The Role of Government in the Economy

The Role of Government in the Economy

Many early post independence leaders, such as Nehru, were influenced by socialist ideas and advocated government intervention to guide the economy, including state ownership of key industries. The objective was to achieve high and balanced economic development in the general interest while particular programs and measures helped the poor. India's leaders also believed that industrialization was the key to economic development. This belief was all the more convincing in India because of the country's large size, substantial natural resources, and desire to develop its own defense industries.

The Industrial Policy Resolution of 1948 gave government a monopoly in armaments, atomic energy, and railroads, and exclusive rights to develop minerals, the iron and steel industries, aircraft manufacturing, shipbuilding, and manufacturing of telephone and telegraph equipment. Private companies operating in those fields were guaranteed at least ten years more of ownership before the government could take them over. Some still operate as private companies.

The Industrial Policy Resolution of 1956 greatly extended the preserve of government. There were seventeen industries exclusively in the public sector. The government took the lead in another twelve industries, but private companies could also engage in production. This resolution covered industries producing capital and intermediate goods. As a result, the private sector was relegated primarily to production of consumer goods. The public sector also expanded into more services. In 1956 the life insurance business was nationalized, and in 1973 the general insurance business was also acquired by the public sector. Most large commercial banks were nationalized in 1969. Over the years, the central and state governments formed agencies, and companies engaged in finance, trading, mineral exploitation, manufacturing, utilities, and transportation. The public sector was extensive and influential throughout the economy, although the value of its assets was small relative to the private sector.

Controls over prices, production, and the use of foreign exchange, which were imposed by the British during World War II, were reinstated soon after independence. The Industries (Development and Regulation) Act of 1951 and the Essential Commodities Act of 1955 (with subsequent additions) provided the legal framework for the government to extend price controls that eventually included steel, cement, drugs, nonferrous metals, chemicals, fertilizer, coal, automobiles, tires and tubes, cotton textiles, food grains, bread, butter, vegetable oils, and other commodities. By the late 1950s, controls were pervasive, regulating investment in industry, prices of many commodities, imports and exports, and the flow of foreign exchange.

Export growth was long ignored. The government's extensive controls and pervasive licensing requirements created imbalances and structural problems in many parts of the economy. Controls were usually imposed to correct specific problems but often without adequate consideration of their effect on other parts of the economy. For example, the government set low prices for basic foods, transportation, and other commodities and services, a policy designed to protect the living standards of the poor. However, the policy proved counterproductive when the government also limited the output of needed goods and services. Price ceilings were implemented during shortages, but the ceiling frequently contributed to black markets in those commodities and to tax evasion by black-market participants. Import controls and tariff policy stimulated local manufacturers toward production of import-substitution goods, but under conditions devoid of sufficient competition or pressure to be efficient.

Private trading and industrial conglomerates (the so-called large houses) existed under the British and continued after independence. The government viewed the conglomerates with suspicion, believing that they often manipulated markets and prices for their own profit. After independence the government instituted licensing controls on new businesses, especially in manufacturing, and on expanding capacity in existing businesses. In the 1960s, when shortages of goods were extensive, considerable criticism was leveled at traders for manipulating markets and prices. The result was the 1970 Monopolies and Restrictive Practices Act, which was designed to provide the government with additional information on the structure and investments of all firms that had assets of more than Rs200 million (for value of the rupee--see Glossary), to strengthen the licensing system in order to decrease the concentration of private economic power, and to place restraints on certain business practices considered contrary to the public interest. The act emphasized the government's aversion to large companies in the private sector, but critics contended that the act resulted from political motives and not from a strong case against big firms. The act and subsequent enforcement restrained private investment.

The extensive controls, the large public sector, and the many government programs contributed to a substantial growth in the administrative structure of government. The government also sought to take on many of the unemployed. The result was a swollen, inefficient bureaucracy that took inordinate amounts of time to process applications and forms. Business leaders complained that they spent more time getting government approval than running their companies. Many observers also reported extensive corruption in the huge bureaucracy. One consequence was the development of a large underground economy in small-scale enterprises and the services sector.

India's current economic reforms began in 1985 when the government abolished some of its licensing regulations and other competition-inhibiting controls. Since 1991 more "new economic policies" or reforms have been introduced. Reforms include currency devaluations and making currency partially convertible, reduced quantitative restrictions on imports, reduced import duties on capital goods, decreases in subsidies, liberalized interest rates, abolition of licenses for most industries, the sale of shares in selected public enterprises, and tax reforms. Although many observers welcomed these changes and attributed the faster growth rate of the economy in the late 1980s to them, others feared that these changes would create more problems than they solved. The growing dependence of the economy on imports, greater vulnerability of its balance of payments, reliance on debt, and the consequent susceptibility to outside pressures on economic policy directions caused concern. The increase in consumerism and the display of conspicuous wealth by the elite exacerbated these fears.

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