemhasbothunionandstatefinancec
ommissionschargedwithperiodicreviewoftheexistingsystem.Thoughthecentral
financecommissionshavehadanimportantimpactoncentral-
statefiscalrelations,thestatefinancecommission(atleast in Karnataka) has been generally
ignored.

Policyagenda to move ahead to a decentralizedfiscalsystem

Indiahasa historicalcommitment to
ruraldecentralization,andPanchayatRajInstitutionsarestronglyinplace.Butpanchayatshavenotliv
eduptotheirpotentialbecausefiscaldecentralizationremainslargelyincomplete. What, then, is the
wayahead?

1. Clarifyexpenditureassignments:Expenditureassignmentsbetweenstateandpanchayatsneedto
beclarifiedbyunbundlingthegeneralsubjectsprescribedintheConstitution,andassigningresponsib
ilitiesatamoredetailedlevelofactivityandsub-
activity.ExpenditureassignmentsamongthethreetiersofPRIsalsoneedtobeclarifiedforexternalitie
s,economicsofscaleandthedemandfor
localcontrol.TheIndiansituationsuggeststhatthemostpracticable option is to acceptthat districts
and blocks areessentiallydeconcentratedagenciesofthestategovernment,
andtoconcentrateforthepresent on empowering villagepanchayats.

2. Consolidateschemes:Theassignmentsystemcanberationalizedbymappingactivitybetweenthe
stategovernmentandrurallocalgovernments;andamongthethreetiersofpanchayats.Equallyimport
antistheautonomyofpanchayatstodesignandimplementassignedfunctions.

3. Augmentpanchayatresources:Someschemes,suchascentrallysponsoredschemes,havetobeco
nsolidatedintountiedfundsforgrampanchayats.Theownrevenuesofgrampanchayatscan
beimproved through systemic changes in both policiesandinstitutionsso thatcapacity–
todesign,administerandenforceexistinggrampanchayattaxes–
isenhanced.Otherprioritiesareimprovingcollectionefficiencyandthepolicyenvironmentforprope
rtytax,modernizing the valuation system, and broadeningthe taxbase.

4. Redesigntransfers:Thefinancecommissionsneedtobeprofessionalizedtoevolvetheappropriat
emethodofdeterminingtherequirementsofdifferenttypesandtiersoflocalgovernments.Unbundlin
gthetransfersystemfromscheme-
basedtransferswouldhelplocalgovernmentsmakeallocationsaccordingtotheirpriorities.Criteria-
basedallocationisnecessaryevenatthewardlevel.Aminimumstandardofpublicservicequalitycanb
eachievedby ensuring that transfersequalize thefinancialcapacities of local bodies.

5. Createinformationsystemonlocalfinances:Itiscrucialtocompileimportanteconomicanddemo
graphicinformationanddataforvariablesattheGPlevel.Subsequently,astandardsystemofbookkee
pingbythepanchayatshastobeevolved.Capacitydevelopmentisessentialforthe collection of
comparableinformation using informalconcepts anddefinitions.

6. Improveaccountability:ThePRIs’accountingandbudgetingsystemneedsoverhauling.Theinter
nalmanagementstructureofgrampanchayatsshouldberedesigned,andthelineofcontrolofthepanch
ayatbureaucracy,especiallythatofthosefromthetransferreddepartments,madeunambiguous.Final
ly,positivemechanismsfordownwardaccountabilityintheKeralaPanchayatRajsystem–
therighttoinformation,overseeingfunctionsofgramsabhas,socialaudit,transparentmethodofbenef
iciaryselection,andthecitizen’scharter–
needtoberetainedandencouraged.Thesefeaturescanbeusedtoevaluatetheperformanceofpanchaya
tsand link it to a system of incentivesand disincentives
23.5.2 Importanceof FiscalDecentralisation

Thefiscaldecentralisationholdsmeritsforseveralreasonsandsomeofthereasonsareasfollows:
i) Promotion of Economic
Value:Fiscaldecentralisationpromoteseconomicvalue.Thefiscalfederalismli
kethepoliticalconceptofdemocracyisconsideredtobeanoptimalinstitutionalarr
angement.Ithastheprovisionofpublicserviceswithcostminimisationandwelfar
emaximisation.It alsocombinestheadvantagesofdecentralisationwith the
benefitsfromeconomiesof scale.
ii) Good Governance:
Fiscaldecentralisationleadstogoodgovernance,byensuringfiscalresponsibilit
ytothelowerlevelofgovernmentthatis.localself-
government.Governancevaluesincluderesponsivenessandaccountability,div
ersityandpoliticalparticipation.Decentralisationplacesallocationdecisionmak
ingclosetothepeople.Asaresult,thisplacesgreaterresponsiveness to
localofficials and greater accountability to citizens.
iii) Political Participation:
Fiscaldecentralisationwouldenhancepoliticalparticipationatthelocallevel.Thi
shasthepotentialtoenhancedemocraticvalueandpoliticalstabilityatthelocallev
el.Itprovidesaforumforlocaldebateaboutlocalprioritiesandcanbeaprovinggro
undforfuturepoliticalleaders.Itimpartsfinancialeducation to
thelocalleadersat thegrassroots levels.
iv) Reduction in
Poverty:Thefiscaldecentralisationissupposedtoreducepovertythroughthenee
dbasedanddemand-
drivenapproachofutilisationofresourcesthroughparticipationoflocalsatthegra
ssroots.ThecountieslikeChinaandIndiaareverymuch in thefavour
offiscaldecentralisationforpovertyreduction.
v) Effective Use of Funds:
Withfiscaldecentralisation,fundsareeffectivelyusedasa)theyaredemand-
drivenandthereishighdegreeoflocalinvolvement;b)theiroperations are
transparent and accountable; c) they arecarefullytargetedtolow-income
group; and d) free fromofficial red tapism.
vi) Government closer to people:
AccordingtoStigler,fiscaldecentralisationbringsgovernmentclosertothepeopl
e.However,arepresentativegovernmentfunctionsinbettermanner,whenitisclo
setothepeople.Thetheoreticalperceptiveofthisargumentgoeslikethis“eachpub
licserviceshouldbeprovidedbythejurisdictionhavingcontrolovertheminimum
geographicalareathatwouldinternalisebenefits and costs of such provision.”
vii) Power to Pursue Agenda:
Inafiscallydecentralisedsystemwherecitizens’participationindecisionmaking
is encouraged,locallyelectedgovernmentshavethepowertopursuethe agenda
mandated by voters.

23.5.3 FiscalDecentralisation inIndia

 In India, fiscal decentralisation assumed importance after 73rd and 74th Constitutional
Amendments, which envisaged the devolution of functions, functionaries and funds to the local
self-government institutions. Before 1992, that is prior to the passing of the 73rd and 74th
Constitutional Amendment, several committees and commission recommended for the fiscal
decentralisation. Let us discuss in detail the recommendations of various committees and
constitutional measures undertaken for fiscal decentralisation in India.

Committees

Variouscommitteesandcommissionswereconstitutedforsuggestingmeasuresforestablishingfina
ncialautonomyofthePanchayatsandmunicipalities.Inthelightofthesesuggestions,theStateshavem
adeappropriateprovisionsintheirPanchayatRajActs.Letusnowreviewtherecommendationsofvari
ouscommitteesappointedfromtimetotimeaboutdecentralisation of finances to local self
government institutions.
i) Finance EnquiryCommittee:
In1951,theLocalFinanceEnquiryCommitteestudiedthisproblemandrecomme
ndedunconditionalassignmentof15%oflandrevenuetoberaisedinthepanchaya
tareaandtheproceedsofsurchargeleviedonthetransferofimmovablepropertytot
hePanchayats.Panchayatswerealsotobeempoweredtoraisetheirownresources
bylevyingcertaintaxesintheirterritories.
ii) Taxation enquirycommittee:
In1954,theTaxationEnquiryCommitteerecommendedfor
reservingcertaintaxessuchastaxonlandandbuilding,octroi,taxonnon-
mechanicaltransport,taxonproperty,taxonprofession,taxonadvertisementoth
erthan
newspapers,theatretax,anddutyontransferofproperty,etc.forPanchayats.
iii) SanthananCommittee:
TheSanthananCommitteeformedin1963stronglyrecommendedthatitwasesse
ntialforstabilityandgrowthoflocalinstitutionstohavesubstantialandgrowingre
sources,whichwereentirelywithintheirpowertoexploitand to develop.
iv) AshokMehtacommittee: In1978,theAshokMehtaCommittee
recommendedthatbesidesgovernmentsupport,panchayatsshouldmobiliseeno
ughresourcesoftheirown,asnodemocraticinstitutioncancontinuetomaintainits
operationalviability by depending upon externalresources.
v) SinghviCommittee:
In1966,theSinghviCommitteeamongothers,suggestedpatternofcompulsorya
ndoptionallevies.TheStateGovernmentsshalllevyandcollecttaxesandfeeson
behalfofPRIsandshalldisbursetothembasedontherecommendationoftheFinan
ceCommissionineachState.Inordertoensureandsafeguardthefinancialautono
myofthePRIs,theyshouldbefreedfromrelyingonthe“UntiedFunds”.Butencour
agedinsteadtotaketoinnovativeresourcemobilisationsuchasgenerationofinco
mefromentrepreneurialactivities,projectedloans,publiccontribution,tax-
sharing,tax-assignmentsand matching grantincentives for taxcollection.
Commissions

The73rdConstitutionalAmendmentprovidesfordevolutionoffunctionsandtransferoffunctionarie
sandfundstothethreetiersofPanchayatiRajInstitutions.Thearticle243GoftheConstitution
states,“Subjecttotheprovisionsof theConstitution,thelegislature
ofastate,bylaw,mayendowthepanchayatswithsuchpowersandauthorityasmaybenecessarytoenab
lethemtofunctionasinstitutionsofself-
government.Suchlawsmaycontainprovisionsforthedevolutionofpowersandresponsibilitiesupon
panchayatsattheappropriatelevel,subjecttosuchconditions as may bespecifiedtherein, with
respect to:
a) The preparation ofplans foreconomic development andsocialjustice; and

b) Theimplementationofschemesforeconomicdevelopmentandsocialjusticeasmaybe
entrusted to them including thosein relation to matters listed in the EleventhSchedule.
Article243AoftheConstitutionofIndiaembodiesthespiritofthedemocraticdecentralisation.

While280(3)(bb)oftheConstitutionenjoinstheCentralFinanceCommissiontosuggestmeasurersne
ededtoaugmenttheconsolidatedfundofastatetosupplementtheresourcesofthepanchayatsandmuni
cipalitiesonthebasisoftherecommendationsmadebytheFinanceCommission of the State.
Article243-H of theConstitution, empowers thestate legislatures to enactlaws:
a) Toauthoriseapanchayattolevy,collectandappropriatesuchtaxes,duties,tollsandfees;
b) Toassign to a panchayat,certaintaxes, duties, tolls leviedandcollected by
thestategovernment;
c) Toprovideformakinggrants-in-aidtothepanchayatsfromtheconsolidatedfundofthe
state;and
d) Toprovidefortheconstitutionofsuchfundsforpanchayatsandalsothewithdrawalof such
money therefrom; as may bespecifiedbylaw.
Article 243-Iof theConstitution envisages forthesetting up of theState Finance
Commission(SFC)onceineveryfiveyearstoreviewthefinancialpositionofthepanchayatsandtoma
kerecommendations to theGovernoras to:
i) Theprincipleswhich should govern

a) Thedistributionbetweenthestateandthepanchayatsofthenetproceedsofthetaxes,duties,t
ollsandfeesleviedbythestate.Itmaybedividedbetweenthemunderthispartandthe
allocationbetween the panchayats at all levelsof theirrespective sharesof suchproceeds;
b) Thedeterminationofthetaxes,duties,tollsandfeeswhichmaybeassignedto,orappropriat
ed by the panchayats;
c) The grants-in-aid to the panchayatsfrom theconsolidated fund of thestate

ii) The measuresneededto improvethe financialposition ofthe panchayats;

iii) AnyothermatterreferredtothefinancecommissionbytheGovernorintheinterestsofsounds
finance of the panchayats.
The74thConstitutionalAmendmentalsostatesthattheStateFinanceCommissiontoreviewthefinan
cialpositionoftheurbanlocalbodies,theirrevenueandcapitalaccountrequirements.Itrecommended
devolutionoftaxes,charges,fees,tolls,duties,sharedrevenues,inter-governmenttransfersand
grantsfromthestatetothemunicipalities.It suggestedmeasuresforthe mobilisation of
municipalresources.
Sources of localgovernmentrevenue
Thevarioussources of local governmentrevenuecanbroadlybe categorized into fourheads:

i) Local Taxation
ii) UserCharges
iii) Inter-GovernmentalTransfers
iv) CapitalFinance
i) LocalTaxation:Thelocalself-
governmentindifferentcountriesusedtoimposelocaltaxesasasourceofrevenue.However,itvariesfr
omstatetostateandregiontoregiondependingondecisionoftheconcernedstategovernment.Localta
xesaregenerallydividedintothreecategoriessuchastaxesonproperty,incomeandsaleofgoodsandse
rvices.Generally,itisobservedthathighlyprogressiveandmobiletaxbasesareassignedtothecentre.
While,userchargesandfeearefoundtobevestedwiththelocalgovernments.Therefore,decentralized
(local) levels of governmentrelymainly on taxes like propertytax, user chargesandfees.
ii) Usercharges:The localgovernmentschargesuserfeefor
theserviceswhichtheyprovidetothecitizenofthemunicipalareas.Nowdaylocalgovernmentsareun
derincreasingpressureto increase tariffs to meet thefull cost of serviceswhich they provide.
iii) IntergovernmentalTransfers: Theintergovernmentaltransferareof two types:

i) Shareofnationaltaxesdistributedeitherbyformula(i.e.percapital)orbyorigin(i.e. to
the localgovernmentwherethey are located).
ii) Thesecondisthegrants/subversionswhichareeithertargetedtosupportspecificexpe
nditure(i.e.socialbenefit,education,etc.)oruntargetedandusedatdiscretion of
localgovernment(often know
asblockgrants).Targetedgrantsareusuallyintendedtostimulateaspecifictypeofexp
enditurewhichisfavouredormandatedbynationalgovernment.Theuntaggedorunti
edgrantsthe otherhand can beused by the localgovernmentsbased on local
needs.
iv) CapitalFinance:Capitalexpenditureisnormallyfinancedfromoneormoreofthefollowing
sources:
i) Grantfrom the statebudget or national funds;
ii) Operating surplus representingexcessof currentrevenueovercurrentexpenditure
iii) Sale ofassets;
iv) Credit(loansand bonds)grantsfrom thestateis acommonphenomenon.

Sources of revenueof urbanlocal India: anoverview bodyinIndia

Some ofthe importantsources ofrevenues of theurbanlocalbodies inIndia areas follows:

i) TaxRevenue:Urbanlocalbodieslevyafewtaxesintheirareasuchasoctroi,propertytax,professio
ntax,entertainmenttax,advertisementtax,animaltax,markettax,watertax,pilgrimtax,tollonnewbri
dges,etc.Nowa-
daysmostofthestateshaveabolishedoctroitax,whichwasamajorsourceofrevenuefortheurbanlocal
bodies.Besides,theurbanlocalbodiesalsogetapercentageoftaxrevenuefromstampduty,electricityt
axandmotorvehicletaximposedby the stategovernment.
ii) Non-
TaxRevenue:Itconsistsoffees,receipts,finesorincomefromremunerativeactivitiesofurbanlocalb
odies.Thefeesiscollectedthroughvariousformsandprocessingfees.Besides,feesarecollectedfrom
parkandexhibitionground,haltingplaces,publicmarket,etc.
a) Grant-in-Aid:TheStateGovernmentgivesgrants-in-
aidtotheurbanlocalbody.Itvariesfromstatetostatedependingontherecommendationsofthe
concernstatefinancecommission.
b) Loans&Bonds:UndertherespectiveMunicipalActs,theUrbanLocalbodiesareentitledt
oraiseloansfromthestategovernments. Theloans aretobepaid
backwithinprescribedtimelimitalongwiththeinterest.Besides,thenowadaysmanymunicip
alitiesandmunicipalcorporationsaresailingbondstoenhancetheirrevenuebase.

Sources of revenues of Panchayati raj institutionsin India

PanchayatiRajInstitutions(PRIs)receivesrevenuesfromvarioussources.Theimportantsources
ofrevenue of the PRIs inIndia areasfollows:
i) RevenuefromtheCentralGovernment:EverystategetsrevenuefromtheCentralGovernmenta
spertherecommendationsoftheCentralFinanceCommission.Thisisbasedonthecriteriafixedbythe
CentralFinanceCommission.ThePRIsofstatesalsogetgrantfromthe National Planning
Commission.
ii) RevenuefromtheStateGovernment:Thetwomainsourcesofrevenuefromthestategovernmen
t to the PRIsare:
a) Allocationas per therecommendation ofthe State Finance Commission;

b) Schemespecific grant from theStatePlanning commission.

iii) InternalresourcesofRevenue:ThePRIsindifferentstateappliesvariousmechanismsforintern
alresources mobilisation. The importantsources are
a) Taxableincomeandfees

b) Non-taxableincomelikeincomefromthecommonpropertyresources,salesofgoods
andservices, borrowings, incomefrom livestocks, etc.

23.5.4 CriteriaforFiscal Devolution

Thefollowingcriteriamaybesuggestedfortheeffectivetransferofresourcestothelocalself-
governments by the centralgovernment.
i) Autonomy:Theessenceofdecentralisationisself-
ruleandautonomy.Thetransfermechanisminnowayshouldresultinadependencysyndrome.Fiscald
isciplineandownresourcemobilisationarethekeytoautonomy.Therefore,thelocalself-
governmentinstitutions creativity inmobilisation of resourcesmust be encouraged.
ii) Equity:Thewell-
knowndictumofequity,namely,‘fromeachaccordingtoone’sabilityandtoeachaccordingtoone’sne
eds’isrelevantinconsideringresourcemobilisationandintergovernmentalresourcetransfersaswell.
ItshouldbenotedthatPanchayatsatalllevelsareveryunequalinsize,resourcesanddevelopmentattain
ments.Giventheextremeregionaldisparities,decentralisation in suchconditionscanproduce the
desirableresults.

iii) Predictability:ThePRIsshouldknowtheamountandtimingofthetransferstomakeprovisionfor
planning,budgetingandimplementationoftheiractivities.Irregularpaymentsarenotconducivetoeff
iciency.Quiteoftenithappensthatallocationsmaynotevenbepaid,resulting in overdue, which
eventuallymaybe permanently lost to them.
iv) Efficiency:Theresourcetransfershouldbesodesignedastofacilitateefficientmanagementand
discourageinefficientanduneconomicpractices.Thetransfermechanismshould not turn out to
bea“gap-filling” approach.
v) AbsorptiveCapacity:Theresourcetransfershouldbeinthetunewiththeutilisationabilityofthere
ceivingPanchayatormunicipalward.Inotherwords,principleshouldbeeach
accordingtoitsneed.Theallocationoffundtothepanchayatandmunicipalwardmustbefreefrombias.
vi) Simplicity:Theformulafortransfertheinter-
governmentalresourcesshouldbesimpleandtransparent.BesidesformulaformulatedbytheCentral
FinanceCommission,thestategovernmentmustdeviceitsownformulabasedonitssocio-
economic,geographicalandpopulationcompositionforallocationofresourcestopanchayatandmun
icipalitiesandalsoamong the different levels of panchayat and urbanlocalbodies.
vii) PromotionofIncentives:Thereshouldbeadequatebuilt-
inarrangementsforencouragingresourcemobilisationandpenalisingwastefulanduneconomicprac
tices.Thepanchayatwhichmobilizesandgeneratetheirownlocalresourcesmustbegivenadditional
matchinggrant,which will create competitiveness among the localself-governmentinstitutions.
viii) PovertyReduction:Removalofpovertyshouldbethemainaimthefiscaldecentralization.Pan
chayatsandmunicipalitiestakingproactivemeasuresinpovertyreductionmust begiven
incentivesfortheir initiatives.
ix) ReductionofDisparities:Socio-economicdisparitiesareoneofthemainconcerns
ofthegovernments.Thelocalself-
governmentcanplayavitalroleinnarrowingdisparitiesatthegrassroots.Thismustbeabasisfortheall
ocationofrevenueamongvariouslocalself-government institutions.

Check Your Progress B

1. Identifyfive broadeconomic argumentsforcentral-state transfers.
……………………………………………………………………………………………
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2. Write down features of Well-Functioning Intergovernmental System in India.
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3. Name at least five committees that were constituted
 forestablishingfinancialautonomyofthePanchayatsandmunicipalities.
4. ……………………………………………………………………………………………
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23.6EmergingIssuesandChallengesinIndia’sFiscalFederalism
Fiscalfederalismistheeconomiccounterparttopoliticalfederalism.Itassignsfunctionstodifferentle
velsofgovernmentandalsooffersappropriatefiscalinstrumentsforcarryingoutthesefunctions.Dete
rminationofthesespecificfiscalinstrumentsisachallengingtask.Buildingtheprinciplesintoanactua
lschemeofassignmentoftaxestodifferentlevelsofgovernmentinaconstitutionisdifficult.InIndia,in
cometaxisleviedonlybytheCentralgovernmentthoughsharedwiththeStates.Giventhepossibilityo
fimbalancebetweenresourcesandresponsibilities,manycountrieshaveasystemofinter-
governmentaltransfers.ThereishugeeconomicandculturaldiversityamongthevariousStates.It
isaterriblemistaketopresumethatallofIndiacanbegovernedfromDelhi.ElectedStategovernmentsa
ndleaderscannotbemadedummieswithoutanyfiscalpowersforlong.Thisfiscalfederalismtensionb
etween the Centreand States can erupt into something moredangerousandspreadwide.

Thereare anumberofchallengesfacingIndia’sfiscalfederalism.

• First,theSeventhScheduleoftheIndianConstitutionbroadlydemarcatesthefunctionsofgov
ernanceintothreelists.Thisscheduledistributesthelegislativeandfinancialpowersbetween
theunionandthestates.ListIpertainstosubjectsofthecentre.ListIIpertainstosubjectsthatbel
ongtothesubnationalgovernments.ListIIIisacategorycalledtheConcurrentList,whichbel
ongstoboththecentralandsubnationalgovernments,andintheeventofconflictinglegislatio
n,thelawpassedbythecentreprevails.

Overtime,theConcurrentListhassoughttooccupyincreasingspace,transgressingitsearmar
kedbordersandinterveninginthesubjectsofsubnationalgovernments.Thishastakenthefor
mofaformalactthrough,forexample,constitutionalamendmentslikethe42ndAmendmento
ftheConstitution(1975),whichshiftedthesubjectsofforestandeducationfrom theStateList
to the Concurrent List.

Therehavebeenotherwaysinwhichtheoriginaldemarcationhasbeenaltered.Take,forinstan
ce,theissueofentitlement-
drivenlegislations.Sometimeago,Indiaenteredaneraofentitlement-basedstand-
alonelegislation.Theclassicexamples
aretheMahatmaGandhiNationalRuralEmploymentGuaranteeActof2005,theRightofChil
drentoFreeandCompulsoryEducationActof2009andtheNationalFoodSecurityActof2013
.Thiswastheareawherefiscalauthoritiesshouldhaveintervened,asemployment,educationa
ndfoodwereoriginallyintendedtobethedomainofsubnational governments.

• Second,thereistheissueoftheincongruenceofArticle282oftheConstitutionwiththeletterand
spiritofthe SeventhSchedule.Article282oftheConstitutionstatesthat
“TheUnionoraStatemaymakeanygrantsforanypublicpurpose,notwithstandingthatthepurp
oseisnotonewithrespecttowhichParliamentortheLegislatureoftheState,as the case may
be,may make laws.”
Originally,intheIndianConstitution,itwasnotexpectedtobeanoverarching
 provision,butanextraordinaryprovisionthatwastobeusedverysparingly.N.A.Palkhivala,aC
onstitutionalexpert,statedinhisopiniongiventoNinthFinanceCommission,“Art.282isnotin
tendedtoenable
theUniontomakesuchgrantsasfallproperlyunderArt.275.Art.282embodiesmerelyaresidua
rypowerwhichenablestheUnionoraStatetomakeanygrantforanypurpose,irrespectiveofthe
questionwhetherthepurposeis one overwhichthe grantorhaslegislative power.”

Thelegitimacy ofall centrally sponsored schemes, most of whichare in thedomain

ofthestates,emanatesfromtheuseormisusethroughrecoursetoArticle282.Basedonanexercis
ebytheFifteenthFinanceCommission,thereareapproximately211schemes/sub-
schemesundertheumbrellaof29coreschemes.Manyoftheseexistmaskedundertheso-
calledumbrellaschemes.Whatisevenmorestaggeringisthatthetotaloutlayofthecentralgover
nmentonthesecentrallysponsoredschemesisapproximatelyINR3.32trillionin2019-
20.Consideringthatthestatesoftenprotestthatthese schemesareill-
designed,notsuitedtotheirspecificneedsandentailsignificantfinancialoutlaysbythem,nostat
ehasdecidedtoabandonthem.Farfromcentrallysponsoredschemesseeingtheend,somelarges
chemesintheshapeofAyushman Bharat and SwachhBharat areexpanding theirscope and
dimensions.

• Anotherchallengeisthatoffiscalincongruity.OneofthetermsofreferencemadetotheFifteent
hFinanceCommissionistoreviewthecurrentlevelofdebtoftheunionandthestatesandrecom
mendafiscalconsolidationroadmapforsoundfiscalmanagement.AspertheamendedFiscalR
esponsibilityandBudgetManagement(FRBM)Act, thecentralgovernment shall take
appropriate steps to ensurethat:

1.Thegeneral government debt does not exceed 60%.

2.Thecentralgovernmentdebtdoesnotexceed40%ofgrossdomesticproduct(GDP)by the
end offiscal year2024/25.
3.Accordingtothecentralgovernmentbudget(StatementofFiscalPolicyasrequiredunderFR
BMAct2003,July2019),thecentralgovernmentdebtisestimatedat48.4%ofGDPfor2018/19
RE.Itisexpectedthatcentralgovernmentliabilitieswillcomedown to 48% of GDP
in2019/20 BE.
4. Theoutstandingliabilitiesofthestategovernmentsstandsat25.1%ofgrossstatedomes
tic product(GSDP)in 2017, with a range of 42.8% in the subnational governmentof
Punjab and17% in the subnationalgovernment ofChhattisgarh(ReserveBank ofIndia,
2019).
• Anotheremergingchallengeis
thatcessesandsurchargesarebecomingadisproportionateproportionoftheoveralldivisible
revenue,withnon-taxrevenuesbeing kept outside thedivisiblepool. These
areworrisomeissues,and thereshould
besomemechanismtoensurethatthebasicspiritofthedevolutionprocessshouldnotbeunder
cutbycleverfinancialengineeringorbythemanipulationofmethodsthatmakesthem
technical and legally tenable, but perhaps not morally so.

Figure3: Challengesfacing the development of fiscalfederalism inIndia

 • Source:https://www.oecd-ilibrary.org/sites/940cc5ee-
en/index.html?itemId=/content/component/940cc5ee-en#figure-d1e27328
• Finally,thereistheissueofthegoodsandservicestax(GST),whichwasrolledoutacrosstheco
untryon1July2017.TheGSTsubsumesthemajorityoftheindirecttaxes –
excise,servicestax,salestax,octroi(entrytax)–
tocreate“OneNation,OneMarket”.Tosortoutissuespertainingtotheimplementationofthe
GST,theGSTCouncilwasformedasaconstitutionalbodyinvolvingthecentreandthestatesu
nderArticle279
A(1).SincetheCouncildecidesthecentralgoodsandservicestax(CGST)andstategoodsand
servicestax(SGST)rates,itensuresthatthestatesaresignificantpartnersevenonissuessucha
smacroeconomicengagement,andindecidingtaxrates.However,ontheflipside,stateshave
losttheautonomytodecidethetaxratesofsubjectsthatfallwithintheStateList.Previously,sta
tegovernmentsusedtofixtaxratesbytakingintoaccounttheirspendingrequirements,revenu
ebase,etc.The
inabilityofstatestofixtaxratestomatchtheirdevelopmentrequirementsimpliesgreaterdepe
ndence on the centre for funds.

23.7Redefining the FiscalArchitecture in India

RestructuringtheFiscalFederalismcanstrengthenthefiscalfederalism.IndependentFinancecommi
ssion,effectiveNITIAayog,creatingthenewfiscalfederalarchitecturebasedontheeffectivedecentra
lisationandtransparentGSTregimecanstrengthenIndia’suniquecooperativefederalismandelimin
ate the inadequacies of vertical and horizontal imbalances.

• Finance Commission must be relievedfrom thedual task of dealing with the

provisionofbasicpublicgoodsandservicesandcapitaldeficits.Itshouldbeconfinedtofocusi
ngon removal of basic publicgoods imbalance(TypeI).
• NITIAayog, fordealingin the realm of infrastructureandcapitaldeficits (Type II).
 ItshouldbeengagedwiththeallocationofcapitalinawaydifferentthanthatusedbytheFinance
Commissionwithdifferentparametersforallocation.NITIAayogshouldreceivesignificantr
esources(1%to2%oftheGDP)toremoveregionalandsub-
regionaldisparitiesamongstatesbyreducingdevelopmentimbalancesintheareasofinfrastru
cturedeficit.NITIAayogshouldbemandatedtocreateanindependentevaluationofficewhic
hwillmonitorandevaluate
theefficacyoftheutilizationofrevenueandcapitalgrants.Itshouldalsobeanintegralpartofthe
decisionmakingprocessesasitcaneffectivelynegotiatebetweenthestatesforthetransferofre
sources.

• Decentralizationcanserveasthe new
fiscalfederalismbystrengtheninglocalfinancesandstatefinance commission.
• Localpublicfinance:thecreationofanurbanlocalbodyorthePanchayatiRajinstitutions
consolidatedfund.
• CentreandStatesshouldcontributeanequalproportionoftheirCentralGST(CGST)andState
GST(SGST)collectionsandsendthemoneytotheconsolidatedfundofthethirdtier.One-
sixthsharingoftheCGSTandSGSTwiththethirdtiercangeneratemorethan1%oftheGDPev
eryyearforthefinancingofpublicgoodsbyurban-levelbodies.
• StateFinanceCommissionshouldbeaccordedthesamestatusastheUnionFinanceCommissi
onandthe3Fsofdemocraticdecentralization(funds,functions,andfunctionaries) should
beimplemented properly.
• Goods andServices Taxshould be simplified in itsstructureandbyensuring:
SingleRateGST:withsuitablesurcharges onsingoods,zero ratingsof
exportsandreformingtheIntegratedGoodsandServicesTax(IGST)andthee-
waybill.GSTisacomprehensive,multi-stage,destination-
basedtaxthatisleviedoneveryvalueaddition.GSTisoneindirecttaxfortheentirecountry.TheGSTco
uncilisthekeydecision-makingbodythatwilltakeallimportantdecisionsregarding the GST. The
GST Council should undertakereforms inaninformedandtransparentmanner, bycreating its
own secretariat and independent experts.

Check Your Progress C

1. Briefly explain few emerging issues in India’s fiscal federalism.
………………………………………………………………………………………………
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2. Write three challenges that are there in India’s fiscal federalism.
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23.8 Let Us Sum Up

Indianpolityhasevolvedbeyondrecognition.WhentheConstitutionofIndiawasdrawnup,theinterde
pendenceamongstates,fosteredbytechnologyandmigrationhadnotgatheredpace.Theautonomyofst
atesinapre-
globalisederaisvastlydifferentfromthatfoundinanerawherebothmigrationandtechnologyerodethe
boundariesofstatesunperceptively.Notunderminingtheimportanceofglobalvalue chains(GVCs),
thetimehas cometodevelopand
fostertheIndianvaluechain.Products,processesandservicescommencedinonestatecouldinvolve
severalstates beforeit reaches thefinal consumer.

NationalprioritiesandnotablepolicyinitiativeslikeSwachhBharat,theNewEducationPolicy,Ayush
manBharatandSwachhJalthroughJalJeevanMissionconstituteanintegralpart ofthechanging
dynamics and natureofresponsibilitiesbetween thecentreand the
states.TheissuesofNationalPrioritytranscendboundariesastheyaredesignedtoaddressthebasictene
tsofgrowthmultipliers,benefittingeverysegmentofsocietyandaddressingwelfaretenetson health,
housing and employment ascorenational priorities.

23.9 Key Words

Fiscalfederalismisdefinedasfinancialrelationsbetweenunitsofgovernmentsinafederalgovernment
system.Fiscalfederalismispartofbroaderpublicfinancediscipline.

Fiscal decentralization is the transfer of expenditure responsibilities and revenue assignments

to lower levels of government.

23.10 Terminal Questions

Q1. What are the main aspects of fiscal federalism?
Q2. What are the criteria for fiscal devolution in India?
Q3. What is the difference between tax revenue and non-tax revenue?
Q4. What are the sources of localgovernmentrevenue?