INTRODUCTORY MACROECONOMICS

UNIT 1 -NATIONAL INCOME AND RELATED AGGREGATES (10 MARKS)

Macroeconomics deals with aggregate economic variables: National Income, Employment, Poverty,
Inflation etc. One of the most important variables of macroeconomics is: National Income.
National Income measures the extent to which economic activities that take place in the economy.
Since growth of National Income is an indicator of economic growth of a country, the govt policies focus on
how to increase national income over a period of time.
These economic activities can be broadly classified into:
1. PRODUCTION:

It’s a process through which raw materials are converted into output. The output can be of both goods and
services.
goods: pen, furniture, cars, buses etc.
services: hospitality, tourism, health, education etc.
In this process value is added to the raw materials.
example: Flour to Bread
value is being added to flour here through the production process and it is being converted into bread.
This process is carried out with the aid or help of the four factors of production:
LAND, LABOUR, CAPITAL, ENTREPRENEURSHIP.
Firms hire the services of these four factors of production to carry out the production process.

2. CONSUMPTION: is defined as the process of using up of goods and services for the satisfaction of
human wants. Consumption is the principal activity of the households. We buy a variety of goods and
services towards satisfaction of our wants.

Households is the sector that owns the factors of production. It supplies these factors to the firms who in
return pay factor incomes to households.

3. INVESTMENT or capital formation: This is the increase in an economy’s stock of capital goods in a
given time period. Capital goods are those durable goods that are used over time to produce other goods and
services: machinery, plant, tools, buildings etc.
Capital formation is imperative for any economy as it raises its productive capacity.
CIRCULAR FLOW OF INCOME

Income is generated within the firms and it flows back into the firms as revenue. Thus income flows in a
circular manner.
Production is the result of the combined efforts of the factors of production- land , labour, capital and
entrepreneurship.
firms undertake production.
 in the process, income is generated.

income generated is distributed amongst the factors of production as rent, wages, interest and profit.

income in the hands of households creates demand for goods and services.

households spend their incomes on goods and services produced by firms to satisfy their wants.

this expenditure in turn goes back to the firms as their revenue.

TWO SECTOR MODEL:

FIRMS AND HOUSEHOLDS

MONEY FLOWS: these represent flow of money in the economy: expenditure on goods and
services and factor payments

REAL FLOWS: these represent flow of actual goods and services including factor services.

INCOME
GENERATION Factor services INCOME
DISTRIBUTION

Factor payments

Expenditure on Goods and services

Production units/
Households
Firms
Goods and services
INCOME SPENDING

BASICS OF NATIONAL INCOME ACCOUNTING:

STOCKS VS FLOW VARIABLES

STOCK VARIABLES FLOW VARIABLES

1. Stock variables are those variables that are 1. Flow variables are those variables that are
measured at a particular point of time. measured over a period of time.

2. They don’t have a time dimension.

3. They have a time dimension.

3. Examples: Population, inventories, 3. Examples: Growth rate of population, change

wealth, money supply. in inventories, income, change in money supply.

DEPRECIATION VS CAPITAL LOSS

Depreciation refers to fall in the value of fixed capital goods due to normal wear and tear and foreseen or
expected obsolescence. By normal wear and tear we mean fall in the value due to normal use in production.
It is also called consumption of fixed capital as it is the usage of fixed assets that leads to depreciation.
Foreseen obsolescence means fall in value of fixed capital due to expected changes in technology, market
demand, government’s policy etc.

Example:
If a delivery truck is purchased by a firm for Rs 10 lakhs and the expected usage or life of this truck is 5
years then the producer will depreciate the capital good as Rs 2 lakhs per year for a period of 5 years. The
value of this truck will come down by Rs 2 lakhs every year.

Depreciation= Value of the asset

Expected life of the asset

= 10/5= Rs 2 lakhs

Capital loss refers to the fall in the value of an asset due to unforeseen obsolescence or due to natural
calamities like floods, earthquakes etc.

GROSS INVESTMENT VS NET INVESTMENT

GROSS INVESTMENT: It refers to total addition of capital goods to the existing stock of capital during a
given time period.

NET INVESTMENT: It is gross investment less depreciation or consumption of fixed capital.

Depreciation is loss in the value of fixed capital due to normal wear and tear and expected obsolescence.
Thus net investment is net availability of new capital taking into account the wear and tear of existing
capital.

ECONOMIC/ DOMESTIC TERRITORY

Domestic territory, besides political frontiers and territorial waters includes:
 1. Shipping, fishing vessels and aircrafts operated by residents between two or more countries.
2. Embassies, consulates, military establishments and aid agencies of the country located abroad.

DOMESTIC PRODUCT:
IT IS THE MONEY VALUE OF FINAL GOODS AND SERVICES PRODUCED WITHIN THE
ECONOMIC TERRITORY OF A COUNTRY.

NORMAL RESIDENT:
A normal resident (institutional units/ individuals) is one who ordinarily resides in a country and whose
economic interest (earning, spending, accumulation) lies within the economic territory of that country.

As per the United Nations System of National Accounts (UNSNA) the economic interest can be in the form
of:
a dwelling: for a household a factory: production units/firms from these economic activities are undertaken.

UNSNA also maintains that the institutional units should have undertaken economic activities for a
considerably long period of time ( more than one year could be taken as that).

A normal resident of a country may or may not be a national of that country.

The following may stay within the domestic territory of a country but are excluded from being termed as
normal residents of a country:

1.Foreign visitors in a country who have come on a vacation, conference etc( provided they stay for less than
a year) are not considered as residents of the country they are visiting.
2.Seasonal workers who come to a country to work for a period of time and then return to their home
country are not residents of the country in which they work. For eg Nepalese who cross the Indian border to
work in India but live in Nepal are not residents of India.
3.Officials, diplomats and armed personnel of other countries staying within the domestic territory. For eg
the Australian Ambassador living in Delhi is not a resident of India.
4.International organizations like the UNO, WHO are treated as normal residents of an international area or
territory and not of the country they operate in.
5.Employees of International Organisations like the World Bank or the UNDP Who are not citizens of the
country in which the office is located are not residents of that country (provided they work in the country for
less than one year).
6.Crew members working on ships and aircrafts.
7.Medical patients and students continue to be residents of their own country irrespective of the time they
are abroad.

NATIONAL PRODUCT: IT IS THE MONEY VALUE OF FINAL GOODS AND SERVICES

PRODUCED BY THE NORMAL RESIDENTS OF A COUNTRY WITHIN A GIVEN TIME
PERIOD.

Domestic product includes income that is accruing to non residents in the domestic territory
excludes income earned by residents abroad.

To be able to calculate NATIONAL PRODUCT from DOMESTIC PRODUCT we need to:

DEDUCT the factor income that is being paid to non residents within the domestic territory and ADD
income earned by residents from outside the economic territory.
Net factor income from abroad= factor income received from abroad (by residents) less factor income paid
to abroad ( to non residents)

National product= Domestic product+ net factor income from abroad ( here you are adding residents’
income and deducting non residents’ )

Domestic product= National product-net factor income from abroad ( here you are deducting residents’
income who are outside domestic territory and adding non residents’ who are within the economic territory)

Net factor income paid to abroad= factor income paid to abroad (to non residents) less factor income
received from abroad

National product= Domestic product- net factor income to abroad (here you are adding residents’ income
and deducting non- residents’)

Domestic product= National product+ net factor income to abroad (here you are deducting residents’ income
who are outside domestic territory and adding non- residents’ who are within the economic territory).

PRODUCT AT FACTOR COST VS PRODUCT AT MARKET PRICE

The price that a firm charges for the commodity it produces, is what it distributes as factor incomes to the
factors of production for their contribution to output.
If output produced is valued using the price a firm charges, it is termed as output at factor cost.
However by the time the commodity reaches the market, some indirect taxes and subsidies may alter the
factor cost and hence the price the consumer pays.
If output produced is valued using the price paid by the consumer, it is termed as output at market price.

INDIRECT TAXES
Taxes are compulsory or unrequited payments made by households and firms to the govt without any quid
pro quo, that is, no direct service is provided to the person who is paying the tax.
Indirect taxes are those where the payer of the tax ( that is who is liable to pay the tax) is different from the
bearer of the tax( that is the one who actually pays the tax).

Examples: GST (levied on manufacture, sale and consumption of goods and services).

WORKING OF AN INDIRECT TAX

10% GST on a shirt of Rs 100

Seller pays Rs 10 to the govt

This Rs 10 is not paid out from Rs 100

It is added to Rs 100 before it is sold to the consumer. Hence the consumer pays Rs 110 to the seller.
Rs 100: received by the seller
Rs 10: received by the govt as tax

Hence Indirect taxes increase the market price of the commodity.

SUBSIDIES

On the other hand, subsidies are concessions or current unrequited payments made by the government to the
firms.

WORKING OF SUBSIDIES

Seller is willing to sell fertilizer at Rs 100 per kg

Govt may feel that this price is too high.

To reduce the market price for the consumer to Rs 60, the govt pays the seller a subsidy of Rs 40.

Therefore subsidies reduce the market price.

Product at market price= Product at factor cost + Indirect taxes- subsidies

Product at factor cost= Product at market price- Indirect taxes+ subsidies.

NET INDIRECT TAXES= INDIRECT TAXES- SUBSIDIES

TRANSFER RECEIPTS VS INCOME RECEIPTS

FACTOR INCOMES/ INCOME RECEIPTS:
Factors of production-land, labour, capital and entrepreneurship receive income in lieu of factor services
they provide in the production process.
Hence factor income arises as the result of a productive activity and is paid for the services rendered in
producing the current output. Like wages, rent, interest and profits.

TRANSFER RECEIPTS: on the other hand are those receipts which accrue to households for not
undertaking any productive activity. This income is received despite no contribution to the production
process. For e.g. scholarships, donations, gifts received by households.

NATIONAL INCOME AGGREGATES

NATIONAL INCOME AGGREGATES

1. NET DOMESTIC PRODUCT AT FACTOR COST/ NDP AT FC(DOMESTIC

PRODUCT/DOMESTIC INCOME)
2. GROSS DOMESTIC PRODUCT AT MARKET PRICE/ GDP AT MP

3.GROSS DOMESTIC PRODUCT AT FACTOR COST/GDP AT FC

4.NET DOMESTIC PRODUCT AT MARKET PRICE/NDP AT MP

5.NET NATIONAL PRODUCT AT FACTOR COST/NNP AT FC

( NATIONAL PRODUCT /NATIONAL INCOME)

6.NET NATIONAL PRODUCT AT MARKET PRICE/NNP AT MP

7.GROSS NATIONAL PRODUCT AT MARKET PRICE/GNP AT MP

8.GROSS NATIONAL PRODUCT AT FACTOR COST/GNP AT FC

From the information given below, calculate:

1.GNP AT MP
2. NNP AT FC( NATIONAL INCOME)
3.NDP AT MP

Particulars RS CRORES

1. GNP AT FC 1000

2. Indirect taxes 200

3. Net factor income from abroad 50

4. Subsidies 100

5. Consumption of fixed capital/ depreciation 100

Solution:
GNPat MP= GNP at FC+ Indirect taxes-subsidies
( Here we need to convert factor cost to market price so we add indirect taxes and deduct subsidies)

= 1000+200-100=Rs 1100Cr

NNP at FC= GNP at FC- Consumption of fixed capital

( Here we need to convert gross to net so we need to deduct consumption of fixed capital)
=1000-100=Rs 900 Cr

NDP at MP= GNP at FC- Consumption of fixed capital+ Indirect taxes-subsidies-Net factor Income from
abroad
( Here we need to convert gross to net so we need to deduct consumption of fixed capital;
factor cost to market price so we add indirect taxes and deduct subsidies;
national to domestic so we deduct net factor income from abroad)

=1000-100+200-100-50
=Rs 950 Cr

Fill in the blanks:

 1 GNP at MP= GDP at MP+ _____________- _______________

2 NDP at MP= GDP at MP-______________

3 NNP at FC= GNP at MP-_____________-__________+__________

4 NDP at MP=NNP at MP-_____________

5 NNP at MP=NDP at FC+__________+____________

END USE CLASSIFICATION OF GOODS

1. FINAL VS INTERMEDIATE PRODUCTS

INTERMEDIATE PRODUCTS: refer to those goods and services which are purchased during the year
by one production unit from another and are either:

1. Completely used up in production of other goods: For example flour, sugar, milk used in production of
biscuits are intermediate goods. Services could be of a plumber, electrician, transportation etc.
2. For resale in the same year: Also goods like bread, butter, biscuits purchased by a grocer, machines
bought by a trader for reselling during the same year are intermediate goods.
FINAL PRODUCTS: refer to goods and services purchased or own produced for the purpose of
consumption and investment.
By consumption we mean purchases of goods and services for satisfaction of human wants.
Investment refers to purchases of durable goods and net addition to stocks.
For example cold drinks, food items, garments etc purchased by households.
For example machines, buildings, vehicles purchased by production units.

DURABLE GOODS VS NON DURABLE GOODS

DURABLE GOODS: are those goods which can be used repeatedly over a period of time.
For e.g. refrigerator, car, air conditioners, machines etc.

NON DURABLE GOODS: are single use goods and are difficult to store for long periods of time. In other
words these goods can be used only once.
For e.g. vegetables, fruits, sugar, milk etc.

CAPITAL VS CONSUMER GOODS

CONSUMPTION/ CONSUMER GOODS:
Goods purchased or self produced for direct satisfaction of wants are called consumption goods.
For e.g. food, clothes, vehicles etc purchased by households for satisfaction of their wants are called
consumption goods.
CAPITAL GOODS:
Goods which help in production of other goods and services are called capital goods. These goods are used
for generating income. For e.g. machines, ships, buildings, aircrafts, vehicles etc are called capital goods.

MEASUREMENT OF NATIONAL INCOME

PRODUCT OR THE VALUE ADDED METHOD

VALUE ADDED HERE REFERS TO THE VALUE ADDED TO THE RAW MATERIALS IN THE
PRODUCTION PROCESS.

Value of output= quantity produced multiplied by its per unit market price

Suppose per unit market price=Rs 100

Output= 50 units
Value of output= 50x100= Rs 5000

VALUE OF OUTPUT

Sales ( Domestic sales+ Exports)

+
Production for self consumption/ investment (output kept aside for own use and not sold in the market but is
part of current year production)
+
Change in stock ( closing stock-opening stock)
It is possible that the output produced by the firm in the given year is not sold in the same year. Since it has
to be accounted for we add the stock with the firm at the end of the year.
However opening stock is part of last year’s production, which has to be deducted as it could have been sold
in the current year.

VALUE ADDED BY THE FIRM

It is calculated as the difference between the total value of its output and the value of inputs it purchases
from other firms. Thus it is the additional value a firm makes to its intermediate inputs by virtue of its
productive activities:
For eg
A chocolate manufacturer buys cocoa, sugar, milk etc as inputs from other firms and then by using its
factors of production, through the production process converts these inputs into chocolate (output).

GVA AT MP is distributed as:

1. Net Indirect taxes.
2. Consumption of fixed capital.
3. Factor payments to the factors of production.
Net Indirect taxes are Indirect taxes less subsidies. Indirect taxes are paid to the govt and subsidies are
received from the govt. None of these are paid to the factors of production.
Consumption of fixed capital/ Depreciation is not paid to any factor of production.
Therefore in order to arrive at the value of output paid out to the factors of production towards their
contribution, we have to deduct both net indirect taxes and depreciation from GVA at MP.

Henceforth we would need to calculate Net Value added at factor cost which is given by:
NET VALUE ADDED AT FC (NVA at FC) = GROSS VALUE ADDED AT MP(GVA at MP) LESS NET
INDIRECT TAXES LESS CONSUMPTION OF FIXED CAPITAL

Why is NVA at FC equal to factor payments?

Value added is a measure of contribution of a production unit to the domestic product. NVA at FC is nothing
but the contribution of the four factors of production- land, labour, capital and entrepreneurship. As such
NVA at FC belongs to them. The production units thus distribute this NVA at FC amongst the owners of
factors of production as wages, rent, interest and profits.

SOLVED NUMERICAL PROBLEMS:

1.From the following data, estimate the Net Value Added at factor cost by the firm using the production
method:
(RS lacs)

1. Domestic Sales 1000

2. Subsidies 10

3. Purchase of raw materials and other inputs 360

4. Exports 500

5. Consumption of fixed capital 45

6. Imports of raw materials 60

7. Change in stock 120

8. Indirect taxes 40

Solution:
Value of output= Sales( Domestic Sales+ Exports)+ Change in stock
=1000+500+120= Rs 1620 Lacs
Value Added/ GVA at MP= Value of output- Purchase of raw materials and other inputs
= 1620-360= 1260
NVA at FC= GVA at MP- Consumption of fixed capital- Indirect taxes+ subsidies
= 1260-45-40+10= Rs 1185 Lacs

Notes to the solution:

1. Total value of sales= Domestic sales+ Exports
2. Purchase of raw materials and other inputs includes imports of raw materials. Imports of raw materials
would have been deducted in case purchase of raw materials from the domestic market would have been
given.

Calculate Value Added by firm A and B for the following data:

(RS lacs)

1. Sales by firm A 150

2. Sales by firm B 100

3. Purchase by firm A from the rest of the world 50

4. Closing stock of firm B 20

5. Purchases by firm B from firm A 50

6. Purchases by firm A from firm B 50

7. Exports by firm A 30

8. Change in stock of firm A 25

9. Opening stock of firm B 30

Solution:
Value added by firms A and B is nothing else but GVA at MP for both firms
Value Added by firm A
Value of Output= Sales+ Change in stock=150+25
=Rs 175 lacs
GVA at MP= Value of Output- Purchases by firm A from the rest of the world- Purchases by firm A from
firm B
=175-50-50=Rs 75 lacs
Value Added by firm B
Value of output= Sales+ Closing stock-Opening stock
= 100+20-30
=Rs 90 lacs
GVA at MP= Value of output-Purchases by firm B from firm A
=90-50=Rs 40 lacs
Notes to the solution:
1. Since sales already include exports, it is not included separately.
2. Intermediate consumption of firm A includes purchases both from the rest of the world and from firm B.
3. Calculate Gross Domestic Product at market price from the data given below:

(RS Cr)

1. Value of output in Primary sector 2500

2. Intermediate Consumption of the Secondary Sector 1000

3. Intermediate Consumption of the Primary Sector 500

4. Net factor income from abroad 120

5. Net indirect taxes 550

6. Value of output in Secondary sector 4500

7. Value of output in Tertiary sector 3000

8. Intermediate Consumption of the Tertiary Sector 750

Solution :
GVA at MP of the Primary Sector= Value of output of the Primary Sector- Intermediate consumption of the
Primary sector
=2500-500= Rs 2000 Cr
GVA at MP of the Secondary Sector= Value of output of the Secondary Sector- Intermediate consumption
of the Secondary sector
=4500-1000= Rs 3500 Cr
GVA at MP of the Tertiary Sector= Value of output of the Tertiary Sector- Intermediate consumption of the
Tertiary sector
=3000-750=Rs Rs 2250 Cr

GDP at MP= ∑ GVA at MP of the three sectors

=2000+ 3500+2250= Rs 7,750 Cr

INCOME METHOD
Under this method National Income is measured by the factor incomes paid out or distributed to the owners
of the factors of production.

Compensation of Employees:
1.Wages and salaries paid in cash;

2.Wages and salaries paid in kind; eg house rent allowance, free membership of clubs, providing a car with a
driver.

3.Employers’ contribution to social security schemes: Employers make contributions to various welfare
schemes for the benefit of their employees. These contributions could be to the General Provident Fund,
Pension Fund, Life Insurance etc.

Important note: Employee’s contribution towards these schemes is not included in the overall compensation
as these are made from the ages and salaries of an employee and thus do not enhance the employee’s
package.

OPERATING SURPLUS

It is defined as income accruing from property and entrepreneurship.

Income from Property:
1.Rent
2.Interest
3. Royalties
Income from Entrepreneurship:
Profit
1.Corporate tax: Tax paid by a corporate to the government on the profit it earns.
2.Undistributed profit/retained earnings: part of profit kept aside by the corporates for future
expansion/expenditure.
3.Distributed profit/dividends: paid out to the shareholders of the firm.

MIXED INCOME OF THE SELF EMPLOYED

This income accrues to people who are self employed. It is difficult to bifurcate the income received by the
person into wages, profit, interest and rent.

NET DOMESTIC PRODUCT AT FACTOR COST/ NDP AT FC= COMPENSATION OF

EMPLOYEES+ OPERATING SURPLUS+MIXED INCOME OF THE SELF EMPLOYED

Steps in measurement:
STEP 1: Identification and classification of production units.
The units are broadly classified into primary, secondary and tertiary sectors. Those units which exploit
natural resources are put in the primary sector. Those units which transform one good into another are put in
the secondary sector. Those units which produce services are put in the tertiary sector. These are further
classified into sub sectors like agriculture, manufacturing, transport etc.
STEP 2: Estimation of factor incomes.
Take the sum of:
1. Compensation of employees;
2. Rent;
3. Interest;
 4. Profits.
Paid out by each industrial sector. In case of unincorporated enterprises mixed income of the self employed
is to be taken. The sum total of these factor payments represents the contribution of the sector to the
domestic factor incomes and equals NVA at fc.
STEP 3: Estimation of NDP at fc. Factor incomes paid out by all the industrial sectors is added to arrive at
NDP at fc or Domestic income.
STEP 4: Estimation of National income.
To the domestic income obtained in step 3 net factor income from abroad is added to obtain National
income.

Solved Numerical Problems

Calculate National Income (NNP at FC) from the following data using the income method:

(RS Cr)

1. Rent 80

2. Interest 100

3. Employees’ contribution to social security 40

4. Wages and salaries 400

5. Mixed income of the self employed 250

6. Operating surplus 250

7. Net factor income from abroad (-)10

Solution
NDP at FC= Wages and salaries+ Operating Surplus + Mixed Income of the self employed
=400+250+250=Rs 900 Cr
NNP at FC= NDP at FC+ Net factor income from abroad
=900+(-10)
=Rs 890 Cr

Notes to the solution

-Employees’ contribution is not included as it is already a part of salaries.

Problem 2
Calculate National Income from the following data:
(RS Cr)

1. Consumption of fixed capital 50

2. Employers’ contribution to social security 75

3. Interest 160

4. Wages and salaries 450

5. Net indirect taxes 55

6. Dividends 45
 7. Corporate tax 15

8. Undistributed profits 10

9 Rent 130

10. Net factor income from abroad (-)10

Solution:
NDP at FC= Compensation of employees (Wages and salaries+ employers’ contribution to social security
schemes) +Interest+ Rent+ Profit( Dividends +Corporate tax+ Undistributed profit)
=(75+450)+ 160+130+ (45+15+10)= Rs 885 Cr

NNP at FC= NDP at FC+ Net factor income from abroad

=885+(-10)= Rs 875 Cr

Notes to the solution

- Wages and salaries and employers’ contribution to social security schemes are added to arrive at
compensation of employees
- Components of profits- undistributed profits, dividends and corporate tax- are given which are to be
added to get profit generated.

EXPENDITURE METHOD
This method measures National Income by taking into account the total expenditure that is undertaken by
different sectors in the economy on its final goods and services( the ones used either for consumption or
investment.
Income earned by the factors of production is disposed off on goods and services produced by firms of the
economy.
Expenditure is undertaken by all sectors in the economy:
Households; Firms; Government; Rest of the world

PRIVATE FINAL CONSUMPTION EXPENDITURE (HOUSEHOLDS)

It is the money value of final goods and services purchased by households including non-profit institutions
serving households, such as clubs, temples, NGOs etc.

GROSS DOMESTIC CAPITAL FORMATION (FIRMS)

Investment or capital formation is the net addition to capital stock of an economy in a given period of time.
It is typically undertaken by firms to enhance the productive capacity of an economy. It is the firms’ final
expenditure on goods.

-Gross Domestic fixed capital formation ( Business fixed investment)

It includes all the additions to capital stock made by firms such as plant, machinery, tools and equipment.
-Inventory Investment or Change in stock
Every business firm keeps a stock of raw materials, semi finished and finished goods to tide over any
fluctuations in demand. These are called inventories. Inventory Investment is measured by change in stock
i.e. closing stock less opening stock.

-Residential construction investment

It is the amount spent on construction of new residences. It also includes any major renovation done in a
house: building a new room or adding a new floor to a building.

GOVERNMENT FINAL CONSUMPTION EXPENDITURE (GOVERNMENT)

Government produces certain services like health, education, transportation etc. For producing these
services, the government purchases goods and services from the firms and households. Thus the government
incurs final expenditure in producing services.
NET EXPORTS / EXPORTS LESS IMPORTS ( REST OF THE WORLD )
Net exports is exports minus imports. It measures the expenditure the rest of the world makes on the
domestic output of an economy excluding any expenditure that the domestic sectors make on output
produced abroad.
Exports- sale of goods and services produced by domestic firms of an economy to the non residents.
Imports- purchase of goods and services produced by the rest of the world bought by residents of an
economy.

GDP AT MP= PRIVATE FINAL CONSUMPTION EXPENDITURE+ GROSS

DOMESTIC CAPITAL FORMATION + GOVERNMENT FINAL CONSUMPTION
EXPENDITURE+ NET EXPORTS

Steps in measurement:
STEP 1: Identification and classification of production units.
The units are broadly classified into primary, secondary and tertiary sectors. Those units which exploit
natural resources are put in the primary sector. Those units which transform one good into another are put in
the secondary sector. Those units which produce services are put in the tertiary sector. These are further
classified into sub sectors like agriculture, manufacturing, transport etc.
STEP 2: Estimating final expenditure on goods and services produced by these industrial sectors.
These final expenditures are categorized as follows:
1. Private final expenditure by households and private non profit institutions serving households.
2. Government final consumption expenditure: this is equal to the value of all the goods and services
provided by the government free of charge or at a nominal price.
3. Gross domestic capital formation: this equals the expenditure incurred on acquiring goods for
investment by production units located within the domestic territory. There are two components of
gross domestic capital formation:
• Purchased and own account produced durable goods;
• Net addition to the stocks of raw materials, semi finished goods and finished goods.
4. Net exports i.e. exports less imports. Exports represent goods and services sold to non residents.
Imports represent goods and services purchased from production units located outside the domestic
territory.
STEP 3: Estimate Domestic income.
We take the sum of these final expenditures to obtain the measure of GDP at mp. From this we deduct
depreciation and net indirect taxes to arrive at NDP at fc or Domestic income.
STEP 4: Estimation of National income.
To the domestic income obtained in step 3 net factor income from abroad is added to obtain
National income.

SOLVED NUMERICAL PROBLEMS

1. Calculate National Income from the following:

S.No. ITEMS RS
CRORES

1. Private final consumption expenditure 200

2. Net Indirect Taxes 20

 3. Change in stocks (-)15

4. Net Current transfers from abroad (-)10

5. Govt. final consumption expenditure 50

6. Consumption of fixed capital 15

7. Net domestic capital formation 30

8. Net factor income from abroad 5

9. Net Imports 10

NDP AT MP= PRIVATE FINAL CONSUMPTION EXPENDITURE+ GOVERNMENT FINAL

CONSUMPTION EXPENDITURE+ NET DOMESTIC CAPITAL FORMATION- NET IMPORTS
200+50+30-10= Rs 270
NNP AT FC= NDP AT MP- NET INDIRECT TAXES+ NET FACTOR INCOME FROM
ABROAD
=270-20+5= Rs 255 Crores

Notes to the solution:

1.The aggregate will be at Net and not Gross as Net capital formation has been given.
2.Net imports is deducted since these are purchases from the rest of the world. These goods and
services have not been produced within the domestic territory.
3.Change in stocks have not been included since total investment has been given which includes it
already.

2. Find National Income from the following data:

S.No. ITEMS RS CRORES

1. Exports 25

2. Govt. final consumption expenditure 300

3. Net current transfers to the rest of the world (-)10

4. Gross domestic fixed capital formation 250

5. Net factor income from abroad 20

6. Private final consumption expenditure 1000

7. Net Indirect Taxes 30

8. Opening stock 60

9. Imports 55

10. Closing stock 50

11. Consumption of fixed capital 50

GDP at MP= Private final consumption expenditure+ Govt final consumption expenditure+ Gross domestic
fixed capital formation + Change in stock (closing stock – opening stock)+ Exports- Imports
=1000+300+250+(50-60)+(25-55)= Rs 1510 Cr
NNP at FC= GDP at MP- Consumption of fixed capital-Net indirect taxes+ Net factor income from abroad
=1510-50-30+20= Rs 1450 Cr
Notes for the solution
1.The aggregate will be at gross since gross capital formation has been given.
2.Change in stock will be added to gross fixed capital formation to arrive at gross capital formation.
3.Exports less Imports will give net exports.

PRECAUTIONS TO BE USED WHILE USING THE THREE METHOD

VALUE ADDED/ PRODUCTION METHOD

1. Avoid double counting of output: This arises when the value of a product is counted more than
once in the estimation of National income. This can be avoided by: a) taking the value added by each
unit; b) taking the value of final product only.

Double counting means counting of the value of the same product more than once. It leads to over
estimation of the national income of an economy.

This can be explained with the help of an example.

Firm A produces raw cotton, assuming that it does not use any inputs and sells it for Rs 1000 firm B. Firm B
converts it into cotton yarn and sells it for Rs 1500 to firm C. Firm C manufactures cotton cloth and sells it
for Rs 2200 to firm D. Firm D produces garments counting and sells them for Rs 3500to final consumers.
The value of output of all the firms is (1000+1500+2200+3500) Rs 8200. In this way the value of raw cotton
has been counted four times, cotton yarn three times and cotton cloth two times.
There are two ways in which the problem of double counting can be avoided:
1. Taking the value added by each unit. i.e. value added by A=1000,
value added by B=1500-1000=500
value added by C=2200-1500=700
value added by D=3500-2200=1300

Total value added= Rs 3500

By taking the value of final products only. In this case the value of final products i.e. garments is Rs
3500.

2. Include value of own account production in total output: own account production means output
produced by production units for self consumption. We need to include the imputed value of
production that is meant for self consumption.

3. Do not include the sale of second hand goods: These reflect merely a transfer of existing goods
from one person to another and there is no addition to the current flow of goods and services.

PRECAUTIONS TO BE USED WHILE USING THE INCOME METHOD

1. Include imputed value of factor services rendered by the owners of production units: In case of
owner occupied houses rentals are ascertained on the basis of prevailing market rate.
 2. Do not include transfer incomes: Transfer earnings such as old age pensions, scholarships, gifts,
lottery prizes, indirect taxes etc should not be included as they are unilateral payments and no
underlying productive activity is taking place in return for such payments.
3. Do not include capital gains arising from sale of second hand goods: Capital gains refer to the
profit arising from the sale of second hand goods. Capital gains from sale of second hand goods-old
car, house, air conditioners etc are not to be included as the value of their original sale has already
been counted in the year of production. In the current year there is merely a transfer of ownership of
the good. However commission or brokerage earned when such sales are made will be included as
this is income earned from providing a productive service in the current year.
4. Do not include income arising from the sale of financial assets: Income arising from sale of
financial assets like shares, bonds, debentures in the market is not treated as income because there is
no corresponding production of goods and services when such sales are made. It reflects a mere
transfer of ownership rights.

5. Income from windfall gains is not included as it is not earned by providing any productive activity.

6. Illegal incomes through activities such as smuggling, black marketing, drug peddling is not included
in national income.

PRECAUTIONS TO BE USED WHILE USING THE EXPENDITURE METHOD

1. Do not include expenditure on intermediate goods and services: Expenditure on only final goods
and services is to be considered and not intermediate products as this will lead to the problem of
double counting.
2. Include imputed expenditure on self consumed or own account produced output used for
consumption and investment: The imputed value of such goods and services should be taken into
account.
3. Do not include expenditure on transfer payments: A transfer payment is one against which no
good or service is provided in return. E.g., payment of gifts, unemployment allowances, scholarships.
Such expenditure is not connected with any productive activity.
4. Do not include expenditure on financial assets: Expenditure on financial assets like shares, bonds
should be excluded because they reflect a mere transfer of ownership. There is no underlying
productive activity. However, expenditure incurred on brokerage or commissions must be included
as that is expenditure on services produced in the year for which national income is being estimated.
5. Do not include expenditure on second hand goods: Expenditure incurred on second hand goods
should not be included because these are not part of current year’s output but output that was
generated in previous years. However, expenditure incurred on brokerage or commissions must be
included.

GDP AND WELFARE

MEANING OF WELFARE
In the macro sense it means people’s well being.
Meaning of economic welfare: Welfare, the sense of well being as affected by only economic factors is
called economic welfare.
Meaning of non economic welfare: Welfare, the sense of well being as affected by non economic factors
is called economic welfare.
The sum total of economic welfare, that is affected by economic factors and non economic welfare that is
affected by non economic factors is called social welfare.
Per capita real GDP equals total real GDP divided by population.
Per capita measure is better than total measure of GDP as an indicator of welfare because it indicates per
capita availability of goods and services. Greater the per capita availability, higher is the level of welfare;
lower the per capita availability, lower is the level of welfare.
REAL GDP
It is defined as the value of current output at some base year prices. It is obtained by multiplying the goods
and services produced in the current year with the prices prevailing in the base or constant year. This
estimate is a reliable index of economic growth of a country. It increases only when there is a rise in the
physical output of final goods and services in a country during a year. If there is a rise in the physical output
of goods and services during a year and prices are taken to be constant as given by the base year or constant
year, GDP at constant prices will rise.

NOMINAL GDP
It is defined as the value of current output at current year prices. It is obtained by multiplying the goods and
services produced in the current year with the prices prevailing in the current year.
It is a poor indicator of economic growth. Even if there is no rise in the physical output of final goods and
services and current prices rise, then GDP at current prices will increase. Clearly, this does not imply
economic growth of a country.

Goods Price of Price Quantity Nominal Real GDP

the of the of GDP
current base current (P1Q1 ) (P0Q1 )
year year year
(P1)(in (P0)(in (Q1)
RS) RS)
(in
units)

A 20 10 100 2000 1000

B 10 5 200 2000 1000

C 30 20 50 1500 1000

∑P1Q1 ∑P0Q1 =Rs

=Rs 3000
5500

In the example above the difference between Real GDP and Nominal GDP is Rs 5500-Rs 3000= Rs
2500.

This is only the monetary difference as the quantity produced is the same. Thus the variation in the
value of the GDP is merely due to the change in the price level in the economy.

Real GDP= Nominal GDP X 100

Price Index

Price Index= GDP deflator

LIMITATIONS OF GDP AS AN INDICATOR OF WELFARE

1. Many goods and services contributing economic welfare are not included in GDP:
There are many goods and services which are left out from the estimation of national income on
account of practical estimation difficulties, e.g. services of housewives and other family members
etc. It is generally agreed that these items contribute to economic welfare. These non exchange and
non monetary production activities are left out on account of non availability of data and problem of
 evaluation. So, in this sense if we take GDP as an indicator of welfare, we would be underestimating
economic welfare.

2. Externalities not taken into account in GDP, but affect welfare: When the activities of one result
in benefit or harm to others with no payment received for the benefit and no payment made for the
harm done, such benefits and harms are called externalities. Activities resulting in benefits to others
are called positive externalities and increase welfare whereas those resulting in harm to others are
called negative externalities and thus decrease welfare.GDP does not take into account these
externalities.

3. Change in the distribution of income may affect welfare: There is unequal distribution of income.
Also in case there is a rise in per capita income, all may not become equally better off. Per capita is
only an average. Income of some may rise by less and some by more than the national average. In
case of some it may even fall.
This implies that the inequality in the distribution of income may increase or decrease. If it increases,
it implies that the rich have become relatively richer and the poor, relatively poorer. Utility of a
rupee of income to the poor is more than to the rich. Suppose the income of the poor declines by one
rupee and that of the rich increases by one rupee. In such a case, the decline in the welfare of the
poor will be more than the increase in the welfare of the rich. Therefore if with the rise in per capita
real income inequality increases, it may lead to a decline in welfare or if welfare rises it may rise in
less proportion as compared to rise in per capita GDP. This point should be kept in mind while
drawing conclusions about economic welfare.

4. All products may not contribute equally to economic welfare: Some products included in GDP
contribute more to the welfare of the people like food, clothes, houses etc. while others like police
services, military services etc may contribute less and may not directly affect the standard of living
of people. Therefore how much is the economic welfare would depend more on the types of goods
and services produced, and not simply on how much is produced.

5. Contribution of some products may be negative: GDP includes all final products whether it is
milk or liquor. While milk does not prove to be harmful to a person’s health, liquor causes harmful
effects on health. GDP includes only the monetary values of the products and not their contribution
to welfare.
UNIT 2- MONEY AND BANKING ( 6 MARKS)
MONEY

Economies have used several commodities like stones, seashells, silver, gold copper bronze as money. The
question that comes to mind is why this commodity is used as money? The answer is very simple. People
accepted these commodities in exchange for other goods and services.

Hence in an economy that use gold coins as money people knew that gold coins would be readily accepted
for the exchange of goods and services.

Money is defined as anything that is widely accepted for the exchange of goods and services. In other
words people are sure that when they use money exchange for a commodity sellers will accept it.

Thus money is a medium through which exchange of goods and services is possible. Hence economists
stand to give a broad definition of money that ‘money is what money does’. It is something which has
general acceptability as a medium and as a measure of store of value.
It refers to the stock of money held by the public at a point of time in an economy.
DIFFICULTIES IN BARTER SYSTEM

1. Lack of double coincidence of wants: It is difficult to come across double coincidence of wants. It
is very difficult for owner of some goods and services to find someone else who wanted both his
goods and services and possessed that good or service that our trader wanted.
2. Lack of common unit of value: When thousands of goods are produced and exchanged, there would
be unlimited exchange ratios since each good would be required to be expressed in terms of other
goods. In the absence of a common commodity to express the value of each commodity, it is a huge
task to maintain exchange rate between various commodities in a barter economy.
3. Lack of a store of value: Storing value means storing the purchasing power for use in future. Barter
system suffers from the drawback that there is no single commodity that can be used as a store of
value. For a commodity to be a store of value it must have certain properties. It should be easily
portable, it should not be perishable, and should be easy to store.
4. Lack of standard of deferred payments: Since there is no common measure for deferred payments
in barter system, trade is often hampered because of problems regarding the type, quality and value
of the good exchanged in future. It is not possible to have a satisfactory unit of future payments like
salaries, interest payments, loan payments etc.

FUNCTIONS OF MONEY

1. Medium of exchange: Money as a medium of exchange divides the exchange transactions into two
parts, namely, sale and purchase. This function of money removes the drawback of double
coincidence of wants. It facilitates sale and purchase independent of each other.
2. Common unit of value: Money serves as a unit of account. It measures the value of all
commodities, i.e. every commodity can be expressed in terms of money. When we express the value
of a commodity in terms of money, it is called price. With its help we can compare the value of two
or more commodities. Also it is easy to determine exchange rates between them. This function
makes possible the keeping of business accounts.
3. Store of value: Money as a store of value implies that it is a means through which purchasing power
can be stored for the future. One can hold one’s earnings until the time one wants to spend it. Money
comes in convenient denominations and is easily portable.
4. Standard of deferred payments: Deferred payments refer to payments that need to be made on a
future date. Suppose an employer needs to pay salary of Rs 1000 to his employee at the end of a
month. The advantage of using money to make the payment is that both the employer and employee
know the definite amount of money that needs to be transacted at the end of the month. This function
of money has facilitated borrowing and lending activities and has lead to the creation of financial
institutions.
MONEY SUPPLY
M₁ includes those assets which can be directly used for transactions. It is also called transaction money. M1
includes only ‘monies’ and not ‘near monies’. It includes:

1. Currency: This is the currency held with the public. It includes notes and coins that are in
circulation with the public. It is also called fiat money. M1 includes only that currency which is held
outside banks.

2. Demand deposits: These are the money deposits made by the depositor or owner of the deposit to
the bank. Bank agree to honour such demands or pay money on demand at any time. For this
purpose the people use cheques to meet financial obligations.

M₁= C+DD
DISTINCTION BETWEEN DEMAND DEPOSITS AND TIME DEPOSITS

Demand deposits of any Bank are those deposits which are payable on demand by cheque or other means.
In demand deposits, the depositor has the flexibility of withdrawing any amount of money that is held in her
account at any time. A depositor typically uses a cheque to either withdraw money or transfer it to another
person.

The ability to transfer money, from one person to another makes the demand deposits, a medium of
exchange.

Time deposits of any Bank are those deposits that need not be paid on demand and hence the bank has the
deposit for a fixed period of time before they are withdrawn.

This implies that a depositor cannot issue a cheque against a time deposit as she needs to keep the money in
the bank for a minimum period of time. Since money cannot be transferred easily from one person to
another, time deposits are not considered as a medium of exchange but a store of value.

BANKING
Besides the households and firms, there is a third sector, it is the sector that helps bridge the gap between
those who demand money which are the firms and suppliers of money which is the households. This sector
is the financial sector. This sector channelises household savings to forms for the latter to invest.

The financial sector consists of several players including the apex or Central Bank of a country commercial
banks regional rural banks cooperative banks Development Banks non-bank financial intermediaries et
cetera.

COMMERCIAL BANKS

All commercial banks in India are regulated by the Banking Regulation Act 1949.

As per the Banking Regulation Act 1949 a commercial bank is defined as an organisation that accepts
chequeable demand deposits and uses the deposit money to lend or invest it to the general public.

The above definition of commercial bank highlights that for any company to be a commercial bank it must
perform both the functions that is:

1.accept demand deposits that have cheque facilities and;

2.lend money to the public.

CENTRAL BANK

A central bank is the apex or head of the financial and monetary system of a country.

The primary role of a central bank of a country is to control, supervise, regulate and organize the financial
and monetary system of an economy.

FUNCTIONS OF CENTRAL BANK

CURRENCY AUTHORITY/ BANK OF ISSUE:

The Central bank is the sole authority for the issue of currency in the country.

There are two main reasons for the central bank having a monopoly over issuing currency:
A. It brings about uniformity in note circulation;

B. It gives the central bank some amount of direct control over money supply.
GOVERNMENT’S BANKER, AGENT AND ADVISOR

BANKER

As a banker to the government ,the central bank provides all banking facilities to both the central and
state governments in a way that is similar to what the commercial banks provide to the general
public.

These include maintaining deposits for the governments, lending to them, issuing cheques, collecting
payments, making remittances etc. The central bank also provides short term credit to the
government through the treasury bill market.
ADVISOR

The central bank advises the government on financial policies. It suggests measures that may be
required to strengthen the monetary and financial system of the economy. It also advises the
government on issues related to foreign exchange.

AGENT

The central bank acts as the agent to the government as it manages public debt. It undertakes
payment of interest on this debt and all sorts of other services relating to public debt. Also it manages
all new issues of government loans.

BANKER’S BANK AND SUPERVISOR

As a banker to the banks, the central bank holds a part of the cash reserves of banks, lends them short
term funds and provides them with central clearing and remittance facilities.

The banks are required to deposit a stipulated ratio of their deposits with the central bank. Its purpose
is to use these reserves as an instrument of monetary and credit control.

Commercial banks if they wish can hold more reserves with the central bank if they have surplus
cash. The central bank uses these reserves to meet the emergency cash needs of the banks. The
central bank gives loans to these banks. In this way the central bank performs the function of the
banker’s bank.
The central bank supervises, regulates and controls the commercial banks. The regulation of banks
may be related to their licensing, branch expansion, liquidity of assets, management, amalgamation
and liquidation.

CUSTODIAN OF NATIONAL RESERVE OF INTERNATIONAL CURRENCY

A central bank is required to maintain a certain minimum reserve of international currency, i.e. gold
and foreign exchange.

The purpose of this reserve is two- fold: to maintain confidence in domestic currency and to meet
emergency requirements of foreign exchange.

LENDER OF LAST RESORT

Central bank lends money directly to the commercial banks. Instead of rediscounting, central bank
gives loans to commercial banks against bills of exchange, promissory notes, treasury bills,
government securities, etc.
 BANK OF CENTRAL CLEARANCE, SETTLEMENT AND TRANSFER

This function relates to mutual indebtedness of banks. A commercial bank receives cheques and
demand drafts drawn on other banks, from its depositors.
It is the job of the bank to present these to the respective banks, receive payment and credit the same
to the accounts of the depositors. This is the ‘transfer of deposit’ function of the bank.
The central bank makes the entire process of collecting bank to bank payments easy and much less
time consuming. Central bank has a clearing house, an institution where mutual indebtedness
between banks is settled.
The representatives of different banks meet daily in the clearing house to settle interbank payments.
The payments are settled by the debit and credit entries in the cash reserve accounts held by the
commercial banks with the central bank.
The differences between the various banks at the end of the day of each daily clearing are settled by
transfer between their respective accounts with the central bank.

CONTROLLER OF MONEY SUPPLY AND CREDIT

A critical function of the RBI is to control the level of money supply in the economy. This is done
through the RBI’s monetary policy. The monetary policy is the measure or tools used by the RBI to
control money supply in the economy.
Broadly we can classify the tools available for controlling money supply into two categories:

QUANTITATIVE MEASURES: THESE MEASURES DIRECTLY AFFECT THE

QUANTITY OF MONEY SUPPLY IN THE ECONOMY

BANK RATE

Bank rate is the rate of interest at which the central bank lends money to commercial banks.

Commercial Banks lend to the general public.

The rate of interest charged by the commercial banks from the general public is called lending rate,
which is higher than the bank rate.

RAISE MONEY SUPPLY AND CREDIT:

The central bank should reduce the bank rate to enhance investment in the economy.

As bank rate falls, the commercial banks lower the lending rates.

As the bank rate reduces, the cost of borrowing for banks reduces.

This translates into banks lowering the interest rate they charge from borrowers.

Reduced cost of borrowing motivates firms to borrow more for investment purposes.

This raises the supply of money and credit in the economy.

REDUCE MONEY SUPPLY AND CREDIT:

The central bank should raise the bank rate to curtail investment in the economy.
As bank rate rises, the commercial banks raise the lending rates.

As the bank rate rises, the cost of borrowing for banks rises.

This translates into banks raising the interest rate they charge from borrowers.

Raised cost of borrowing discourages firms to borrow more for investment purposes.

This reduces the supply of money and credit in the economy.

LEGAL RESERVE RATIO

Under the law banks cannot lend the entire amount of money that they receive as deposits. They need
to keep a minimum of certain percentage of deposits as reserves. There are two components of these
legal reserves:

• STATUTORY LIQUIDITY RATIO: It is a percentage of the deposits of the banks which

the banks have to maintain in the form of designated liquid assets (cash, gold and government
securities).

• CASH RESERVE RATIO: It is the percentage of the deposits of the banks which they are
required to keep with the central bank.

RAISE MONEY SUPPLY AND CREDIT:

The central bank reduces the legal reserve ratio.

This gives banks more money in their hands to lend to firms.

It results in increased investment and hence increase in money supply and credit.

REDUCE MONEY SUPPLY AND CREDIT

The central bank raises the legal reserve ratio.

This gives banks lesser money in their hands to lend to firms.

It results in reduced investment and hence decrease in money supply and credit.

OPEN MARKET OPERATIONS

 Open market operations refer to sale and purchase of government securities by the central bank
to the public, including banks.
RAISE MONEY SUPPLY AND CREDIT

The central bank purchases securities from member banks in return for cash.

With enhanced availability of credit, banks have the flexibility of lending more for investment.

This results in an increase in money supply and credit in the economy.

REDUCE MONEY SUPPLY AND CREDIT

The central bank sells securities from member banks in return for cash.

The amount of money left with the member banks to lend reduces.

Thus, as securities are sold by the central bank, it reduces the money supply in the economy.

REPO RATE (RR)

It is the interest rate at which the commercial banks can borrow from the central bank to meet their short
term needs. The central bank has the legal power to fix it and/or change it.

REDUCE MONEY SUPPLY AND CREDIT

Increasing RR makes the borrowings by the commercial banks costly.

This forces these banks to raise the interest rates on lending to the general public.
 Borrowings from banks become costly leading to decline in the demand for borrowings from the
banks.

Since borrowings decline, so does the money supply in the economy.

RAISE MONEY SUPPLY AND CREDIT

Lowering RR makes borrowings by the commercial banks cheaper.

As a result the commercial banks will also lower their interest rates on lending to the general public.

Demand for borrowings from banks rises. Thus, raising the money supply in the economy.

REVERSE REPO RATE (RRR)

It is the interest rate at which the commercial banks can deposit their funds with the central bank. The
central bank has the legal power to fix it and/ or change it.

REDUCE MONEY SUPPLY AND CREDIT

Raising RRR gives incentive to the commercial banks to park their funds with the central bank.

This reduces liquidity with the commercial banks and has an adverse effect on their credit creation
capability.

Borrowings from banks decline, thereby reducing the money supply in the economy.

RAISE MONEY SUPPLY AND CREDIT

 Lowering RRR discourages the commercial banks from parking their funds with the central bank.

Thus raising their liquidity and hence their ability to create credit.

QUALITATIVE CONTROLS: THESE MEASURES DO NOT DIRECTLY IMPACT THE

AVAILABILITY OF CREDIT IN THE ECONOMY
1. Moral suasion: Under this banks are persuaded to increase lending to stimulate investment in the
economy.
2. Margin requirements: Margin requirements refer to the difference between the extent of loan
granted and the amount of security that banks ask for the loan.

For example a borrower pledges a building worth Rs 50 lakhs as security with the bank. Suppose the
margin requirement fixed is 20%, it means that the maximum amount of loan the bank can give
against this security is Rs 40 lakhs. Clearly higher the margin, lower the amount one would borrow
from the commercial banks. On the other hand as margin requirements are reduced, borrowers find it
more attractive to borrow money which encourages investment in the economy.

CREDIT CREATION BY COMMERCIAL BANKS

A new deposit in banks leads to creation of more deposits by banks. Total deposits created are many times
the initial deposit. The multiple by which deposits can increase due to an initial deposit is called money
multiplier or deposit multiplier.
The value of deposit multiplier is determined by the legal reserve ratio.
Deposit multiplier= 1/ LRR

ROUNDS DEPOSITS LOANS RESERVES

INITIAL 1000 800 200
I ROUND 800 640 160
II ROUND 640 512 128
. . . .
. . . .
. . . .
5000 4000 1000

The working
Suppose new deposits of Rs 1000 are made in banks. Let the LRR be 20 percent. This implies that banks get
to keep only Rs 200 as cash and lends the remaining amount of Rs 800.The banks create deposits of Rs 800
in the names of the borrowers. This is the first round of creation and equals 80 per cent of the initial deposit.
Suppose borrowers withdraw the entire amount of loan and spend the same on the goods and services
needed for investment. The sellers of these goods and services receive Rs 800 as revenue and deposit the
same in their respective bank accounts. The banks get new deposits. They keep 20 percent of these deposits,
i.e. Rs 160 as cash and lend the remaining amount of Rs 640. This is the second round increase. It is 80
percent of the previous round increase.
In the same manner as above, the third round creation of deposits will be 80 percent of the previous round.
In each round the increase becomes smaller and smaller and eventually becomes zero. The sum total of all
deposits will be Rs 5000, i.e. 5 times the initial deposit.(1/LRR=1/0.2=5).

UNIT 3-DETERMINATION OF INCOME AND EMPLOYMENT (12 marks)

AGGREGATE DEMAND

Aggregate demand is defined as the total willingness of all sectors of an economy to demand goods and
services in an economy in a given period. It is the total amount of money, which the buyers are ready to
spend on the purchase of goods and services produced in the economy during a given period.

The main components are:

PRIVATE CONSUMPTION DEMAND:
It is the total expenditure that all households in an economy are willing to incur on the purchase of goods
and services for their personal consumption in a given period time. The level of household consumption
depends directly upon the level of household’s disposable income (income earns less personal taxes paid).

PRIVATE INVESTMENT DEMAND:

This refers to the desired demand for capital goods by private investors during a given period of time.
Investment as per Keynes means expenditure in creation of new capital assets of a country. It does not mean
investment in stocks and shares.

GOVERNMENT DEMAND:
Government purchases highlight the government’s willingness to purchase goods and services in a given
period of time. Government purchases are done for the provision of services that are collectively consumed
by society- roads, street lighting, law and order, justice, security, education, welfare. The primary
determinant of the extent of government demand for goods and services is the objective of social welfare.
Other factors influencing government demand are the past and present policies, inflation, monetary and
fiscal policies.

NET EXPORTS DEMAND:

It is the demand by the rest of the world for the goods and services of an economy in a given period of time.
Net exports are the difference between a country’s exports and imports. Factors that influence the extent of
trade in a country are tariff barriers, terms of trade, trade policy.

AGGREGATE SUPPLY

Aggregate Supply measures the money value of goods and services that all producers are willing to supply
in the economy in a given time period.

We know under the circular flow of income the total output of the economy in terms of money is equal to
the factor incomes generated in the economy. In other words, the final output is distributed as rent; wages,
interest and profit among factors of production that help produce the output.
When all factor incomes are added, we get the domestic income of the economy. Under the assumption of a
closed economy, this domestic income is equal to national income. Thus,

AGGREGATE SUPPLY= NATIONAL INCOME= NATIONAL INCOME

Factor income earned by households will either be consumed by them or saved. Thus, the aggregate supply
of goods and services in the economy are either consumed or saved. Hence
AS=C+S=Y

CONSUMPTION FUNCTION/ PROPENSITY TO CONSUME

The relationship between consumption and income is called consumption function or propensity to consume.
Propensity to consume means proportion of income spent on consumption.
We may bifurcate consumption in two parts:

First part relates to consumption when income is zero. This implies that people need certain basic goods and
services to sustain themselves, even if income is zero. This consumption is termed as autonomous
consumption and is independent of the level of income.

Second part of consumption is when income increases, consumption also increases. According to Keynes’
famous psychological law of consumption – As income increases consumption also increases but less
proportionately than the use in income. Consumption that is dependent on the level of income is called
induced consumption.

The consumption function may represented in the following equation:

C=C0+ bY

20+ 0.75Y

C- Total Consumption, bY- Induced consumption, Co – Autonomous consumption, b- MPC

CONSUMPTION FUNCTION –:

Income (Y)--- (Rs. Consumption ( C )--- (Rs.

Crores) Crores)

0 20

40 50

80 80

120 110

160 140

200 170

Consumption Curve:
A diagrammatic representation of the relationship between income and consumption levels gives the
consumption curve.
The x-axis measures the income levels and the y-axis measures the consumption levels. The line Y depicts
the income line, which is equidistant from both the axes.
Salient Points:

The consumption curve starts from a positive point on the y-axis implying that there is consumption even
when income levels fall to zero.
The consumption curve slopes upwards, reflecting the direct relationship between income and consumption.
Point B is the break-even point where consumption is equal to income. In other words, households consume
the entire income.

Average Propensity to Consume is defined as the ratio of total consumption to total income. Thus,

APC=C/Y

It is the percentage of income, which is spent on consumption.

Salient Features:
As income increases, APC falls continuously. However, APC can never be equal to zero for any income
level.
At break- even point the value of APC is always equal to 1. At this point, the entire income is being
consumed, making consumption equal to income.
At income levels lower than break even, the value of APC is greater than 1. This reflects that households are
consuming more than the income.
At income levels greater than break even, the value of APC is less than 1. At these income levels the
households are not consuming the entire output that is being produced in the economy.
Marginal Propensity to Consume is defined as the ratio of change in consumption to change in income. It
indicates the proportion of additional income that is being an additional consumption.
MPC= ΔC/ΔY
The value of MPC is always between 0 and 1 as the incremental income can be either completely consumed
or is entirely saved.
If the entire additional income is consumed then change in consumption is equal to change in income,
making MPC = 1. If the entire additional income is saved, then the change in consumption is zero. This
makes the value of MPC = 0.

SAVINGS FUNCTION:
The part of income which is not spent on consumption is called saving.
The functional relationship between savings and income is called saving function or propensity to save.

S = f (Y)
Savings Function:
Income (Y) Consumption ( C ) Savings (S)
 0 20 -20

40 50 -10

80 80 0

120 110 10

160 140 20

200 170 30

S= -C0+(1-b)Y

S= -20+ 0.25 Y

Salient Features:
Savings increase as income increases.
There is a direct relationship between income and savings. Initially savings are negative. As income levels
increase the level of dissavings reduce. Savings then became zero and finally become positive.
Break Even Point:
At break-even income, savings are equal to zero as households consume their entire income. At income
levels less than break even, savings are negative. At income levels higher than break even, savings are
positive.
SAVINGS CURVE

The savings curve slopes upwards. This depicts the direct relationship that exists between income and
saving.
Point B is the break-even point, where consumption is equal to income. Therefore savings are zero. At
break-even income, the savings curve cuts the x-axis.
At income levels less than break-even income, saving curve is below the x-axis, which reflects dissavings by
the household sector.
At income levels greater than break-even income, the savings curve is above the x-axis as savings take a
positive value.
Average Propensity to Save is defined as the ratio of total savings to total income. Alternatively, it is the
percentage of total income that is saved.
APS=S/Y
Salient Features:
 As income rises, APS also rises.
The value of APS is always equal to 0 at break-even point, as the entire income is being consumed and
savings are equal to zero.
At income level prior to break-even point, APS has a negative value. This reflects the fact that there are
dissavings in the economy.
For income levels beyond the break-even, APS has a positive value. This highlights the fact that households
are saving.
The value of MPS always lies between 0 and 1. We know that incremental income can either be entirely
consumed or saved. If the incremental income is entirely consumed, there are no additional savings. This
makes the value of MPS equal to zero. On the other hand, if the entire incremental income is saved, MPS
shall be equal to 1.

Marginal Propensity to Save is defined as the ratio of change in savings to change in income. Alternatively
MPS is the part of additional income, which is saved.
MPC= ΔC/ΔY
The value of MPS always lies between 0 and 1. We know that incremental income can either be entirely
consumed or saved. If the incremental income is entirely consumed, there are no additional savings. This
makes the value of MPS equal to zero. On the other hand, if the entire incremental income is saved, MPS
shall be equal to 1.

EX ANTE VS EX POST VARIABLES

Ex-ante refers to what is intended or planned in the beginning. For e.g. ex-ante investment is what we plan
to invest during a particular period.
Ex-post refers to what is actual or realized at the end. For e.g. ex-post investment means actual investment
made.
The significance of this distinction is that all variables in the theory of income determination are ex-ante
variables.

MODERN THEORY OF INCOME DETERMINATION

AD-AS APPROACH

An economy will achieve equilibrium at the income level where aggregate demand is equal to aggregate
supply

Aggregate demand refers to the willingness of different sectors of an economy to demand goods and
services produced in a given period of time.

Aggregate supply measures the total supply of goods and services that all producers in the economy are
willing to sell in a given period.

We can illustrate this with the help of the following hypothetical schedule. Here AD has been shown as the
sum of total consumption and investment and aggregate supply as sum of total consumption and savings.
INCOM CONSUMPTI INVESTMENT SAVING AD AS EFFECT ON
E ON Rs S Rs Rs INCOME&EMPLOYMENT
Rs Rs crores Rs crores crores
crores crores crores (C+I) (C+S)
0 20 20 -20 40 0 INCREASES
40 50 20 -10 70 40 INCREASES
80 80 20 0 100 80 INCREASES
120 110 20 10 130 120 INCREASES
160 140 20 20 160 160 EQUILIBRIUM
200 170 20 30 190 200 DECREASES
240 200 20 40 220 240 DECREASES
In the schedule above we can see that the economy attains equilibrium at an income level of Rs 160 crores
where aggregate demand is equal to aggregate supply.

• If AD is less than AS:

• At the income level of Rs 200 crores, aggregate demand in the economy is Rs 190 crores. Against
this, the firms are willing to produce Rs 200 crores worth of goods and services. Thus there is an
excess of Rs 10 crores worth of goods and services that is not consumed.
• The excess goods are added to the inventory stock of firms.
• As firms see a rise in their inventories beyond the desired level, they reduce production.
• As production reduces, output and income also reduce. This also results in a reduction of the
underlying employment levels. Such a reduction in output continues as long as AD is lower than AS.
• If AD is more than AS:
• At the income level of Rs 120 crores, the aggregate demand in the economy equals to Rs 130 crores.
• However at this income level, firms are willing to produce goods and services worth Rs 120 crores.
• Thus, there would be a shortfall in the availability of goods and services by Rs 10 crores.
• Since the aggregate demand is greater than aggregate supply, firms meet the extra demand of Rs 10
crores by selling their inventories.
• A depletion of inventories provides the firm with the incentive to increase production.
• As production is stepped up, output and income increase in the economy. This also results in an
increase in the underlying level of employment. This process continues as long as AD is greater than
AS.

PLANNED SAVING- PLANNED INVESTMENT APPROACH

An economy attains equilibrium level of income when planned savings are equal to planned investment.
Savings of an economy mean that part of national income which is not spent on current consumption by
households.
Investment refers to the planned expenditure made by firms on the creation of new capital assets. It is
assumed to be autonomous, i.e. it is independent of income levels.

INCOME CONSUMPTION INVESTMENT SAVINGS EFFECT ON

Rs crores Rs crores Rs crores Rs crores INCOME AND
EMPLOYMENT
0 20 20 -20 INCREASES
40 50 20 -10 INCREASES
80 80 20 0 INCREASES
120 110 20 10 INCREASES
 160 140 20 20 EQUILIBRIUM
200 170 20 30 DECREASES
240 200 20 40 DECREASES
In the table above the economy is at equilibrium at an income level of Rs 160 crores. At this level of
income, firms plan to invest Rs 20 crores whereas households plan to save Rs 20 crores.
• If planned savings exceed planned investment:
• At income level of Rs 200 crores, the firms plan to invest Rs 20 crores, but households are planning
to save Rs 30 crores.
• This means that households are consuming less than firms expected then to do.
• As a result firms’ stock of unsold goods pile up, i.e. there will be unplanned build up of inventories
of unsold goods.
• Firms scale down production. As production reduces, output, income and employment also reduce.
This process continues as long as planned investment is less than planned savings.

• If planned savings fall short of planned investment:

• At income level of Rs 120 crores, the firms desire to invest Rs 20 crores, but at this level of income
households have planned to save only Rs 10 crores.
• This means that households are consuming more than what the firms had expected.
• As a result firms witness a reduction in their inventory stock.
• In order to maintain inventory stock at the desired level, firms step up production, which translates
into increased output, income and employment.

FULL EMPLOYMENT: Full employment is a situation when every able bodied person who is willing to
work at the current wage rate is employed.

INVOLUNTARY UNEMPLOYMENT: Involuntary unemployment is said to occur when able bodied

persons who are willing to work at the given wage rate are unable to find a job.

VOLUNTARY UNEMPLOYMENT: Voluntary unemployment is a situation wherein people choose not

to work at the given wage rate.

EFFECTIVE DEMAND: It refers to the level of aggregate demand at the equilibrium in the economy.

DEFICIENT DEMAND: It refers to a situation where aggregate demand falls short of the aggregate supply
at full employment level of income. In other words, there is a lack of effective demand.

EXCESS DEMAND: It refers to a situation where aggregate demand in the economy exceeds aggregate
supply at full employment level of income.

Deflationary gap measures the extent to which aggregate demand falls short of the aggregate supply at full
employment level. Thus, it measures the extent to which there is deficient demand in the economy.
 • The economy achieves full employment at E and full employment level of income is OM.
• Given the current aggregate demand AD₁ implies that the current level of AD is BM. However OM
is not the equilibrium level of income, OM1 is the equilibrium level of income.
• Here AD, BM is less than Output (A.S.) EM.
• The difference between the two i.e. actual demand BM and aggregate supply at full employment EM
is EB which depicts deflationary gap. E1 is under equilibrium point.

Inflationary gap measures the extent to which aggregate demand exceeds the aggregate supply at full
employment level. Thus, it measures the extent to which there is excess demand in the economy.

• The economy achieves equilibrium at point E and full employment level of income is OM.
• Given the current A.D.1 =BM. However OM is not the equilibrium level of income.
• Here aggregate demand BM is more than the output produced or A.S. = EM.
• The difference between BM i.e. A.D. at full employment and EM i.e. A.S. at full employment is BE
which depicts inflationary gap

IMPACT OF DEFICIENT DEMAND ON THE ECONOMY

1. It leads to a reduction in output.
2. It leads to reduction in employment and income.
3. It leads to a reduction in price levels.
 4. It leads to underemployment of resources in the economy.

IMPACT OF EXCESS DEMAND ON THE ECONOMY

It leads to inflationary pressures in the economy as demand is beyond full employment of resources and
supply of goods and services cannot increase to meet this demand, as output is already at its maximum level.

MEASURES TO CORRECT SITUATIONS OF EXCESS AND DEFICIENT DEMAND

FISCAL POLICY:
Fiscal Policy refers to the expenditure and taxation policy of the government.
EXCESS DEMAND
1. Decrease expenditure: when there is excess demand in the economy, the government needs to
reduce the spending on goods and services. With government reducing expenditure, aggregate
demand in the economy will reduce, thereby reducing inflationary pressures in the economy.
2. Increase taxes: This will reduce the disposable income in the hands of the households. As
disposable income reduces, consumption levels will also reduce thereby decreasing aggregate
demand.
DEFICIENT DEMAND
1. Increase expenditure: The government should increase its expenditure on goods and services. This
will increase the aggregate demand.
2. Decrease taxes: When taxes are reduced, it increases the disposable income in the hands of the
households. Increased disposable income results in increased household consumption levels. This
increases the aggregate demand in the economy.

MONETARY POLICY

It refers to the central Bank’s policy towards the control of money supply in the economy.
EXCESS DEMAND Quantitative controls
1. Increase Bank rate: Bank rate is the rate of interest at which the central bank lends money to
commercial banks. Commercial Banks lend to the general public. The rate of interest charged by the
commercial banks from the general public is called lending rate, which is higher than the bank rate.
The central bank should increase the bank rate to reduce investment in the economy. As bank rate
increases, commercial banks raise the lending rates. With the result the cost of borrowing of banks
increases. Higher costs of borrowings discourage firms to borrow for investment
2. Increase legal reserve ratio: Under the law banks cannot lend the entire amount of money that they
receive as deposits. They need to keep a minimum of certain percentage of deposits as reserves.
There are two components of these legal reserves:
• Statutory liquidity ratio: It is a percentage of the deposits of the banks which the banks have
to maintain in the form of designated liquid assets (cash, gold and government securities).
• Cash reserve ratio: It is the percentage of the deposits of the banks which they are required
to keep with the central bank. The central bank raises the legal reserves required to be kept by
the commercial banks. This gives banks less money in their hands to lend because more cash
gets blocked as reserves with the central bank.
3. Sale of securities in the open market: Open market operations refer to sale and purchase of
government securities by the central bank to the public, including banks. The central bank sells
securities to member banks in return of cash. As securities are sold by the central bank, the amount
of money left with the member banks to lend reduces. This decreases the money supply in the
economy and hence investment.
4. Increasing Repo Rate (RR): is the interest rate at which the commercial banks can borrow from the
central bank to meet their short term needs. The central bank has the legal power to fix it and/or
change it. Increasing RR makes the borrowings by the commercial banks costly. This forces these
banks to raise the interest rates on lending to the general public. Borrowings from banks become
costly leading to decline in the demand for borrowings from the banks. Since borrowings decline,
spending capacity of people declines leading to fall in demand for goods and services. Thus reducing
the money supply in the economy.
 5. Raising Reverse Repo Rate (RRR): is the interest rate at which the commercial banks can deposit
their funds with the central bank. The central bank has the legal power to fix it and/ or change it.
Raising RRR gives incentive to the commercial banks to park their funds with the central bank. This
reduces liquidity with the commercial banks and has an adverse effect on their credit creation
capability. Borrowings from banks decline, lowering the demand for goods and services in the
economy thereby reducing the money supply in the economy.
Qualitative Controls
1. Increasing margin requirements: Margin requirements refer to the difference between the
extent of loan granted and the amount of security that banks ask for the loan. For example a
borrower pledges a building worth Rs 50 lakhs as security with the bank. Suppose the margin
requirement fixed is 20%, it means that the maximum amount of loan the bank can give against
this security is Rs 40 lakhs.
As margin requirements are raised, borrowers find it less attractive to borrow money. Hence
investment levels fall in the economy.

2. Moral suasion: Under moral suasion member banks are persuaded to decrease lending in order
to reduce investment levels in the economy.

DEFICIENT DEMAND Quantitative controls

1. Reduce bank rate: Bank rate is the rate of interest at which the central bank lends money to
commercial banks. Commercial Banks lend to the general public. The rate of interest charged by the
commercial banks from the general public is called lending rate, which is higher than the bank rate.
The central bank should reduce the bank rate to enhance investment in the economy. As bank rate
falls, commercial banks lower the lending rates. As the bank rate reduces, the cost of borrowing for
banks reduces. This translates into banks lowering the interest rate they charge from borrowers.
Reduced cost of borrowing motivates firms to borrow more for investment purposes.
2. Reduce legal reserve ratio: Under the law banks cannot lend the entire amount of money that
they receive as deposits. They need to keep a minimum of certain percentage of deposits as reserves.
There are two components of these legal reserves:
• Statutory liquidity ratio: It is a percentage of the deposits of the banks which the banks have
to maintain in the form of designated liquid assets (cash, gold and government securities).
• Cash reserve ratio: It is the percentage of the deposits of the banks which they are required
to keep with the central bank. The central bank reduces the legal reserve ratio. This gives
banks more money in their hands to lend to firms. As money supply increases, it results in
increased investment.
3. Purchase securities in the open market: Open market operations refer to sale and purchase of
government securities by the central bank to the public, including banks. The central bank purchases
securities from member banks in return for cash. As securities are purchased by the central bank, it
increases the money supply in the economy. With enhanced availability of credit, banks have the
flexibility of lending more for investment.
4. Lowering Repo Rate (RR): is the interest rate at which the commercial banks can borrow from the
central bank to meet their short term needs. The central bank has the legal power to fix it and/or
change it. Lowering RR makes borrowings by the commercial banks cheaper. As a result the
commercial banks will also lower their interest rates on lending to the general public. Demand for
borrowings from banks rises. Spending capacity of the people rises, leading to a rise in demand for
goods and services. Thus raising the money supply in the economy.
5. Lowering Reverse Repo Rate (RRR): is the interest rate at which the commercial banks can
deposit their funds with the central bank. The central bank has the legal power to fix it and/ or
change it.
Lowering RRR discourages the commercial banks from parking their funds with the central bank.
Thus raising their liquidity and hence their ability to create credit.
Qualitative Controls
1. Moral suasion: Under this banks are persuaded to increase lending to stimulate investment in the
economy.
 2. Reduce margin requirements: Margin requirements refer to the difference between the extent
of loan granted and the amount of security that banks ask for the loan. For example a borrower
pledges a building worth Rs 50 lakhs as security with the bank. Suppose the margin requirement
fixed is 20%, it means that the maximum amount of loan the bank can give against this security
is Rs 40 lakhs. As margin requirements are reduced, borrowers find it more attractive to borrow
money. This encourages investment in the economy.

INVESTMENT MULTIPLIER

In a country when investment is increased by a certain amount, the change in income is a multiple of change
in investment. The multiplier is the ratio of the change in income to change in investment. It is the number
with which the change in investment needs to be multiplied in order to determine the resulting change in
income or output.

K= ∆Y/∆I
Where K is the multiplier; ∆Y= change in income
∆I=change in investment
K=1/1-MPC
Or K=1/MPS
The operation of multiplier is based on the fact that one person’s expenditure is another person’s income.
We know that K=1/1-MPC
Suppose we are given that ∆I- Rs 100 crores and MPC=0.80. Investment is undertaken to generate income.
The total increase in income is in several rounds.
First round increase
Investment means expenditure on producer goods. So, an investment of Rs 100 crores raises the income of
the producers of these goods by Rs 100 crores.
Second round increase
Given that MPC=0.80, people spend 80% of increase in income i.e. Rs 80 crores(0.80x100) on consumption.
This raises the income of the producers of consumer goods by Rs 80 crores. It equals 80% of the first round
increase.
The total increase in income at the end of the second round stands at Rs 100+80=Rs 180 crores.
Third round increase
Given MPC=0.80, people again spend 80% of Rs 80 crores i.e. Rs 64 crores on consumption. This leads to
another increase in income of Rs 64 crores of the producers of the consumer goods. It equals 80% of the
second round increase.
At the end of the third round, total increase in income stands at Rs 244 crores(100+80+64).
All other rounds of increase
In this way national income goes on increasing round after round. However, the increase in each round is
restricted to 80% of the increase in the previous round. The absolute increase becomes smaller and smaller
with every round. Eventually, time comes when no more increase is possible.

UNIT 4- GOVERNMENT BUDGET AND THE ECONOMY (6 MARKS)

A government budget is a statement showing item wise the estimated receipts and estimated expenditure
under various heads during a fiscal year.
 GOVERNMENT
BUDGET

BUDGETARY RECEIPTS BUDGETARY EXPENDITURE

Budgetary expenditure refers to the
Budgetary receipts refer to the funds
estimated expenditure under various
planned to be raised from various
heads.
sources.

BUDGETARY RECEIPTS

REVENUE RECEIPTS CAPITAL RECEIPTS

Revenue receipts are defined as those receipts Capital receipts are defined as any receipt of the
of the government that do not either create a government which either creates a liability or
liability or lead to reduction in the value of its leads to reduction in assets.
assets.

REVENUE RECEIPTS ARE CLASSIFIED INTO TWO GROUPS:

1. Tax revenue: It includes receipts from all types of taxes that are imposed by the government like
income tax, sales tax, excise duty, custom duty etc. Taxes can be direct or indirect.

DIRECT VS INDIRECT TAXES

What is a tax? A tax is a compulsory payment made to the government either by a household or by
a corporate with no quid pro quo.
A direct tax is one in which the liability to pay a tax and the burden of that tax falls on the same person.
E.g. income tax, corporation tax etc. They are difficult to avoid as they are imposed directly on a person’s
property or income.
On the other hand when the liability to pay a tax and the burden of that tax is on different persons, it is called
an indirect tax. For example sales tax, excise duty etc. Indirect taxes can be avoided to some extent as a
person need not pay this tax if he decides not to consume the product on which the tax is imposed.

2. Non tax revenue: It includes receipts from sources other than tax. It includes: a)Interest: received on
loans extended by the government.
b) Dividend: received on shares of public sector undertakings held by the government.
c) Profit: earned from enterprises directly owned by the government.
d)External grants: or aid are the financial help received from foreign governments and other
agencies.
e) Administrative revenue: This is the revenue that the government earns by virtue of its
administrative duties. It includes license fee, fines and penalties etc.

CAPITAL RECEIPTS ARE CLASSIFIED INTO THREE GROUPS:

1. Borrowings and other liabilities: Since borrowings create a liability, these funds are treated as
capital receipts. Government raises loans from various sources such as:
a) Market loans: These loans are raised from public through the capital and money markets.
b) Issuance of treasury bills: Government borrows money from the RBI in the form of treasury bills.
c) Foreign governments and other bodies: The government borrows from foreign governments and
other bodies like the World Bank, IMF, Asian Development Bank etc.
2. Recoveries of loans: The central government grants loans to state governments, union territory
governments and other parties. Granting loans increases financial assets of the government. When
government recovers these loans from its debtors it is treated as a capital receipt since it leads to a
decline in its assets.
3. Other capital receipts: These include capital receipts other than the recovery of loans and
borrowing. The government holds ownership in several public sector undertakings. When the
government sells a part or whole of its shares in a company, it is termed as disinvestment. Funds
raised from disinvestments are a capital receipt because it leads to a reduction in the assets of the
government.

REVENUE EXPENDITURE: Such expenditures are incurred for the normal running of government
departments and maintenance of services. The main examples of such expenditures are payment of salaries,
pensions, interest, subsidies, grants to state governments.

CAPITAL EXPENDITURE: It includes:

1. Expenditure on purchasing buildings, shares, land.
2. Loans granted by the central government to the state, Union territories and foreign governments and
public enterprises and other parties.
3. Repayment of outstanding loans.

MEASURES OF DEFICIT

DEFICIT BUDGET: A deficit budget is when budgetary receipts of the government fall short of budgetary
expenditure.

BALANCED BUDGET: A balanced budget is when budgetary receipts of the government are equal to its
budgetary expenditure.
SURPLUS BUDGET: A surplus budget is when budgetary receipts of the government are more than its
budgetary expenditure.

REVENUE DEFICIT: Revenue deficit refers to excess of total revenue expenditure over total revenue
receipts.
Revenue deficit=total revenue expenditure-total revenue receipts
A revenue deficit signifies that the government’s own revenue is insufficient to meet the normal running of
government departments and provision of services. A revenue deficit implies that the government has to
make up for this shortfall from capital receipts, i.e. from borrowing or sale of its assets.
Borrowings undertaken to finance the revenue deficit will increase interest payments in the future which will
in turn increase revenue expenditure. A high revenue deficit is bad for the economy as it implies that the
government is not borrowing to finance any capital formation in the economy.

FISCAL DEFICIT: Fiscal deficit is equal to the excess of total budgetary expenditure (capital and revenue)
over the sum of revenue and capital receipts excluding borrowing.
Fiscal deficit= Total budgetary expenditure-Revenue receipts-Capital receipts excluding borrowing.
Implications:
It increases future liabilities of the government in two ways:
1. The government has to pay the loan in the coming years.
2. It has to pay interest on these loans.
This may lead to a higher revenue deficit. This may further lead to more borrowing and more interest
payments. This could create a vicious circle with the government borrowing to finance interest
payments. Therefore the government likes to keep the fiscal deficit as low as possible.

PRIMARY DEFICIT: Primary deficit is equal to fiscal deficit less interest payments.
Primary deficit=Fiscal deficit-interest payments
Primary deficit indicates the extent of borrowings required to meet the interest burden of previous loans of
the government. A low primary deficit implies that the government is borrowing largely to fund previous
interest payments. On the other hand a higher primary deficit implies that the government is using a larger
component of its fiscal deficit to finance the current year’s expenditure rather than previous year’s burden.

OBJECTIVES OF THE GOVERNMENT BUDGET

1. Reallocation of resources in the economy: There are many economic activities not undertaken by
the private sector either due to lack of profits or due to huge investment involved. There are many
activities like water supply, sanitation etc which are necessarily undertaken by the government in
public interest.
Government can start these activities on its own. In addition, the government can encourage the private
sector through tax concessions, subsidies etc., to undertake certain production in public interest.
2. Reducing inequalities in income and wealth: In order to realize this objective, the government
takes two types of fiscal policy measures:
• it imposes a higher rate of tax on higher incomes and goods consumed by the rich. This reduces the
gap between the rich and the poor.
• it can spend more money on schemes that benefit the poor and provide them with many services free
of charge like education, free medical treatment. This will raise the disposable income of the poor.
In this way the gap between the rich and poor can be reduced.

3. Bringing economic stability: Economic stability means absence of large scale fluctuations in prices.
Such fluctuations create uncertainties in the economy. Government can exercise control over these
fluctuations through taxes and expenditure. For example in an inflationary situation, the government can
reduce its own expenditure and raise direct taxes thereby reducing the disposable incomes of households and
discouraging spending. In times of depressed conditions, the government can raise its expenditure and can
encourage spending by giving tax concessions, subsidies etc.
 UNIT 5- BALANCE OF PAYMENTS (6 marks)

WHAT IS FOREIGN CURRENCY?

Foreign exchange is any currency other than the domestic currency of the country.

EXAMPLES: US $, Japanese Yen, Pound Sterling, Euro etc.

HOW CAN ONE CURRENCY BE EXCHANGED FOR ANOTHER?

AT FOREIGN EXCHANGE RATE

Foreign exchange is the rate at which one currency can be converted into another currency.

SO 1 U.S.$= Rs 75

1 EURO= Rs 88

1 U.K. POUND STERLING= Rs 97

The above are examples of exchange rates.

HOW ARE THESE RATES DETERMINED?

FLEXIBLE EXCHANGE RATE SYSTEM

SOURCES OF DEMAND OF FOREIGN EXCHANGE

SOURCES OF SUPPLY OF FOREIGN EXCHANGE
RELATIONSHIP BETWEEN PRICE OF FOREIGN CURRENCY AND ITS DEMAND
RELATIONSHIP BETWEEN PRICE OF FOREIGN CURRENCY AND ITS SUPPLY
THUS THERE IS A DIRECT RELATIONSHIP BETWEEN PRICE OF FOREIGN CURRENCY AND ITS
SUPPLY
FIXED EXCHANGE RATE SYSTEM

DEVALUATION OF DOMESTIC
CURRENCY
REVALUATION OF DOMESTIC CURRENCY
 FLEXIBLE EXCHANGE RATE SYSTEM

DEPRECIATION OF DOMESTIC CURRENCY

 APPRECIATION OF DOMESTIC CURRENCY

MANAGED FLOATING RATE: ESSENTIALLY A FLOATING RATE.

It is called managed because the Central Bank tries to influence the rate by entering the market as a bulk
buyer or seller.
When the Central Bank finds the floating rate too high

It starts selling foreign exchange from its reserves to bring down the rate. This is to protect the interest of
importers.
When the Central Bank finds the rate too low,

It starts buying to raise the rate. This is to protect the interest of exporters
WHAT ARE BALANCE OF PAYMENTS?

Balance of payments account of a country is defined as the systematic record of all transactions that are
undertaken between the residents of the country and residents of other countries over a period of time.
All economic transactions that are carried out with the rest of the world are either credited or debited in the
balance of payments account.
Transactions that bring foreign exchange into the economy are credited. For e.g. when Indian exports are
sold overseas US dollars are earned and brought into the economy. Therefore, exports are a credit item in the
balance of payments account.
Conversely, transactions that cause an outflow of foreign exchange from the economy are debited. An
example of this would be imports, as an importer needs to pay in foreign exchange for the goods that he is
importing. Balance of Payments account will always balance. In other words, debits are always equal to
credits. In case of an imbalance, the country’s foreign exchange restores the balance.
 CURRENT ACCOUNT

The current account relates to all activities that do not alter the value of assets and liabilities of a nation. The
current account records imports and exports of goods, services, and unilateral transfers. The current account
combines the transactions of the trade account, services account and unilateral transfers.

1. Balance of trade account: It depicts the exports and imports of goods such as machinery, paper,
garments etc. It is also called balance of visible account as goods are visible items and can be seen
and touched.
Balance of trade is defined as equal to exports of goods less imports of goods. If exports are greater
than imports of goods we have a surplus on balance of trade account. On the other hand if imports
are greater than exports, the balance of trade account is said to be in a deficit. It is also called the
merchandise account.
2. Balance of invisible account: It depicts the value of exports and imports of services such as
banking, insurance, shipping, airlines, hospitality, etc. Since services cannot be seen, it is termed as
balance of invisible account.
This account also consists of investment income and compensation of employees. Investment income
includes profits, rent, interest. Compensation of employees includes wages and salaries.
Like the trade account, if export of services is greater than export of services, balance of invisible
account is in surplus. Similarly, if imports are greater than export of services, the balance on the
invisible account is in deficit. The invisible account is also called the service account.
3. Unilateral transfers: are payments and receipts that are made without any quid pro quo. In other
words, for such payments and receipts there are no underlying good or service that is provided. Such
transfers can either be private or government. Private transfers would include examples such as gifts,
scholarships, donations, etc. Government transfers would include grants and aid.

BALANCE ON CURRENT ACCOUNT

It is defined as equal to the difference between the sum of credits and sum of debits on the current account.
Balance on current account=Sum of credits on current account- Sum of debits on current account.
A positive balance means that the nation has spent less on foreign products plus transfer and income
payments than it has earned through the sale of products and transfers and incomes received from the rest of
the world. A positive balance leads to an improvement in the asset position vis-à-vis the rest of the world.

CURRENT ACCOUNT DEFICIT : The Current Account Deficit (CAD) occurs when there is a negative
balance on the current account. This means that a nation has spent more on foreign products plus transfer
and income payments than it has earned through sale of products and transfer and income received. A
negative balance leads to decline in the net asset position vis-à-vis the rest of the world.

CAPITAL ACCOUNT

1. Transactions that affect the assets and liabilities of individuals, business, non- profit organizations.
These include sale and purchase of property, borrowing money from foreign lending agencies,
repayment of foreign loans, purchase of financial assets, etc.

2. Transactions undertaken by the government with the rest of the world. Examples would include
borrowing and lending from/ to foreign governments, borrowing from multilateral agencies such as
the World Bank and foreign commercial banks. It would also include repaying of debt to foreign
commercial banks, foreign governments and multinational agencies.
 3. Foreign direct investment made by multinational corporations. This leads to ownership of domestic
assets by them.

Similar investments made by resident firms abroad leading to ownership of assets by residents.

4. Portfolio investment that is purchase of shares or purchase of bonds issued by a foreign organization/
enterprise by residents abroad and by non residents of bonds and shares issued by resident
enterprises.

5. Changes in foreign exchange reserves: Foreign exchange reserves are the financial assets of the
government held in the central bank. These consist of : a)gold; b)foreign exchange; c)special
drawing rights.

BALANCE ON CAPITAL ACCOUNT

It is defined as equal to the difference between the sum of credits and sum of debits on the capital account.
Balance on capital account=Sum of credits on capital account- Sum of debits on capital account.
Credits in capital account represent increase in liabilities or decrease in assets. Debits represent decrease in
liabilities or increase in assets. So, a positive balance on capital account indicates decrease and a negative
balance increase, in net asset position of the country vis-à-vis the rest of the world.

DEFICIT AND SURPLUS ON BALANCE OF PAYMENTS ACCOUNT

AUTONOMOUS VS ACCOMMODATING TRANSACTIONS

Autonomous transactions refer to international economic transactions in the current and capital account
that take place due to some economic motives like profit maximization. Such transactions are independent of
the state of country’s balance of payments. These items are generally called ‘above the line items’ in BOP.
Deficit or surplus in BOP depends upon the balance of autonomous items. BOP is in deficit if the
autonomous receipts are less than autonomous payments. BOP is in surplus if the autonomous receipts are
more than autonomous payments.
Accommodating transactions refer to transactions that take place because of other activity in BOP like the
government financing. These transactions are undertaken to cover the deficit or surplus in autonomous
transactions are called accommodating transactions. These are generally called ‘below the line items’.
Suppose the autonomous inflow of foreign exchange during the year is $1000, while the total outflow is
$1100. It means that there is a deficit of $100. To meet the shortfall, one option before the country is to
borrow from abroad. Such a borrowing is an accommodating transaction because it is undertaken to cover
the deficit. External assistance from abroad and borrowings from the IMF are examples of accommodating
borrowings. Another option is to withdraw from foreign exchange reserves to cover the deficit. So, use of
foreign exchange reserves is also an accommodating transaction.
If there is a surplus in BOP, it can be used for making accommodating lending and adding to the foreign
exchange reserves. External assistance to abroad, repayments to the IMF and adding to the foreign exchange
reserves are examples of accommodating transactions.

Official reserve transactions refer to transactions by the central bank that cause changes in its official reserves of
foreign exchange. Such transactions take place when a country withdraws from its stock of foreign exchange
reserves to finance the deficit in its overall balance of payments (BOP). A country with surplus in its overall BOP
leads to rise in foreign exchange reserves. These transactions are very important as they help to bring the country’s
balance of payments Account. So such transactions act as an accommodating transaction on the BOP.
 INDIAN ECONOMIC DEVELOPMENT
UNIT 6- DEVELOPMENT EXPERIENCE (1947-90) AND
ECONOMIC REFORMS SINCE 1991 ( 12 MARKS)

INDIAN ECONOMY ON THE EVE OF INDEPENDENCE

LOW LEVEL OF ECONOMIC DEVELOPMENT UNDER THE COLONIAL RULE

India had an independent economy before the advent of the British rule. Though agriculture was the
main source of livelihood for most people, yet, the country’s economy was characterised by various
kinds of manufacturing activities. India was particularly well known for its handicraft industries in the
fields of cotton and silk textiles, metal and precious stone works etc. These products enjoyed a
worldwide market based on the reputation of the fine quality of material used and the high standards of
craftsmanship seen in all imports from India.

The economic policies pursued by the colonial government in India were concerned more with the
protection and promotion of the economic interests of their home country than with the development of
the Indian economy. Such policies brought about a fundamental change in the structure of the Indian
economy — transforming the country into a supplier of raw materials and consumer of finished
industrial products from Britain.

Obviously, the colonial government never made any sincere attempt to estimate India’s national and
per capita income. Some individual attempts which were made to measure such incomes yielded
conflicting and inconsistent results. Among the notable estimators — Dadabhai Naoroji, William
Digby, Findlay Shirras, V.K.R.V. Rao and R.C. Desai — it was Rao, whose estimates during the
colonial period was considered very significant. However, most studies did find that the country’s
growth of aggregate real output during the first half of the twentieth century was less than two
per cent coupled with a meagre half per cent growth in per capita output per year.

AGRICULTURAL SECTOR
• India’s economy under the British colonial rule remained fundamentally agrarian — about 85
per cent of the country’s population lived mostly in villages and derived livelihood directly or
indirectly from agriculture. However, despite being the occupation of such a large population,
the agricultural sector continued to experience stagnation and, not infrequently, unusual
deterioration.
• Agricultural productivity became low though, in absolute terms, the sector experienced some
growth due to the expansion of the aggregate area under cultivation. This stagnation in the
agricultural sector was caused mainly because of:
A. the various systems of land settlement that were introduced by the colonial government.
Particularly, under the zamindari system which was implemented in the then Bengal Presidency
comprising parts of India’s present-day eastern states, the profit accruing out of the agriculture
sector went to the zamindars instead of the cultivators.
B. However, a considerable number of zamindars, and not just the colonial government, did
nothing to improve the condition of agriculture. The main interest of the zamindars was only to
collect rent regardless of the economic condition of the cultivators; this caused immense misery
and social tension among the latter. To a very great extent, the terms of the revenue settlement
were also responsible for the zamindars adopting such an attitude; dates for depositing specified
sums of revenue were fixed, failing which the zamindars were to lose their rights.
C. Besides this, low levels of technology, lack of irrigation facilities and negligible use of
fertilisers, all added up to aggravate the plight of the farmers and contributed to the dismal level
of agricultural productivity.
D. There was, of course, some evidence of a relatively higher yield of cash crops in certain areas of
 the country due to commercialisation of agriculture. But this could hardly help farmers in
improving their economic condition as, instead of producing food crops, now they were
producing cash crops which were to be ultimately used by British industries back home.
E. Despite some progress made in irrigation, India’s agriculture was starved of investment in
terracing, flood-control, drainage and desalinisation of soil.
F. While a small section of farmers changed their cropping pattern from food crops to commercial
crops, a large section of tenants, small farmers and sharecroppers neither had resources and
technology nor had incentive to invest in agriculture.

INDUSTRIAL SECTOR
• As in the case of agriculture, so also in manufacturing, India could not develop a sound
industrial base under the colonial rule. Even as the country’s world famous handicraft industries
declined, no corresponding modern industrial base was allowed to come up to take pride of
place so long enjoyed by the former.
• The primary motive of the colonial government behind this policy of systematically de
industrialising India was two-fold.
a. The intention was, first, to reduce India to the status of a mere exporter of important raw
materials for the upcoming modern industries in Britain and,
b. second, to turn India into a sprawling market for the finished products of those industries so
that their continued expansion could be ensured to the maximum advantage of their home
country — Britain.

In the unfolding economic scenario, the decline of the indigenous handicraft industries created not only
massive unemployment in India but also a new demand in the Indian consumer market, which was now
deprived of the supply of locally made goods. This demand was profitably met by the increasing
imports of cheap manufactured goods from Britain.

During the second half of the nineteenth century, modern industry began to take root in India but its
progress remained very slow.
• Initially, this development was confined to the setting up of cotton and jute textile mills. The
cotton textile mills, mainly dominated by Indians, were located in the western parts of the
country, namely, Maharashtra and Gujarat, while the jute mills dominated by the foreigners
were mainly concentrated in Bengal.
• Subsequently, the iron and steel industries began coming up in the beginning of the twentieth
century. The Tata Iron and Steel Company (TISCO) was incorporated in 1907. A few other
industries in the fields of sugar, cement, paper etc. came up after the Second World War.

However, there was hardly any capital goods industry to help promote further industrialisation in
India. Capital goods industry means industries which can produce machine tools which are, in turn,
used for producing articles for current consumption. The establishment of a few manufacturing units
here and there was no substitute to the near wholesale displacement of the country’s traditional
handicraft industries.
Furthermore, the growth rate of the new industrial sector and its contribution to the Gross Domestic
Product (GDP) remained very small.
Another significant drawback of the new industrial sector was the very limited area of operation of the
public sector. This sector remained confined only to the railways, power generation, communications,
ports and some other departmental undertakings.

FOREIGN TRADE

• India has been an important trading nation since ancient times. But the restrictive policies of
commodity production, trade and tariff pursued by the colonial government adversely affected
the structure, composition and volume of India’s foreign trade. Consequently, India became an
exporter of primary products such as raw silk, cotton, wool, sugar, indigo, jute etc. and an
importer of finished consumer goods like cotton, silk and woollen clothes and capital goods like
 light machinery produced in the factories of Britain.
• For all practical purposes, Britain maintained a monopoly control over India’s exports and
imports. As a result, more than half of India’s foreign trade was restricted to Britain while the
rest was allowed with a few other countries like China, Ceylon (Sri Lanka) and Persia (Iran).
• The opening of the Suez Canal further intensified British control over India’s foreign trade. The
most important characteristic of India’s foreign trade throughout the colonial period was the
generation of a large export surplus. But this surplus came at a huge cost to the country’s
economy.
• Several essential commodities—food grains, clothes, kerosene etc. — were scarcely available in
the domestic market.
• Furthermore, this export surplus did not result in any flow of gold or silver into India. Rather,
this was used to make payments for the expenses incurred by an office set up by the colonial
government in Britain, expenses on war, again fought by the British government, and the import
of invisible items, all of which led to the drain of Indian wealth.

DEMOGRAPHIC CONDITION

•Various details about the population of British India were first collected through a census in
1881. every ten years such census operations were carried out.
• Before 1921, India was in the first stage of demographic transition. The second stage of
transition began after 1921. However, neither the total population of India nor the rate of
population growth at this stage was very high.
• The various social development indicators were also not quite encouraging.
a. The overall literacy level was less than 16 per cent. Out of this, the female literacy level was
at a negligible low of about seven per cent.
b. Public health facilities were either unavailable to large chunks of population or, when
available, were highly inadequate. Consequently, water and air-borne diseases were rampant
and took a huge toll on life. No wonder, the overall mortality rate was very high and in
that, particularly, the infant mortality rate was quite alarming—about 218 per thousand in
contrast to the present infant mortality rate of 63 per thousand. Life expectancy was also
very low—44 years in contrast to the present 66 years.
OCCUPATIONAL STRUCTURE

During the colonial period, the occupational structure of India, i.e., distribution of working persons
across different industries and sectors, showed little sign of change.
• The agricultural sector accounted for the largest share of workforce, which usually remained at
a high of 70-75 per cent while the manufacturing and the services sectors accounted for only 10
and 15-20 per cent respectively.
• Another striking aspect was the growing regional variation. Parts of the then Madras Presidency
(comprising areas of the present-day states of Tamil Nadu, Andhra Pradesh, Kerala and
Karnataka), Bombay and Bengal witnessed a decline in the dependence of the workforce on the
agricultural sector with a commensurate increase in the manufacturing and the services sectors.
However, there had been an increase in the share of workforce in agriculture during the same
time in states such as Orissa, Rajasthan and Punjab.

INFRASTRUCTURE
• Under the colonial regime, basic infrastructure such as railways, ports, water transport, posts
and telegraphs did develop. However, the real motive behind this development was not to
provide basic amenities to the people but to subserve various colonial interests.
• Roads constructed in India prior to the advent of the British rule were not fit for modern
transport. The roads that were built primarily served the purposes of mobilising the army within
India and drawing out raw materials from the countryside to the nearest railway station or the
port to send these to far away England or other lucrative foreign destinations. There always
remained an acute shortage of all weather roads to reach out to the rural areas during the rainy
 season. Naturally, therefore, people mostly living in these areas suffered grievously during
natural calamities and famines.
• The British introduced the railways in India in 1850 and it is considered as one of their most
important contributions. The railways affected the structure of the Indian economy in two
important ways. On the one hand it enabled people to undertake long distance travel and thereby
break geographical and cultural barriers while, on the other hand, it fostered commercialisation
of Indian agriculture which adversely affected the self-sufficiency of the village economies in
India. The volume of India’s exports undoubtedly expanded but its benefits rarely accrued to the
Indian people. The social benefits, which the Indian people gained owing to the introduction of
the railways, were thus outweighed by the country’s huge economic loss.
• Along with the development of roads and railways, the colonial dispensation also took measures
for developing the inland trade and sea lanes. However, these measures were far from
satisfactory. The inland waterways, at times, also proved uneconomical.
• The introduction of the expensive system of electric telegraph in India, similarly, served the
purpose of maintaining law and order. The postal services, on the other hand, despite serving a
useful public purpose, remained all through inadequate

INDIAN ECONOMY: 1950-1990

The leaders of independent India had to decide, among other things, the type of economic system most
suitable for our nation, a system which would promote the welfare of all rather than a few. There are
different types of economic systems.
Under Socialism all the means of production, i.e. all the factories and farms in the country, were owned by
the government and there was no private property. It is not possible in a democracy like India for the
government to change the ownership pattern of land and other properties of its citizens.
Nehru, and many other leaders and thinkers of the newly independent India, sought an alternative to the
extreme versions of capitalism and socialism. India adopted the economic system of ‘mixed economy’.
In 1950, the Planning Commission was set up with the Prime Minister as its Chairperson. The era of five
year plans had begun.

DIFFERENCE BETWEEN SOCIALIST AND CAPITALIST ECONOMY

CAPITALIST ECONOMY SOCIALIST ECONOMY

Resources are owned by private individuals. Resources are owned by the state.

Answers to the central problems of what, how and A socialist society answers the three questions in a
for whom to produce depends on the market forces totally different manner. In a socialist society the
of supply and demand. In a market economy, also government decides what goods are to be
called capitalism, only those consumer goods will be produced in accordance with the needs of society.
produced that are in demand, i.e., goods that can be It is assumed that the government knows what is
sold profitably either in the domestic or in the good for the people of the country and so the
foreign markets. If cars are in demand, cars will be desires of individual consumers are not given
produced and if bicycles are in demand, bicycles much importance. The government decides how
will be produced. If labour is cheaper than capital, goods are to be produced and how they should be
more labour-intensive methods of production will be distributed. In principle, distribution under
used and vice-versa. In a capitalist society the goods socialism is supposed to be based on what people
produced are distributed among people not on the need and not on what they can afford to purchase.
 basis of what people need but on the basis of Unlike under capitalism, for example, a socialist
Purchasing Power—the ability to buy goods and nation provides free healthcare to all its citizens.
services. That is, one has to have the money in the Strictly, a socialist society has no private property
pocket to buy it. Low cost housing for the poor is since everything is owned by the state.
much needed but will not count as demand in the
market sense because the poor do not have the
purchasing power to back the demand. As a result
this commodity will not be produced and supplied as
per market forces.
Most economies are mixed economies, i.e. the government and the market together answer the three
questions of what to produce, how to produce and how to distribute what is produced. In a mixed
economy, the market will provide whatever goods and services it can produce well, and the government
will provide essential goods and services which the market fails to do.

THE GOALS OF FIVE YEAR PLANS

What is a Plan?
A plan spells out how the resources of a nation should be put to use. It should have some general goals as
well as specific objectives which are to be achieved within a specified period of time; in India plans are of
five years duration and are called five year plans. Our plan documents not only specify the objectives to be
attained in the five years of a plan but also what is to be achieved over a period of twenty years. This long-
term plan is called ‘perspective plan’.
The goals of the five year plans are:
1. GROWTH: It refers to an increase in the country’s capacity to produce the output of goods and
services within the country. It implies either a larger stock of productive capital, or a larger size of
supporting services like transport and banking, or an increase in the efficiency of productive capital
and services. A good indicator of economic growth, in the language of economics, is steady increase
in the Gross Domestic Product (GDP) It is necessary to produce more goods and services if the
people of India are to enjoy (in the words of the First Five Year Plan) a more rich and varied life.
The GDP of a country is derived from the different sectors of the economy, namely the agricultural
sector, the industrial sector and the service sector. The contribution made by each of these sectors
makes up the structural composition of the economy.
(Mahalanobis: the Architect of Indian Planning)

2. MODERNISATION: To increase the production of goods and services the producers have to adopt new
technology. For example, a farmer can increase the output on the farm by using new seed varieties instead
of using the old ones. Similarly, a factory can increase output by using a new type of machine. Adoption of
new technology is called modernisation. However, modernisation does not refer only to the use of new
technology but also to changes in social outlook such as the recognition that women should have the same
rights as men. In a traditional society, women are supposed to remain at home while men work. A modern
society makes use of the talents of women in the work place — in banks, factories, schools etc. — and such
a society in most occasions is also prosperous.

3. SELF-RELIANCE: A nation can promote economic growth and modernization by using its own
resources or by using resources imported from other nations. The first seven five year plans gave
importance to self-reliance which means avoiding imports of those goods which could be produced in India
itself. This policy was considered a necessity in order to reduce our dependence on foreign countries,
especially for food. It is understandable that people who were recently freed from foreign domination
should give importance to self-reliance. Further, it was feared that dependence on imported food supplies,
foreign technology and foreign capital may make India’s sovereignty vulnerable to foreign interference in
our policies.

4.EQUITY: Now growth, modernization and self-reliance, by themselves, may not improve the kind of life
which people are living. A country can have high growth, the most modern technology developed in the
country itself, and also have most of its people living in poverty. It is important to ensure that the benefits of
economic prosperity reach the poor sections as well instead of being enjoyed only by the rich. So, in
addition to growth, modernisation and self-reliance, equity is also important. Every Indian should be able to
meet his or her basic needs such as food, a decent house, education and health care and inequality in the
distribution of wealth should be reduced.

AGRICULTURE

Land Reforms: 1. Abolition of intermediaries: At the time of independence, the land tenure system was
characterised by intermediaries (variously called zamindars, jagirdars etc.) who merely collected rent from
the actual tillers of the soil without contributing towards improvements on the farm. Just a year after
independence, steps were taken to abolish intermediaries and to make the tillers the owners of land. The
idea behind this move was that ownership of land would give incentives to the tillers to invest in making
improvements provided sufficient capital was made available to them.
2. Land ceiling was another policy to promote equity in the agricultural sector. This means fixing the
maximum size of land which could be owned by an individual. The purpose of the land ceiling was to
reduce the concentration of land ownership in a few hands.

CRITICAL APPRAISAL OF THE LAND REFORMS:

• The abolition of intermediaries meant that some 200 lakh tenants came into direct contact with the
government — they were thus freed from being exploited by the zamindars. The ownership
conferred on tenants gave them the incentive to increase output and this contributed to growth in
agriculture. However, the goal of equity was not fully served by abolition of intermediaries. In some
areas the former zamindars continued to own large areas of land by making use of some loopholes
in the legislation; there were cases where tenants were evicted and the landowners claimed to be self
cultivators (the actual tillers), claiming ownership of the land; and even when the tillers got
ownership of land, the poorest of the agricultural labourers (such as sharecroppers and landless
labourers) did not benefit from land reforms.
• The land ceiling legislation also faced hurdles. The big landlords challenged the legislation in the
courts, delaying its implementation. They used this delay to register their lands in the name of close
relatives, thereby escaping from the legislation. The legislation also had a lot of loopholes which
were exploited by the big landholders to retain their land. Land reforms were successful in Kerala
and West Bengal because these states had governments committed to the policy of land to the tiller.
Unfortunately other states did not have the same level of commitment and vast inequality in
landholding continues to this day.

NEW AGRICULTURAL STRATEGY: TECHNOLOGICAL REFORMS: The Green Revolution:

At independence, about 75 per cent of the country’s population was dependent on agriculture.
Productivity in the agricultural sector was very low because of the use of old technology and the absence of
required infrastructure for the vast majority of farmers. India’s agriculture vitally depends on the monsoon
and if the monsoon fell short the farmers were in trouble unless they had access to irrigation facilities which
very few had.

Green revolution: This refers to the large increase in production of food grains resulting from the use of
high yielding variety (HYV) seeds especially for wheat and rice. The use of these seeds required the use of
fertiliser and pesticide in the correct quantities as well as regular supply of water; the application of these
inputs in correct proportions is vital. The farmers who could benefit from HYV seeds required reliable
irrigation facilities as well as the financial resources to purchase fertiliser and pesticide.

ACHIEVEMENTS:
1. The spread of green revolution technology enabled India to achieve self-sufficiency in food
grains; we no longer had to be at the mercy of America, or any other nation, for meeting our nation’s food
requirements.
2. The portion of agricultural produce which is sold in the market by the farmers is called marketed
surplus. A good proportion of the rice and wheat produced during the green revolution period
 (available as marketed surplus) was sold by the farmers in the market. As a result, the price of food
grains declined relative to other items of consumption. The low income groups, who spend a large
percentage of their income on food, benefited from this decline in relative prices.
3. The green revolution enabled the government to procure sufficient amounts of food grains to build
BUFFER stock which could be used in times of food shortage.

SHORTCOMINGS:

1. In the first phase of the green revolution (approximately mid 1960s up to mid
1970s), the use of HYV seeds was restricted to the more affluent states such as Punjab, Andhra Pradesh and
Tamil Nadu.

2. Further, the use of HYV seeds primarily benefited the wheat growing regions only. In the second
phase of the green revolution (mid-1970s to mid-1980s), the HYV technology spread to a larger number of
states and benefited more variety of crops.

3.While the nation had immensely benefited from the green revolution, the technology involved was not
free from risks. One such risk was the possibility that it would increase the disparities between small and
big farmers—since only the big farmers could afford the required inputs, thereby reaping most of the
benefits of the green revolution. Moreover, the HYV crops were also more prone to attack by pests and the
small farmers who adopted this technology could lose everything in a pest attack.

Fortunately, these fears did not come true because of the steps taken by the government. The government
provided loans at a low interest rate to small farmers and subsidized fertilisers so that small farmers could
also have access to the needed inputs. Since the small farmers could obtain the required inputs, the output
on small farms equalled the output on large farms in the course of time. As a result, the green revolution
benefited the small as well as rich farmers. The risk of the small farmers being ruined when pests attack
their crops was considerably reduced by the services rendered by research institutes established by the
government.

The Debate Over Subsidies: The economic justification of subsidies in agriculture is, at present, a hotly
debated question. It is generally agreed that it was necessary to use subsidies to provide an incentive for
adoption of the new HYV technology by farmers in general and small farmers in particular. Any new
technology will be looked upon as being risky by farmers. Subsidies were, therefore, needed to encourage
farmers to test the new technology.
Some economists believe that once the technology is found profitable and is widely adopted, subsidies
should be phased out since their purpose has been served. Further, subsidies are meant to benefit the
farmers but a substantial amount of fertiliser subsidy also benefits the fertiliser industry; and among
farmers, the subsidy largely benefits the farmers in the more prosperous regions. Therefore, it is argued that
there is no case for continuing with fertiliser subsidies; it does not benefit the target group and it is a huge
burden on the government’s finances.
On the other hand, some believe that the government should continue with agricultural subsidies because
farming in India continues to be a risky business. Most farmers are very poor and they will not be able to
afford the required inputs without subsidies. Eliminating subsidies will increase the inequality between rich
and poor farmers and violate the goal of equity.
These experts argue that if subsidies are largely benefiting the fertiliser industry and big farmers,
the correct policy is not to abolish subsidies but to take steps to ensure that only the poor farmers enjoy the
benefits.

Thus, by the late 1960s, Indian agricultural productivity had increased sufficiently to enable the country to
be self-sufficient in food grains. This is an achievement to be proud of. On the negative side, some 65 per
cent of the country’s population continued to be employed in agriculture even as late as 1990. Economists
have found that as a nation becomes more prosperous, the proportion of GDP contributed by agriculture as
well as the proportion of population working in the sector declines considerably. In India, between 1950 and
1990, the proportion of GDP contributed by agriculture declined significantly but not the population
depending on it (67.5 per cent in 1950 to 64.9 per cent by 1990). Why was such a large proportion of the
population engaged in agriculture although agricultural output could have grown with much less people
working in the sector? The answer is that the industrial sector and the service sector did not absorb the
people working in the agricultural sector. Many economists call this an important failure of our policies
followed during 1950-1990.

INDUSTRY

Economists have found that poor nations can progress only if they have a good industrial sector. Industry
provides employment which is more stable than the employment in agriculture; it promotes modernization
and overall prosperity. It is for this reason that the five year plans place a lot of emphasis on industrial
development.
We needed to expand the industrial base with a variety of industries if the economy was to grow.

Public and Private Sectors in Indian Industrial Development: The big question facing the policy makers was
— what should be the role of the government and the private sector in industrial development?
• At the time of independence, Indian industrialists did not have the capital to undertake investment in
industrial ventures required for the development of our economy;
• nor was the market big enough to encourage industrialists to undertake major projects even if they
had the capital to do so.
It is principally for these reasons that the state had to play an extensive role in promoting the
industrial sector. In addition, the decision to develop the Indian economy on socialist lines led to the
policy of the state controlling the commanding heights of the economy, as the Second Five Year
plan put it. This meant that the state would have complete control of those industries that were vital
for the economy. The policies of the private sector would have to be complementary to those of the
public sector, with the public sector leading the way.

Industrial Policy Resolution 1956 (IPR 1956): In accordance with the goal of the state controlling the
commanding heights of the economy, the Industrial Policy Resolution of 1956 was adopted. This resolution
formed the basis of the Second Five Year Plan, the plan which tried to build the basis for a socialist pattern
of society. This resolution classified industries into three categories:

A. The first category comprised industries which would be exclusively owned by the state. There were 17
industries in this category.

B. the second category consisted of industries in which the private sector could supplement the
efforts of the state sector, with the state taking the sole responsibility for starting a new unit. There were 12
industries in this category.

C. the third category consisted of the remaining industries which were to be in the private sector.

INDUSTRIAL LICENSING

• Although there was a category of industries left to the private sector, the sector was kept under state
control through a system of licenses. No new industry was allowed unless a license was obtained
from the government. This policy was used for promoting industry in backward regions; it was
easier to obtain a license if the industrial unit was established in an economically backward area. In
addition, such units were given certain concessions such as tax benefits and electricity at a lower
tariff. The purpose of this policy was to promote regional equality.

• Even an existing industry had to obtain a license for expanding output or for diversifying production
(producing a new variety of goods). This was meant to ensure that the quantity of goods produced
was not more than what the economy required.

• License to expand production was given only if the government was convinced that the economy
 required a larger quantity of goods.

Small-Scale Industry:
• In 1955, the Village and Small-Scale Industries Committee, also called the Karve Committee, noted
the possibility of using small-scale industries for promoting rural development.
• A ‘small-scale industry’ is defined with reference to the maximum investment allowed on the assets
of a unit. This limit has changed over a period of time.
• In 1950 a small-scale industrial unit was one which invested a maximum of rupees five lakh; at
present the maximum investment allowed is rupees one crore.
• It is believed that small-scale industries are more ‘labour intensive’ i.e., they use more labour than
the large-scale industries and, therefore, generate more employment.
• But these industries cannot compete with the big industrial firms; it is obvious that development of
small-scale industry requires them to be shielded from the large firms. For this purpose, the
production of a number of products was reserved for the small-scale industry; the criterion of
reservation being the ability of these units to manufacture the goods. They were also given
concessions such as lower excise duty and bank loans at lower interest rates.
:

TRADE POLICY: IMPORT SUBSTITUTION

• The industrial policy that we adopted was closely related to the trade policy. In the first seven plans,
trade was characterised by what is commonly called an inward looking trade strategy. Technically,
this strategy is called import substitution. This policy aimed at replacing or substituting imports with
domestic production. For example, instead of importing vehicles made in a foreign country,
industries would be encouraged to produce them in India itself. In this policy the government
protected the domestic industries from foreign competition.
• Protection from imports took two forms: tariffs and quotas. Tariffs are a tax on imported goods;
they make imported goods more expensive and discourage their use. Quotas specify the quantity of
goods which can be imported. The effect of tariffs and quotas is that they restrict imports and,
therefore, protect the domestic firms from foreign competition.
• The policy of protection is based on the notion that industries of developing countries are not in a
position to compete against the goods produced by more developed economies. It is assumed that if
the domestic industries are protected they will learn to compete in the course of time.
• Our planners also feared the possibility of foreign exchange being spent on import of luxury goods if
no restrictions were placed on imports. Nor was any serious thought given to promote exports until
the mid-1980s.

Effect of Policies on Industrial Development:

• The achievements of India’s industrial sector during the first seven plans are impressive indeed. The
proportion of GDP contributed by the industrial sector increased in the period from 11.8 per cent in
1950-51 to 24.6 per cent in 1990-91.
• The rise in the industry’s share of GDP is an important indicator of development. The six per cent
annual growth rate of the industrial sector during the period is commendable.
• No longer was Indian industry restricted largely to cotton textiles and jute; in fact, the industrial
sector became well diversified by 1990, largely due to the public sector.
• The promotion of small-scale industries gave opportunities to those people who did not have the
capital to start large firms to get into business.
• Protection from foreign competition enabled the development of indigenous industries in the areas
of electronics and automobile sectors which otherwise could not have developed.
• In spite of the contribution made by the public sector to the growth of the Indian economy, some
economists are critical of the performance of many public sector enterprises. It was proposed at the
beginning of this chapter that initially the public sector was required in a big way. It is now widely
held that state enterprises continued to produce certain goods and services (often monopolizing
 them) although this was no longer required. An example is the provision of telecommunication
service. This industry continued to be reserved for the Public Sector even after it was realised that
private sector firms could also provide it. Due to the absence of competition, even till the late 1990s,
one had to wait for a long time to get a telephone connection. Another instance could be the
establishment of Modern Bread, a bread-manufacturing firm, as if the private sector could not
manufacture bread! In 2001 this firm was sold to the private sector.
• The point is that after four decades of Planned development of Indian Economy no distinction was
made between (i) what the public sector alone can do and (ii) what the private sector can also do.
For example, even now only the public sector supplies national defence. And even though the
private sector can manage hotels well, yet, the government also runs hotels. This has led some
scholars to argue that the state should get out of areas which the private sector can manage and the
government may concentrate its resources on important services which the private sector cannot
provide.
• Many public sector firms incurred huge losses but continued to function because it is difficult to
close a government undertaking even if it is a drain on the nation’s limited resources. This does not
mean that private firms are always profitable (indeed, quite a few of the public sector firms were
originally private firms which were on the verge of closure due to losses; they were then
nationalised to protect the jobs of the workers). However, a loss-making private firm will not waste
resources by being kept running despite the losses.
• The need to obtain a license to start an industry was misused by industrial houses; a big industrialist
would get a license not for starting a new firm but to prevent competitors from starting new firms.
• The excessive regulation of what came to be called the permit license raj prevented certain firms
from becoming more efficient. More time was spent by industrialists in trying to obtain a license or
lobby with the concerned ministries rather than on thinking about how to improve their products.
• The protection from foreign competition is also being criticised on the ground that it continued even
after it proved to do more harm than good. Due to restrictions on imports, the Indian consumers had
to purchase whatever the Indian producers produced. The producers were aware that they had a
captive market; so they had no incentive to improve the quality of their goods. Why should they
think of improving quality when they could sell low quality items at a high price? Competition from
imports forces our producers to be more efficient.
• A few economists also point out that the public sector is not meant for earning profits but to
promote the welfare of the nation. The public sector firms, on this view, should be evaluated
on the basis of the extent to which they contribute to the welfare of people and not on the
profits they earn.

ECONOMIC REFORMS SINCE 1991

CRISIS THAT EMERGED IN 1990-91

1. A continuing and increasing fiscal deficit.
2. High rate of inflation.
3. A falling exchange rate economy.
4. A high and potentially increasing trade deficit and balance of payments crisis.
5. A high level and high growth rate in external debt leading to debt trap.
6. Reduction in foreign exchange reserves: we did not have enough foreign exchange reserves to pay for two
week’s imports.
7. Failure of the public sector.

LIBERALISATION

Liberalisation was introduced to put an end to restrictions and open up various sectors of the economy. Though a
few liberalisation measures were introduced in the 1980s in areas of industrial licensing, export-import policy,
technology up gradation, fiscal policy and foreign investment, reform policies initiated in 1991 were more
comprehensive.

INDUSTRIAL POLICY

In India, regulatory mechanisms were enforced in various ways:

(i) industrial licensing under which every entrepreneur had to get permission from government
officials to start a firm, close a firm or to decide the amount of goods that could be produced (ii) private sector was
not allowed in many industries (iii) some goods could be produced only in small scale industries and (iv) controls
on price fixation and distribution of selected industrial products.

The reform policies introduced in and after 1991 removed many of these restrictions:
1. Industrial licensing was abolished for almost all but product categories — alcohol, cigarettes, hazardous
chemicals, industrial explosives, electronics, aerospace and drugs and pharmaceuticals.
2. The only industries which are now reserved for the public sector are defence equipments, atomic energy
generation and railway transport. Many goods produced by small scale industries have now been de-
reserved.
3. In many industries, the market has been allowed to determine the prices.
4. De reservation of goods earlier reserved for the small scale industries.

FINANCIAL SECTOR REFORMS:

Financial sector includes financial institutions such as commercial banks, investment banks, stock exchange
operations and foreign exchange market. The financial sector in India is regulated by the Reserve Bank of India
(RBI). All the banks and other financial institutions in India are regulated through various norms and regulations of
the RBI. The RBI decides the amount of money that the banks can keep with themselves, fixes interest rates, nature
of lending to various sectors etc. One of the major aims of financial sector reforms is to:
1. Reduce the role of RBI from regulator to facilitator of the financial sector. This means that the financial
sector may be allowed to take decisions on many matters without consulting the RBI.
2. The reform policies led to the establishment of private sector banks, Indian as well as foreign.
3. Foreign investment limit in banks was raised to around 50 per cent.
4. Those banks which fulfil certain conditions have been given freedom to set up new branches without the
approval of the RBI and rationalize their existing branch networks. Though banks have been given
permission to generate resources from India and abroad.
5. Certain managerial aspects have been retained with the RBI to safeguard the interests of the account holders
and the nation.
6. Foreign Institutional Investors (FII) such as merchant bankers, mutual funds and pension funds are now
allowed to invest in Indian financial markets.

TAX REFORMS:

Tax reforms are concerned with the reforms in government’s taxation and public expenditure policies which are
collectively known as its fiscal policy. There are two types of taxes: direct and indirect. Direct taxes consist of
taxes on incomes of individuals as well as profits of business enterprises.

1. Since 1991, there has been a continuous reduction in the taxes on individual incomes as it was felt that high
rates of income tax were an important reason for tax evasion. It is now widely accepted that moderate rates
of income tax encourage savings and voluntary disclosure of income. The rate of corporation tax, which
was very high earlier, has been gradually reduced.
2. Efforts have also been made to reform the indirect taxes, taxes levied on commodities, in order to facilitate
the establishment of a common national market for goods and commodities.
3. Another component of reforms in this area is simplification. In order to encourage better compliance on the
 part of taxpayers many procedures have been simplified and the rates also substantially lowered.

FOREIGN EXCHANGE REFORMS:

1. In 1991, as an immediate measure to resolve the balance of payments crisis, the rupee was devalued against
foreign currencies. This led to an increase in the inflow of foreign exchange.
2. It also set the tone to free the determination of rupee value in the foreign exchange market from government
control. Now, more often than not, markets determine exchange rates based on the demand and supply of
foreign exchange.

TRADE AND INVESTMENT POLICY REFORMS:

Liberalisation of trade and investment regime was initiated to increase international competitiveness of
industrial production and also foreign investments and technology into the economy. The aim was also to
promote the efficiency of the local industries and the adoption of modern technologies.
The trade policy reforms aimed at:
1. Dismantling of quantitative restrictions on imports and exports
2. Reduction of tariff rates and
3. Removal of licensing procedures for imports. Import licensing was abolished except in case of hazardous
and environmentally sensitive industries.
4. Quantitative restrictions on imports of manufactured consumer goods and agricultural products were also
fully removed from April 2001.
5. Export duties have been removed to increase the competitive position of Indian goods in the international
markets.

PRIVATISATION

It implies shedding of the ownership or management of a government owned enterprise. Government companies
are converted into private companies in two ways (i) by withdrawal of the government from ownership and
management of public sector companies and or (ii) by outright sale of public sector companies.

Privatisation of the public sector enterprises by selling off part of the equity of PSEs to the public is known as
disinvestment. The purpose of the sale, according to the government, was mainly to improve financial discipline
and facilitate modernisation. It was also envisaged that private capital and managerial capabilities could be
effectively utilised to improve the performance of the PSUs.

Navratnas and Public Enterprise Policies : In order to improve efficiency, infuse professionalism and enable them
to compete more effectively in the liberalised global environment, the government identifies PSEs and declare
them as maharatnas, navratnas and miniratnas.
They were given greater managerial and operational autonomy, in taking various decisions to run the company
efficiently and thus increase their profits.
Greater operational, financial and managerial autonomy has also been granted to profit-making enterprises referred
to as miniratnas.

The Central Public Sector Enterprises are designated with different status.
A few examples of public enterprises with their status are as follows:
Maharatnas – (a) Indian Oil Corporation Limited, and (b) Steel Authority of India Limited, (ii) Navratnas – (a)
Hindustan Aeronautics Limited, (b) Mahanagar Telephone Nigam Limited; and (iii) Miniratnas – (a) Bharat
Sanchar Nigam Limited; (b) Airport Authority of India and (c) Indian Railway Catering and Tourism Corporation
Limited.

The government envisaged that privatisation could provide strong impetus to the inflow of FDI. The government
has also made attempts to improve the efficiency of PSUs by giving them autonomy in taking managerial
decisions. For instance, some PSUs have been granted special status as maharatnas, navratnas and miniratnas.

GLOBALISATION

Although globalisation is generally understood to mean integration of the economy of the country with the world
economy, it is a complex phenomenon. It is an outcome of the set of various policies that are aimed at transforming
the world towards greater interdependence and integration. It involves creation of networks and activities
transcending economic, social and geographical boundaries.

Globalisation attempts to establish links in such a way that the happenings in India can be influenced by events
happening miles away. It is turning the world into one whole or creating a borderless world.

Outsourcing: This is one of the important outcomes of the globalisation process. In outsourcing, a company hires
regular service from external sources, mostly from other countries, which was previously provided internally or
from within the country (like legal advice, computer service, advertisement, security — each provided by
respective departments of the company). As a form of economic activity, outsourcing has intensified, in recent
times, because of the growth of fast modes of communication, particularly the growth of Information Technology
(IT). Many of the services such as voice-based business processes (popularly known as BPO or call centres), record
keeping, accountancy, banking services, music recording, film editing, book transcription, clinical advice or even
teaching are being outsourced by companies in developed countries to India. With the help of modern
telecommunication links including the Internet, the text, voice and visual data in respect of these services is
digitized and transmitted in real time over continents and national boundaries. Most multinational corporations, and
even small companies, are outsourcing their services to India where they can be availed at a cheaper cost with
reasonable degree of skill and accuracy. The low wage rates and availability of skilled manpower in India
have made it a destination for global outsourcing in the post-reform period.

World Trade Organisation (WTO): The WTO was founded in 1995 as the successor organisation to the General
Agreement on Trade and Tariff (GATT). GATT was established in 1948 with 23 countries as the global trade
organization to administer all multilateral trade agreements by providing equal opportunities to all countries in the
international market for trading purposes.

• WTO is expected to establish a rule-based trading regime in which nations cannot place arbitrary
restrictions on trade.
• its purpose is also to enlarge production and trade of services,
• to ensure optimum utilisation of world resources and to protect the environment.
• The WTO agreements cover trade in goods as well as services to facilitate international trade (bilateral and
multilateral) through removal of tariff as well as non-tariff barriers and providing greater market access to
all member countries.

As an important member of WTO, India has been in the forefront of framing fair global rules, regulations and
safeguards and advocating the interests of the developing world. India has kept its commitments towards
liberalisation of trade, made in the WTO, by removing quantitative restrictions on imports and reducing tariff rates.
Some scholars question the usefulness of India being a member of the WTO as a major volume of international
trade occurs among the developed nations. They also say that while developed countries file complaints over
agricultural subsidies given in their countries, developing countries feel cheated as they are forced to open up their
markets for developed countries but are not allowed access to the markets of developed countries.

APPRAISAL OF THE ECONOMIC REFORMS 1991

1.ECONOMIC GROWTH:
The performance of the Indian economy during this period can be measured by the Gross Domestic Product. The
growth of GDP increased from 5.6 per cent during 1980-91 to 8.2 per cent during 2007-1012. During the reform
period, the growth of agriculture has declined. While the industrial sectors reported fluctuation, the growth of
service sector has gone up.
2.FOREIGN INVESTMENT AND FOREIGN EXCHANGE RESERVES: The opening up of the economy has
led to rapid increase in foreign direct investment and foreign exchange reserves. The foreign investment, which
includes foreign direct investment(FDI) and foreign institutional investment(FII), has increased from about US $
100 million in 1990-91 to US $ 467 billion in 2012-13. There has been an increase in the foreign exchange reserves
from about US $ 6 billion in 1990-91 to about US $ 304 billion in 2013-14. India is one of the largest foreign
exchange reserve holders in the world. India is seen as a successful exporter of auto parts, engineering goods, IT
software and textiles in the reform period.

3. GROWTH AND EMPLOYMENT: Though the GDP growth rate has increased in the reform period, scholars
point out that the reform-led growth has not generated sufficient employment opportunities in the country.

4.REFORMS IN AGRICULTURE:
• Reforms have not been able to benefit agriculture, where the growth rate has been decelerating.
• Public investment in the agriculture sector,especially in infrastructure, which includes irrigation, power,
roads, market linkages and research and extension (which played a crucial role in the Green Revolution),
has fallen in the reform period.
• Further, the removal of fertiliser subsidy has led to increase in the cost of production, which has severely
affected the small and marginal farmers.
• This sector has been experiencing a number of policy changes such as reduction in import duties on
agricultural products, removal of minimum support price and lifting of quantitative restrictions on
agricultural products; these have adversely affected Indian farmers as they now have to face increased
international competition.
• Moreover, because of export oriented policy strategies in agriculture, there has been a shift from production
for the domestic market towards production for the export market focusing on cash crops in lieu of
production of food grains. This puts pressure on prices of food grains.

4.REFORMS IN INDUSTRY: Industrial growth has also recorded a slowdown.

• This is because of decreasing demand of industrial products due to various reasons such as cheaper imports,
inadequate investment in infrastructure etc.
• In a globalised world, developing countries are compelled to open up their economies to greater flow of
goods and capital from developed countries and rendering their industries vulnerable to imported goods.
• Cheaper imports have, thus, replaced the demand for domestic goods. Domestic manufacturers are facing
competition from imports.
• The infrastructure facilities, including power supply, have remained inadequate due to lack of investment.
• Moreover, a developing country like India still does not have the access to developed countries’ markets
because of high non-tariff barriers. For example, although all quota restrictions on exports of textiles and
clothing have been removed in India, U.S.A. has not removed their quota restriction on import of textiles
from India and China
• Globalisation is, thus, often seen as creating conditions for the free movement of goods and services from
foreign countries that adversely affect the local industries and employment opportunities in developing
countries..

5.DISINVESTMENT: 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. Moreover, the
proceeds from disinvestment were used to offset the shortage of government revenues rather than using it for the
development of PSEs and building social infrastructure in the country.

6.REFORMS AND FISCAL POLICIES: Economic reforms have placed limits on

the growth of public expenditure especially in social sectors. The tax reductions in the reform period, aimed at
yielding larger revenue and to curb tax evasion, have not resulted in an increase in tax revenue for the government.
Also, the reform policies involving tariff reduction have curtailed the scope for raising revenue through customs
duties. In order to attract foreign investment, tax incentives were provided to foreign investors which further
reduced the scope for raising tax revenues. This has a negative impact on developmental and welfare expenditures.
7. Rising prices have also been kept under control.

SOCIAL JUSTICE AND WELFARE: 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. Some of 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. Viewed from the
Indian context, some studies have stated that the crisis that erupted in the early 1990s was basically an outcome of
the deep-rooted inequalities in Indian society and the economic reform policies initiated as a response to the crisis
by the government, with externally advised policy package, further aggravated the inequalities.
Further, it has increased the income and quality of consumption of only high-income groups and the growth has
been concentrated only in some select areas in the services sector such as telecommunication, information
technology, finance, entertainment, travel and hospitality services, real estate and trade, rather than vital sectors
such as agriculture and industry which provide livelihoods to millions of people in the country.

Demonetisation - It is the process of stripping a currency unit from its status as legal tender in the country.
Demonetisation results in change in national currency. The present currency in circulation is pulled off and new
currency is circulated.
Types of Demonetisation - (i) Total Demonetisation (ii) Partial Demonetisation

Purposes sought by Demonetisation –

(i) Stripping corruption.
(ii) Combating inflation.
(iii) Curbing counterfeit currency.
(iv) Combating tax evasion.
(v) Increasing performance of economy.
History of Demonetisation in India - (i) On 12/01/1946 all notes of denominations of Rs. 500 and Rs. 1000 were
demonetised with a time limit of 10 days to exchange demonetised notes. Its purpose was to catch tax evaders.
(ii) On 16/01/1978 all notes of denominations of Rs. 1000, Rs. 5000 and Rs. 10000 were demonetised with a time
limit of 3 days to exchange demonetised notes. Its purpose was to catch corrupt leaders and officials in predecessor
governments.
(iii) On 08/11/2016 all notes of denominations of Rs. 500 and Rs. 1000 were demonetised with a time limit of 50
days in exchange demonetised notes from banks and some essential service stores.
Demonetisation of 2016 – (i) On 8 November 2016, the Government of India announced that the demonetization
of all Rs. 500 and Rs, 1000 banknotes of the Mahatma Gandhi series. (ii) Rs. 500 (new series) and Rs. 2000 notes
were introduced. (iii) 50 days time limit given for exchange of demonetised notes. (iv) Limits were put on
exchange per day and withdrawal per day (and week) during this time. (v) Mixed reaction by the public but
strongly criticized by the opposition.
Effects of 2016 Demonetisation – (1) Pushed India towards cashless economy (ii) Raised tax payments (iii)
Brought an end to black money (iv) Curbed terrorist funding (v) Curbed effect on growth and revenues of MSMEs.

Objectives of GST –
(i) To eliminate the cascading impact of taxes on production and distribution coat of goods and services.
(ii) Streamlining indirect tax regime.
(iii) Growth of revenue in States and Union Territories.
(iv) Reduction in transaction costs and unnecessary wastage.
(v) Elimination of the multiplicity of taxation.
(vi) One Point Single Tax.
(vii) Reduction in average tax burdens.
(viii) Reduction in corruption.
Types of GST laws:
(i) At a centre level called Central GST (CGST)
(ii) At the state level State GST (SGST)
Benefits of GST
(i) GST provides comprehensive and wider coverage of input credit set off, one can use service tax credit for the
payment of tax on sale of goods etc.
(ii) Many indirect taxes at state and central level have been included by GST. One needs to pay a single GST
instead of all.
(iii) Uniformity of tax rates across the states.
(iv) Ensure better compliance due to aggregate tax rate reduction.
(v) By reducing the tax burden, the competitiveness of Indian products in the international market has increased
and there by development of the nation.
(vi) Prices of goods are expected to reduce in the long run as the benefits of less tax burden would be passed on to
the consumer.

UNIT 7: CURRENT CHALLENGES FACING THE INDIAN

ECONOMY (22 MARKS)

HUMAN CAPITAL FORMATION

HUMAN CAPITAL: It refers to the stock of skill, ability, expertise, education and knowledge in a nation at a
given point.
SOURCES OF HUMAN CAPITAL

• EDUCATION:
Investment in education is considered as one of the main sources of human capital. Spending on education
by individuals is similar to spending on capital goods by companies with the objective of increasing future
profits over a period of time. Likewise, individuals invest in education with the objective of increasing
their future income.
• HEALTH:
Like education, health is also considered as an important input for the development of a nation as much as
it is important for the development of an individual.
A sick labourer without access to medical facilities is compelled to abstain from work and there is loss of
productivity. Hence, expenditure on health is an important source of human capital formation.
Preventive medicine (vaccination), curative medicine (medical intervention during illness), social
medicine (spread of health literacy) and provision of clean drinking water and good sanitation are the
various forms of health expenditures. Health expenditure directly increases the supply of healthy labour
force and is, thus, a source of human capital formation.

• ON THE JOB TRAINING:

Firms spend on giving on-the-job-training to their workers.

This may take different forms:

1. One, the workers may be trained in the firm itself under the supervision of a skilled worker;
2. Two, the workers may be sent for off-campus training.
In both these cases firms incur some expenses. Firms will, thus, insist that the workers should work for a specific
period of time, after their on-the-job training, during which it can recover the benefits of the enhanced
productivity owing to the training.
Expenditure regarding on-the-job training is a source of human capital formation as the return of such expenditure
in the form of enhanced labour productivity is more than the cost of it.
 • MIGRATION:

People migrate in search of jobs that fetch them higher salaries than what they may get in their native
places. Unemployment is the reason for the rural-urban migration in India. Technically qualified persons,
like engineers and doctors, migrate to other countries because of higher salaries that they may get in such
countries.
Migration in both these cases involves cost of transport, higher cost of living in the migrated places and
psychic costs of living in a strange socio cultural setup. The enhanced earnings in the new place outweigh
the costs of migration; hence, expenditure on migration is also a source of human capital formation.
• INFORMATION:
People spend to acquire information relating to the labour market and other markets like education and
health. For example, people want to know the level of salaries associated with various types of jobs,
whether the educational institutions provide the right type of employable skills and at what cost. This
information is necessary to make decisions regarding investments in human capital as well as for efficient
utilisation of the acquired human capital stock. Expenditure incurred for acquiring information relating to
the labour market and other markets is also a source of human capital formation.

PHYSICAL AND HUMAN CAPITAL

SIMILARITIES: Both the forms of capital formation are outcomes of conscious investment decisions.

Both forms of capital depreciate with time but the nature of depreciation differs between the two.

Continuous use of machine leads to depreciation and change of technology makes a machine obsolete.

In the case of human capital, depreciation takes

place with ageing but can be reduced, to a large extent, through continuous investment in education, health, etc.

HUMAN CAPITAL PHYSICAL CAPITAL

Human capital is intangible; it is endogenously Physical capital is tangible and can be easily sold
built in the body and mind of its owner. Human in the market like any other commodity.
capital is not sold in the market; only the services
of the human capital are sold and, hence, there
arises the necessity of the owner of the human
capital to be present in the place of production.
Human capital is inseparable from its owner. The physical capital is separable from its owner.

Human capital is not perfectly mobile between Physical capital is completely mobile between
countries as movement is restricted by nationality countries except for some artificial trade
and culture. Therefore, human capital formation is restrictions, physical capital formation can be built
to be done through conscious policy formulations even through imports.
in consonance with the nature of the society and
economy and expenditure by the
state and the individuals.

The investment in Human capital facilitates the This is not the case with physical capital.
human capital to cope with change in technology.

Human capital benefits not only the owner but Physical capital creates only private benefit. That
also the society in general. This is called external is, benefits from a capital good flow to those who
 benefit. An educated person can effectively take pay the price for the product and services
part in a democratic produced by it.
process and contribute to the socio-economic
progress of a nation. A healthy person, by
maintaining personal hygiene and sanitation, stops
the spread of contagious diseases and epidemics.
Human capital creates both private and social
benefits

HUMAN CAPITAL AND ECONOMIC GROWTH:

• Economic growth means the increase in real national income of a country; naturally, the contribution of
the educated person to economic growth is more than that of an illiterate person.

If a healthy person could provide uninterrupted labour supply for a longer period of time, then health is
also an important factor for economic growth. Thus, both education and health, along with many other
factors like on-the-job training, job market information and migration, increase an individual’s income
generating capacity.
• This enhanced productivity of human beings or human capital contributes substantially not only
towards increasing labour productivity but also stimulates innovations and creates ability to absorb new
technologies.
• Education provides knowledge to understand changes in society and scientific advancements, thus,
facilitate inventions and innovations. Similarly, the availability of educated labour force facilitates
adaptation to new technologies.

Using the indicators mentioned above, an analysis of improvement in education and health sectors and
growth in real per capita income in both developing and developed countries shows that there is
convergence in the measures of human capital but no sign of convergence of per capita real income.
In other words, the human capital growth in developing countries has been faster but the growth of per
capita real income has not been that fast.
• There are reasons to believe that the causality between human capital and economic growth flows in either
directions. That is, higher income causes building of a high level of human capital and vice versa, that is, a
high level of human capital causes growth of income.
India recognised the importance of human capital in economic growth long ago. The Seventh Five Year Plan
says, “Human resources development (read human capital) has necessarily to be assigned a key role in any
development strategy, particularly in a country with a large population. Trained and educated on sound lines, a
large population can itself become an asset in accelerating economic growth and in ensuring social change in
desired directions.” It is difficult to establish a relation of cause and effect from the growth of human capital
(education and health) to economic growth. These sectors have grown simultaneously. Growth in each sector
probably has reinforced the growth of every other sector.

HUMAN CAPITAL AND HUMAN DEVELOPMENT

HUMAN CAPITAL HUMAN DEVELOPMENT

Human capital considers education and health as a Human development is based on the idea that education
means to increase labour productivity. and health are integral to human well-being because only
when people have the ability to read and write and the
ability to lead a long and healthy life, they will be able to
make other choices which they value.
Human capital treats human beings as a means to In the human development perspective, human beings are
an end; the end being the increase in productivity. ends in themselves. Human welfare should be increased
In this view, any investment in education and through investments in education and health even if such
 health is unproductive if it does not enhance investments do not result in higher labour productivity.
output of goods and services. Therefore, basic education and basic health are important
in themselves, irrespective of their contribution to
labour productivity. In such a view, every individual has
a right to get basic education and basic health care, that
is, every individual has a right to be literate and lead a
healthy life.

STATE OF HUMAN CAPITAL FORMATION IN INDIA

We know that ours is a federal country with a union government, state governments and local governments
(Municipal Corporations, Municipalities and Village Panchayats). The Constitution of India mentions the
functions to be carried out by each level of government.

Accordingly, expenditures on both education and health are to be carried out simultaneously by all the three tiers
of the government.

Education and health care services create both private and social benefits and this is the reason for the existence
of both private and public institutions in the education and health service markets.

Expenditures on education and health make substantial long-term impact and they cannot be easily reversed;
hence, government intervention is essential.

WHY SO?

For instance, once a child is admitted to a school or health care centre where the required services are not
provided, before the decision is taken to shift the child to another institution, substantial amount of damage would
have been done.

Moreover, individual consumers of these services do not have complete information about the quality of services
and their costs. In this situation, the providers of education and health services acquire monopoly power and are
involved in exploitation.

The role of government in this situation is to ensure that the private providers of these services adhere to the
standards stipulated by the government and charge the correct price.

Furthermore, when basic education and health care is considered as a right of the citizens, then it is essential that
the government should provide education and health services free of cost for the deserving citizens and those
from the socially oppressed classes.
Both, the union and state governments, have been stepping up expenditures in the education sector over the years
in order to fulfil the objective of attaining cent per cent literacy and considerably increase the average educational
attainment of Indians.

GROWTH IN GOVERNMENT EXPENDITURE ON EDUCATION:

Expenditure by the government on education is expressed in two ways (i) as a percentage of ‘total government
expenditure’
(ii) as a percentage of Gross Domestic Product (GDP).

The percentage of ‘education expenditure of total government expenditure’ indicates the importance
of education in the scheme of things before the government. The percentage of ‘education expenditure
of GDP’ expresses how much of our income is being committed to the development of education in
the country.
• During 1952-2012, education expenditure as percentage of total government expenditure increased from
7.92 to 11.7 and as percentage of GDP increased from 0.64 to 3.31. Throughout this period the increase in
education expenditure has not been uniform and there has been irregular rise and fall.
• To this if we include the private expenditure incurred by individuals and by philanthropic institutions, the
total education expenditure should be much higher.

• Elementary education takes a major share of total education expenditure and the share of the
higher/tertiary education (institutions of higher learning like colleges, polytechnics and universities) is the
least. Though, on an average, the government spends less on tertiary education, ‘expenditure per student’
in tertiary education is higher than that of elementary. This does not mean that financial resources should
be transferred from tertiary education to elementary education. As we expand school education, we need
more teachers who are trained in the higher educational institutions; therefore, expenditure on all levels of
education should be increased.

In 2009-10, the per capita education expenditure differs considerably across states from as high as Rs 12,500 in
Himachal Pradesh to as low as Rs 2200 in Punjab. This leads to differences in educational opportunities and
attainments across states.

One can understand the inadequacy of the expenditure on education if we compare it with the desired level of
education expenditure as recommended by the various commissions.

• About 50 years ago, the Education Commission (1964–66) had recommended that at least 6 per cent of
GDP be spent on education so as to make a noticeable rate of growth in educational achievements.

The Tapas Majumdar Committee, appointed by the Government of India in 1998, estimated an expenditure of
around Rs 1.37 lakh crore over 10 years (1998-99 to 2006-07) to bring all Indian children in the age group of 6-14
years under the purview of school education. Compared to this desired level of education expenditure of around 6
per cent of GDP, the current level of a little over 4 per cent has been quite inadequate. In principle, a goal of 6 per
cent needs to be reached—this has been accepted as a must for the coming years.

• In 2009, the Government of India enacted the Right of Education Act to make free education a
fundamental right of all children in the age group of 6-14 years.
Government of India has also started levying a 2 per cent ‘education cess’ on all Union taxes. The
revenues from education cess has been earmarked for spending on elementary education. In addition to
this, the government sanctions a large outlay for the promotion of higher education and new loan schemes
for students to pursue higher education.

GROWTH OF EDUCATION SECTOR IN INDIA

There has been considered growth in the field of Education. The number of schools increased from
230.7 thousands (1950-51) to 1,215.8 thousands (2005-06). The no. of teachers in the same period
increased from 751 thousand to 6010 thousands & no of students from 23,800 thousands to 2, 22,700
thousands.
➢ Gross Enrolment Ratio

Gross Enrollment Ratio (GER) is the total enrolment of pupil in grade or cycle or level of education,
regardless of age, expressed as percentage of the corresponding eligible official age group population in
a given school year. GER in elementary education increased steadily from 82% in 1950-51 to 94.85% in
2005-06.
➢ Literacy Rate

The literacy rate has increased from 18.33% to in 1951 to 64.84% in 2001
➢ Elementary Education in India
Elementary Education in India means eight years of schooling from the age of six i.e. primary & middle
school education together, is called Elementary Education. Elementary Education, therefore is the
foundation on which the development of every citizens and the nation as a whole hinges. The
government has made elementary education compulsory and free. But, the goal of universal elementary
education in India has been very difficult to achieve till now. In December 2002, the government of
India made free and compulsory education, a fundamental right of all children in the age group of 6-14
years.

➢ Primary Education Schemes

Government has made number of schemes to make “Education for all”

The following are the few schemes
✓ Sarva Shiksha Abhiyan (SSA)

It was launched in 2001 to universalize & improve the quality of Elementary Education
in India through community ownership of Elementary Education. The SSA is being implemented in
partnership with states to address the needs of children in age group of 6-14 years. The achievements
under SSA up to September 30, 2007, include constructions of 7, 13,179 additional classrooms, 1,
72,381 drinking water facilities, construction of 2, 18,075 toilets. Supply of free textbooks of 6.64 crore
children & appointment of 8.10 lakh teacher‘s besides opening of 1,86,985 (till 31.3.07) new schools.
✓ National Programme for Education of Girls at Elementary Education (NPEGEL):

The programme is aimed at enhancing girl‘s education by providing additional support

for development of a model girl child friendly school. In every cluster with more
intense
community mobilization and supervision of girls enrolment in schools. Under NPEGEL, 35,252 models
schools have been opened. In addition to supporting 25,537 Early Childhood Care & Education (ECCE)
centers. Besides, 24,837 additional classrooms have been constructed and 18.75 lakh teachers have been
given training on gender sensitization.
✓ Kasturba Gandhi Balika Vidyalaya (KGBV)

The Kasturba Gandhi Balika Vidyalaya (KGBV) scheme was launched in July 2004 for
setting up residential schools at upper primary level, for girls belonging predominantly to the SC, ST,
OBC & minority community. The scheme ran as separate scheme for two years but was merged with
Sarva Siksha Abhiyan w.e.f April 1, 2007.
➢ Secondary Education

Secondary Education, which starts with classes IX and X leads to senior secondary classes XI and XII
aims to in cooperate basic skills & analytical abilities. It provides a stepping stone to higher professional
and technical education.
➢ Higher Education

The Higher Education System comprises both general and technical education. The higher education has
undergone a manifold expansion since Independence. The no. of universities in the country has
increased from 27 in 1950-51 to 350 in 2005-06 .University Grants Commission (UGC) takes measures
for promotion and coordination of university education and determination and maintenance of standards
in teaching, examination and research in universities and allocation and disbursement of grants to them.
➢ Technical Education
 Technical Education plays a vital role in human resources development of the country by creating
skilled manpower, enhancing Industrial productivity and improving the quality of life. Since
independence, there has been a phenomenal expansion of Technical Education Sector in the country.
With 43 diploma level polytechnic at the time of independence, the no. increased to 1,231 in 2000-01.
Similarly, the no. of degree level engineering institutions rose from 38 in 1947 to 1265 in 2001-02. All
India Council for
Technical Education (AICTE) is the apex body in the field of Technical Education.

EDUCATIONAL ACHIEVEMENTS IN INDIA:

Generally, educational achievements in a country are indicated in terms of adult literacy level, primary education
completion rate and youth literacy rate.

PROBLEMS OF HUMAN CAPITAL FORMATION IN INDIA:

• The main problems of human capital formation in less developed countries like
India in brief are as under.
• 1. Faster increase in population.
• 2. Defective pattern of investment in education. In the developing
• 3. More stress on the provision of building and equipments.
• 4. Shortage of health and nutrition facilities.
• 5. No facilities of on the job training.
• 6. Study programme for adults.
• 7. Half hearted measures for promotion of employment.
• 8. No manpower planning.
• 9. Neglect of agriculture education.

RURAL DEVELOPMENT

WHY RURAL DEVELOPMENT?

It is because more than two-third of India’s population depends on agriculture that is yet to become productive
enough to provide for them; one-third of rural India still lives in abject poverty.

That is the reason why we have to see a developed rural India if our nation has to realize real progress.
WHAT IS RURAL DEVELOPMENT?

It essentially focuses on action for the development of areas that are lagging behind in the overall development
of the village economy.

• Development of human resources including

– literacy, more specifically, female literacy, education and skill development.

– health, addressing both sanitation and public health.
• Land reforms.
• Development of the productive resources of each locality.
• Infrastructure development like electricity, irrigation, credit, marketing, transport facilities including
construction of village roads and feeder roads to nearby highways, facilities for agriculture research and
extension, and information dissemination.
• Special measures for alleviation of poverty and bringing about significant improvement in the living conditions
of the weaker sections of the population emphasizing access to productive employment opportunities.

HOW TO ACHIEVE RURAL DEVELOPMENT?

• People engaged in farm and non-farm activities in rural areas have to be provided with various means
that help them increase the productivity.
• They also need to be given opportunities to diversify into various non-farm productive activities such as
food processing.
• Enabling them better and more affordable access to healthcare, sanitation facilities at workplaces and
homes and education for all would also need to be given top priority for rapid rural development.

CREDIT AND MARKETING IN RURAL AREAS

Credit:

Growth of rural economy depends primarily on infusion of capital, from time to time, to realize higher
productivity in agriculture and non-agriculture sectors.

As the time gestation between crop sowing and realisation of income after production is quite long, farmers
borrow from various sources to meet their initial investment on seeds, fertilisers, implements and other family
expenses of marriage, death, religious ceremonies etc.

Non Institutional Sources of credit:

These constitute the money lenders, large farmers, local merchants and traders.

Moneylenders and traders exploited small and marginal farmers and landless labourers by lending to them on
high interest rates and by manipulating the accounts to keep them in a debt-trap.
Institutional Sources of credit:

A major change occurred after 1969 when India adopted social banking and multiagency approach to adequately
meet the needs of rural credit.

Later, the National Bank for Agriculture and Rural Development (NABARD) was set up in 1982 as an apex
body to coordinate the activities of all institutions involved in the rural financing system.

The Green Revolution was a harbinger of major changes in the credit system as it led to the diversification of the
portfolio of rural credit towards production oriented lending.

The institutional structure of rural banking today consists of a set of multi-agency institutions, namely,
commercial banks, regional rural banks (RRBs), cooperatives and land development banks. They are expected
to dispense adequate credit at cheaper rates.

SHGs: Recently, Self-Help groups(henceforth SHGs) have emerged to fill the gap in the formal credit system
because the formal credit delivery mechanism has not only proven inadequate but has also not been fully
integrated into the overall rural social and community development.
Since some kind of collateral is required, vast proportion of poor rural households were automatically out of the
credit network.

The SHGs promote thrift in small proportions by a minimum contribution from each member.

From the pooled money, credit is given to the needy members to be repayable in small instalments at reasonable
interest rates.

By March end 2003, more than seven lakh SHGs had reportedly been credit linked. Such credit provisions are
generally referred to as micro-credit programmes. SHGs have helped in the empowerment of women. It is
alleged that the borrowings are mainly confined to consumption purposes.

Rural Banking — a Critical Appraisal:

• Rapid expansion of the banking system had a positive effect on rural farm and non-farm output, income
and employment, especially after the green revolution — it helped farmers to avail services and credit
facilities and a variety of loans for meeting their production needs.

• Famines became events of the past; we have now achieved food security which is reflected in the
abundant buffer stocks of grains.
However, all is not well with our banking system.

• With the possible exception of the commercial banks, other formal institutions have failed to develop a
culture of deposit mobilisation — lending to worthwhile borrowers and effective loan recovery.
Agriculture loan default rates have been chronically high.
• The expansion and promotion of the rural banking sector has taken a backseat after reforms. To improve
the situation, it is suggested that banks need to change their approach from just being lenders to building
up relationship banking with the borrowers. Inculcating the habit of thrift and efficient utilisation of
financial resources needs to be enhanced among the farmers too.
AGRICULTURAL MARKET SYSTEM

Agricultural marketing is a process that involves the assembling, storage, processing, transportation, packaging,
grading and distribution of different agricultural commodities across the country.

Problems faced by the farmers:

• Prior to independence, farmers, while selling their produce to traders, suffered from faulty weighing and
manipulation of accounts.
• Farmers who did not have the required information on prices prevailing in markets were often forced to
sell at low prices.
• They also did not have proper storage facilities to keep back their produce for selling later at a better
price.
Even today, more than 10 per cent of goods produced in farms are wasted due to lack of storage.
Therefore, state intervention became necessary to regulate the activities of the private traders.

FOUR MEASURES THAT WERE INITIATED TO IMPROVE THE MARKETING ASPECT:

• The first step was regulation of markets to create orderly and transparent marketing conditions. By and
large, this policy benefited farmers as well as consumers. However, there is still a need to develop about
27,000 rural periodic markets as regulated market places to realise the full potential of rural markets.
• Second component is provision of physical infrastructure facilities like roads, railways, warehouses,
godowns, cold storages and processing units. The current infrastructure facilities are quite inadequate to
meet the growing demand and need to be improved.
• Cooperative marketing, in realising fair prices for farmers’ products, is the third aspect of government
initiative.
 • The fourth element is the policy instruments like:

(i) assurance of minimum support prices (MSP) for agricultural products;

(ii) maintenance of buffer stocks of wheat and rice by Food Corporation of India and
(iii) distribution of food grains and sugar through PDS.

These instruments are aimed at protecting the income of the farmers and providing food grains at a subsidised
rate to the poor.

However, despite government intervention, private trade (by moneylenders, rural political elites, big merchants
and rich farmers) predominates agricultural markets.

The need for government intervention is imminent particularly when a large share of agricultural products, is
handled by the private sector.

Emerging Alternate Marketing Channels:

It has been realised that if farmers directly sell their produce to consumers, it increases their incomes.

Some examples of these channels are:

Apni Mandi (Punjab, Haryana and Rajasthan);
Hadaspar Mandi (Pune);
Rythu Bazars (vegetable and fruit markets in Andhra Pradesh and Telangana) and
Uzhavar Sandies (farmers markets in Tamil Nadu).

Further, several national and multinational fast food chains are increasingly entering into contracts/alliances
with farmers to encourage them to cultivate farm products (vegetables, fruits, etc.) of the desired quality by
providing them with not only seeds and other inputs but also assured procurement of the produce at pre decided
prices. It is argued that such arrangements will help in reducing the price risks of farmers and would also expand
the markets for farm products.

DIVERSIFICATION INTO PRODUCTIVE ACTIVITIES

Diversification includes two aspects - one relates to change in cropping pattern and the other relates to a shift of
workforce from agriculture to other allied activities (livestock, poultry, fisheries etc.) and non-agriculture sector.

NEED FOR DIVERSIFICATION?

The need for diversification arises from the fact that there is greater risk in depending exclusively on farming for
livelihood.
Diversification towards new areas is necessary not only to reduce the risk from agriculture sector but also to
provide productive sustainable livelihood options to rural people.
Much of the agricultural employment activities are concentrated in the Kharif season. But during the Rabi
season, in areas where there are inadequate irrigation facilities, it becomes difficult to find gainful employment.

As agriculture is already overcrowded, a major proportion of the increasing labour force needs to find alternate
employment opportunities in other non-farm sectors.

Non-farm economy has several segments in it; some possess dynamic linkages that permit healthy growth while
others are in subsistence, low productivity propositions.
The dynamic sub-sectors include agro-processing industries, food processing industries, leather industry,
tourism, etc.
Those sectors which have the potential but seriously lack infrastructure and other support include traditional
home-based industries like pottery, crafts, handlooms etc.

Majority of rural women find employment in agriculture while men generally look for non-farm employment. In
recent times, women have also begun looking for non-farm jobs.

Animal Husbandry:

In India, the farming community uses the mixed crop-livestock farming system — cattle, goats, fowl are the
widely held species.
Livestock production provides increased stability n income, food security, transport, fuel and nutrition for the
family without disrupting other food-producing activities.
Today, livestock sector alone provides alternate livelihood options to over 70 million small and marginal
farmers including landless labourers. A significant number of women also find employment in the livestock
sector.
Poultry accounts for the largest share with 58 per cent followed by others. Other animals which include camels,
asses, horses, ponies and mules are in the lowest rung.
India had about 300 million cattle, including 108 million buffaloes, in 2012. Performance of the Indian dairy
sector over the last three decades has been quite impressive.
Milk production in the country has increased by more than five times between 1960-2012. This can be attributed
mainly to the successful implementation of ‘Operation Flood’. It is a system whereby all the farmers can pool
their milk produced according to different grading (based on quality) and the same is processed and marketed to
urban centres through cooperatives. In this system the farmers are assured of a fair price and income from the
supply of milk to urban markets.

FISHERIES: The fishing community regards the water body as ‘mother’ or ‘provider’. The water bodies
consisting of sea, oceans, rivers, lakes, natural aquatic ponds, streams etc. are, therefore, an integral and life-
giving source for the fishing community.
In India, after progressive increase in budgetary allocations and introduction of new technologies in fisheries
and aquaculture, the development of fisheries has come a long way.

Presently, fish production from inland sources contributes about 64 per cent to the total fish production and the
balance 36 per cent comes from the marine sector (sea and oceans). Today total fish production accounts for 0.8
per cent of the total GDP.
In India, West Bengal, Andhra Pradesh, Kerala, Gujarat, Maharashtra and Tamil Nadu are major fish producing
states. A large share of fish worker families are poor.
Rampant underemployment, low per capita earnings, absence of mobility of labour to other sectors and a high
rate of illiteracy and indebtedness are some of the major problems fishing community face today.
Even though women are not involved in active fishing, about 60 per cent of the workforce in export marketing
and 40 per cent in internal marketing are women.
There is a need to increase credit facilities through cooperatives and SHGs for fisherwomen to meet the working
capital requirements for marketing.

HORTICULTURE:

Blessed with a varying climate and soil conditions, India has adopted growing of diverse horticultural crops
such as fruits, vegetables, tuber crops, flowers, medicinal and aromatic plants, spices and plantation crops.
These crops play a vital role in providing food and nutrition, besides addressing employment concerns.
Horticulture sector contributes nearly one-third of the value of agriculture output and six per cent of Gross
Domestic Product of India.
 India has emerged as a world leader in producing a variety of fruits like mangoes, bananas, coconuts, cashew
nuts and a number of spices and is the second largest producer of fruits and vegetables.
Economic condition of many farmers engaged in horticulture has improved and it has become a means of
improving livelihood for many unprivileged classes.
Flower harvesting, nursery maintenance, hybrid seed production and tissue culture, propagation of fruits and
flowers and food processing are highly remunerative employment options for women in rural areas.
There has been a substantial rise in production of a variety of fruits and vegetables during the time period 1991-
2003. This period is known as Golden Revolution.

OTHER ALTERNATE LIVELIHOOD OPTIONS:

The IT has revolutionised many sectors in the Indian economy. There is broad consensus that IT can play a
critical role in achieving sustainable development and food security in the twenty-first century.
Governments can predict areas of food insecurity and vulnerability using appropriate information and software
tools so that action can be taken to prevent or reduce the likelihood of an emergency.

It also has a positive impact on the agriculture sector as it can disseminate information regarding emerging
technologies and its applications, prices, weather and soil conditions for growing different crops etc.

SUSTAINABLE DEVELOPMENT AND ORGANIC FARMING

In recent years, awareness of the harmful effect of chemical-based fertilisers and pesticides on our health is
on a rise. Conventional agriculture relies heavily on chemical fertilisers and toxic pesticides etc., which enter
the food supply, penetrate the water sources, harm the livestock, deplete the soil and devastate natural eco-
systems.

Efforts in evolving technologies that are eco-friendly are essential for sustainable development and one such
technology which is eco-friendly is organic farming. In short, organic agriculture is a whole system of
farming that restores, maintains and enhances the ecological balance.

There is an increasing demand for organically grown food to enhance food safety throughout the world.

Benefits of Organic Farming:

1. Organic agriculture offers a means to substitute costlier agricultural inputs (such as HYV seeds,
chemical fertilisers, pesticides etc.) with locally produced organic inputs that are cheaper and thereby
generate good returns on investment.
2. Organic agriculture also generates income through exports as the demand for organically grown
crops is on a rise.
3. Studies across countries have shown that organically grown food has more nutritional value than
chemical farming thus providing us with healthy foods.
4. Since organic farming requires more labour input than conventional farming, India will find organic
farming an attractive proposition.
5. Finally, the produce is pesticide-free and produced in an environmentally sustainable way.

Concerns regarding Organic Farming

1. Popularising organic farming requires awareness and willingness on the part of farmers to adapt to
new technology.
2. Inadequate infrastructure and the problem of marketing the products are major concerns that need to
be addressed apart from an appropriate agriculture policy to promote organic farming.
 3. It has been observed that the yields from organic farming are less than modern agricultural farming
in the initial years. Therefore, small and marginal farmers may find it difficult to adapt to large-scale
production.
4. Organic produce may also have more blemishes and shorter shelf life than sprayed produce.
5. Choice in the production of off-season crops is quite limited in organic farming.

Nevertheless, organic farming helps in the sustainable development of agriculture and India has a
clear advantage in producing organic products for both domestic and international markets.

EMPLOYMENT: GROWTH INFORMALISATION AND OTHER ISSUES

Who is a worker?

Activities which contribute to the gross national product are called economic activities. All those who are
engaged in economic activities, in whatever capacity — high or low, are workers.

What is employment?

The nature of employment in India is multifaceted. Some get employment throughout the year; some others get
employed for only a few months in a year. Many workers do not get fair wages for their work.

While estimating the number of workers, all those who are engaged in economic activities are included as
employed.

• During 2011-12, India had about a 473 million strong workforce. Since majority of our people reside in
rural areas, the proportion of workforce residing there is higher.

• The rural workers constitute about three fourth of this 473 million. Men form the majority of workforce
in India. About 70 per cent of the workers are men and the rest are women (men and women include
child labourers in respective sexes).

• Women workers account for one-third of the rural workforce whereas in urban areas, they are just one-
fifth of the workforce.

• Women carry out works like cooking, fetching water and fuel wood and participate in farm labour.
They are not paid wages in cash or in the form of grains; at times they are not paid at all. For this
reason, these women are not categorised as workers. Economists have argued that these women should
also be called workers.

PARTICIPATION OF PEOPLE IN EMPLOYMENT

Worker-population ratio:
To arrive at the worker-population ratio for India, we divide the total number of workers in India by
the population in India and multiply it by 100.

It is an indicator which is used for analysing the employment situation in the country.
This ratio is useful in knowing the proportion of population that is actively contributing to the production of
goods and services of a country.
If the ratio is higher, it means that the engagement of people is greater; if the ratio for a country is medium, or
low, it means that a very high proportion of its population is not involved directly in economic activities.
 • For every 100 persons, about 39 are workers in India. In urban areas, the proportion is about 36
whereas in rural India, the ratio is about 40.

This is so as people in rural areas have limited resources to earn a higher income and participate more
in the employment market.
Many do not go to schools, colleges and other training institutions. Even if some go, they discontinue
in the middle to join the workforce; whereas, in urban areas, a considerable section is able to study in
various educational institutions.
Urban people have a variety of employment opportunities. They look for the appropriate job to suit
their qualifications and skills.
In rural areas, people cannot stay at home as their economic condition may not allow them to do so.
Compared to females, more males are found to be working.

• The difference in participation rates is very large in urban areas: for every 100 urban females, only
about 15 are engaged in some economic activities. In rural areas, for every 100 rural women about 25
participate in the employment market. Why are women, in general, and urban women, in particular, not
working? It is common to find that where men are able to earn high incomes, families discourage
female members from taking up jobs.

SELF -EMPLOYED AND HIRED WORKERS

Workers who own and operate an enterprise to earn their livelihood are known as self employed.

• About 52 per cent workforce in India belongs to this category.

• Casual wage labourers account for 30 per cent of India’s workforce. Such labourers are casually
engaged in others’ farms and, in return, get a remuneration for the work done.

• When a worker is engaged by someone or an enterprise and paid his or her wages on a regular basis,
they are known as regular salaried employees. They account for 18 per cent of India’s workforce.

• Self employment is a major source of livelihood for both men and women as this category accounts for
more than 50 per cent of the workforce.

• Casual wage work is the second major source for both men and women, a little more so for the latter
(31 per cent).

• When it comes to regular salaried employment, men are found to be so engaged in greater proportion.
They form 20 per cent whereas women form only 13 per cent. One of the reasons could be skill
requirement.
• Since regular salaried jobs require skills and a higher level of literacy, women might not have been
engaged to a great extent.
• When we compare the distribution of workforce in rural urban areas you will notice that the self
employed and casual wage labourers are found more in rural areas than in urban areas.

• In the latter, both self employment and regular wage salaried jobs are greater. In the former, since
majority of those depending on farming own plots of land and cultivate independently, the share of self
employed is greater.

• The nature of work in urban areas is different. Obviously everyone cannot run factories, shops and
 offices of various types. Moreover enterprises in urban areas require work

EMPLOYMENT IN FIRMS, FACTORIES AND OFFICES

In the course of economic development of a country, labour flows from agriculture and other related activities
to industry and services.
In this process, workers migrate from rural to urban areas.
Eventually, at a much later stage, the industrial sector begins to lose its share of total employment as the
service sector enters a period of rapid expansion.

This shift can be understood by looking at the distribution of workers by industry. Generally, we divide all
economic activities into eight different industrial divisions.

They are:
(i) Agriculture (ii) Mining and Quarrying (iii) Manufacturing (iv) Electricity, Gas and Water Supply (v)
Construction (vi) Trade (vii) Transport and Storage and (viii) Services.

For simplicity, all the working persons engaged in these divisions can be clubbed into three major sectors
viz., (a) primary sector which includes (i) , (b) secondary sector which includes (ii), (iii), (iv) and (v) and
(c) service sector which includes divisions (vi), (vii) and (viii).

Distribution of working persons in different industries during the year 2011-12.

• Primary sector is the main source of employment for majority of workers in India.
• Secondary sector provides employment to only about 24 per cent of workforce.
• About 27 per cent of workers are in the service sector.
• About 67 per cent of the workforce in rural India depends on agriculture, forestry and fishing.
• About 16 per cent of rural workers are working in manufacturing industries, construction and other
industrial activities.
• Service sector provides employment to only about 17 per cent of rural workers.
• Agriculture is not a major source of employment in urban areas where people are mainly engaged in the
service sector. About 60 per cent of urban workers are in the service sector.
• The secondary sector gives employment to about 30 per cent of urban workforce.
Though both men and women workers are concentrated in the primary sector, women workers’
concentration is very high there. About 63 per cent of the female workforce is employed in the primary
sector whereas less than half of males work in that sector.
Men get opportunities in both secondary and service sectors.

GROWTH AND CHANGING STRUCTURE OF EMPLOYMENT

• During the period 1950–2010, Gross Domestic Product (GDP) of India grew positively and was higher
than the employment growth. However, there was always fluctuation in the growth of GDP. During this
period, employment grew at the rate of not more than 2 per cent.
• In the late 1990s, employment growth started declining and reached the level of growth that India had
in the early stages of planning. During these years, we also find a widening gap between the growth of
GDP and employment. This means that in the Indian economy, without generating employment, we
have been able to produce more goods and services. Scholars refer to this phenomenon as jobless
growth.

• We know that India is an agrarian nation; a major section of population lives in rural areas and is
dependent on agriculture as their main livelihood.

• Developmental strategies in many countries, including India, have aimed at reducing the proportion of
people depending on agriculture. Distribution of workforce by industrial sectors shows substantial shift
 from farm work to non-farm work (see Table 7.3). In 1972-73, about 74 per cent of workforce was
engaged in primary sector and in 2011-12, this proportion has declined to about 50 per cent. Secondary
and service sectors are showing promising future for the Indian workforce. You may notice that the
shares of these sectors have increased from 11 to 24 per cent and 15 to 27 per cent, respectively.

• The distribution of workforce in different status indicates that over the last four decades (1972-2012)
people have moved from self employment and regular salaried employment to casual wage work.
Yet self-employment continues to be the major employment provider. Scholars call the process of
moving from self-employment and regular salaried employment to casual wage work as casualisation
of workforce. This makes the workers highly
vulnerable.

INFORMALISATION OF INDIAN WORKFORCE

• One of the objectives of development planning in India, since India’s independence, has been to
provide decent livelihood to its people.

It has been envisaged that the industrialisation strategy would bring surplus workers from agriculture
to industry with better standard of living as in developed countries.

We have seen in the preceding section, that even after 55 years of planned development, more than half
of the Indian workforce depends on farming as the major source of livelihood.

• A small section of Indian workforce is getting regular income. The government, through its labour
laws, enable them to protect their rights in various ways. This section of the workforce forms trade
unions, bargains with employers for better wages and other social security measures.

CLASSIFICATION OF THE WORKFORCE

We classify workforce into two categories: workers in formal and informal sectors, which are also
referred to as organised and unorganized sectors.

FORMAL SECTOR

All the public sector establishments and those private sector establishments which employ 10 hired workers or
more are called formal sector establishments and those who work in such establishments are formal sector
workers.

Those who are working in the formal sector enjoy social security benefits. They earn more than those in the
informal sector.

INFORMAL SECTOR

All other enterprises and workers working in those enterprises form the informal sector.

Thus, informal sector includes millions of farmers, agricultural labourers, owners of small enterprises and
people working in those enterprises as also the self-employed who do not have any hired workers.
It also includes all non-farm casual wage labourers who work for more than one employer such as construction
workers and head load workers.

Workers and enterprises in the informal sector do not get regular income; they do not have any protection or
regulation from the government. Workers are dismissed without any compensation.
Developmental planning envisaged that as the economy grows, more and more workers would become formal
sector workers and the proportion of workers engaged in the informal sector would dwindle.

But what has happened in India?

• There are about 473 million workers in the country. There are about 30 million workers in the formal
sector.
About only six per cent.
Thus, the rest 94 per cent are in the informal sector. Out of 30 million formal sector workers, only 6
million, that is, only about 21 per cent are women. In the informal sector, male workers account for 69
per cent of the workforce.

• Since the late 1970s, many developing countries, including India, started paying attention to enterprises
and workers in the informal sector as employment in the formal sector is not growing.
• Technology used in the informal sector enterprises is outdated; they also do not maintain any accounts.
Workers of this sector live in slums and are squatters.

Of late, owing to the efforts of the International Labour Organisation (ILO), the Indian government has
initiated the modernisation of informal sector enterprises and provision of social security measures to informal
sector workers.

UNEMPLOYMENT

NSSO defines unemployment as a situation in which all those who, owing to lack of work, are not working but
either seek work through employment exchanges, intermediaries, friends or relatives or by making applications
to prospective employers or express their willingness or availability for work under the prevailing condition of
work and remunerations. There are a variety of ways by which an unemployed person is identified.

Economists define unemployed person as one who is not able to get employment of even one hour in half a
day.

There are three sources of data on unemployment : Reports of Census of India, National Sample Survey
Organisation’s Reports of Employment and Unemployment Situation and Directorate General of Employment
and Training Data of Registration with Employment Exchanges.

Though they provide different estimates of unemployment, they do provide us with the attributes of the
unemployed and the variety of unemployment prevailing in our country.

DISGUISED UNEMPLOYMENT:

Suppose a farmer has four acres of land and he actually needs only two workers and himself to carry out
various operations on his farm in a year, but if he employs five workers and his family members such as his
wife and children, this situation is known as disguised unemployment. One study conducted in the late 1950s
showed about one third of agriculture workers in India as disguisedly unemployed.

SEASONAL UNEMPLOYMENT:

Many people migrate to an urban area, pick up a job and stay there for some time, but come back to their home
villages as soon as the rainy season begins. This is because work in agriculture is seasonal; there
are no employment opportunities in the village for all months in the year.

When there is no work to do on farms, people

go to urban areas and look for jobs. This kind of unemployment is known as seasonal unemployment. This is
 also a common form of unemployment prevailing in India.

GOVERNMENT AND EMPLOYMENT GENERATION

MGNREGA: You may recall about the National Rural Employment Guarantee Act 2005. It promises 100 days
of guaranteed wage employment to all rural households who volunteer to do unskilled manual work.

This scheme is one of the many measures governments implement to generate employment for those who are
in need of jobs in rural areas.

Since independence, the Union and state governments have played an important role in generating employment
or creating opportunities for employment generation. Their efforts can be broadly categorised into two —
direct and indirect.

In the first category, as you have seen in the preceding section, government employs people in various
departments for administrative purposes.

It also runs industries, hotels and transport companies and hence provides employment directly to workers.
When output of goods and services from government enterprises increases, then private enterprises which
receive raw materials from government enterprises will also raise their output and hence increase the number
of employment opportunities in the economy.

For example, when a government owned steel company increases its output, it will result in direct increase in
employment in that government company. Simultaneously, private companies, which purchase steel from it,
will also increase their output and thus employment. This is the indirect generation of employment
opportunities by the government initiatives in the economy.

Many programmes that the governments implement, aiming at alleviating poverty, are through employment
generation. They are also known as employment generation programmes.
All these programmes aim at providing not only employment but also services in areas such as primary health,
primary education, rural drinking water, nutrition, assistance for people to buy income and employment
generating assets, development of community assets by generating wage employment, construction of houses
and sanitation, assistance for constructing houses, laying of rural roads, development of wastelands/ degraded
lands.

CAUSES OF UNEMPLOYMENT
* Slow rate of economic growth
* Population explosion
* Underdeveloped agriculture
* Defective educational system
* Slow growth of Industry
* Decline of collage and small industry .
* Faulty planning
* Inadequate employment planning.
* Low capital formation.

ENVIRONMENT & SUSTAINABLE DEVELOPMENT

ENVIRONMENT — DEFINITION AND FUNCTIONS

Environment is defined as the total planetary inheritance and the totality of all resources. It includes all the
biotic and abiotic factors that influence each other. While all living elements—the birds, animals and plants,
forests, fisheries etc.—are biotic elements, abiotic elements include air, water, land etc. Rocks and sunlight
are all examples of abiotic elements of the environment.

Functions of the Environment: The environment performs four vital functions:

(i) it supplies resources: resources here include both renewable and non-renewable resources.
Renewable resources are those which can be used without the possibility of the resource becoming
depleted or exhausted. That is, a continuous supply of the resource remains available. Examples of
renewable resources are the trees in the forests and the fishes in the ocean. Non-renewable resources,
on the other hand, are those which get exhausted with extraction and use, for example, fossil fuel
(ii) it assimilates waste.
(iii) it sustains life by providing genetic and bio diversity and
(iv) it also provides aesthetic services like scenery etc.

The environment is able to perform these functions without any interruption as long as the demand on these
functions is within its carrying capacity. This implies that the resource extraction is not above the rate of
regeneration of the resource and the wastes generated are within the assimilating capacity of the
environment. When this is not so, the environment fails to perform its third and vital function of life
sustenance and this results in an environmental crisis.
This is the situation today all over the world. The rising population of the developing countries and the
affluent consumption and production standards of the developed world have placed a huge stress on the
environment in terms of its first two functions.

Many resources have become extinct and the wastes generated are beyond the absorptive capacity of the
environment. Absorptive capacity means the ability of the environment to absorb degradation. The result
— we are today at the threshold of environmental crisis.

The past development has polluted and dried up rivers and other aquifers making water an economic good.
Besides, the intensive and extensive extraction of both renewable and non-renewable resources has
exhausted some of these vital resources and we are compelled to spend huge amounts on technology and
research to explore new resources. Added to these are the health costs of degraded environmental quality —
decline in air and water quality (seventy per cent of water in India is polluted) have resulted in increased
incidence of respiratory and water-borne diseases. Hence the expenditure on health is also rising. To make
matters worse, global environmental issues such as global warming and ozone depletion also contribute to
increased financial commitments for the government.

GLOBAL WARMING

Global warming is a gradual increase in the average temperature of the earth’s lower atmosphere as a result
of the increase in greenhouse gases since the Industrial Revolution.

Much of the recent observed and projected global warming is human-induced. It is caused by man-made
increases in carbon dioxide and other greenhouse gases through the burning of fossil fuels and
deforestation. Adding carbon dioxide, methane and such other gases (that have the potential to absorb heat)
to the atmosphere with no other changes will make our planet’s surface warmer.

The atmospheric concentrations of carbon dioxide and CH4 have increased by 31 per cent and 149 per cent
respectively above pre-industrial levels since 1750.

During the past century, the atmospheric temperature has risen by 1.1°F (0.6°C) and sea level has risen
several inches. Some of the longer-term results of global warming are melting of polar ice with a resulting
rise in sea level and coastal flooding; disruption of drinking water supplies dependent on snow melts;
extinction of species as ecological niches disappear; more frequent tropical storms; and an increased
incidence of tropical diseases.

Among factors that may be contributing to global warming are the burning of coal and petroleum products
(sources of carbon dioxide, methane, nitrous oxide, ozone); deforestation, which increases the amount of
carbon dioxide in the atmosphere; methane gas released in animal waste; and increased cattle production,
which contributes to deforestation, methane production, and use of fossil fuels.

A UN Conference on Climate Change, held in Kyoto, Japan, in 1997, resulted in an international agreement
to fight global warming which called for reductions in emissions of greenhouse gases by industrialised
nations.
Thus, it is clear that the opportunity costs of negative environmental impacts are high.

OZONE DEPLETION

Ozone depletion refers to the phenomenon of reductions in the amount of ozone in the stratosphere.

The problem of ozone depletion is caused by high levels of chlorine and bromine compounds in the
stratosphere. The origins of these compounds are chlorofluorocarbons (CFC), used as cooling substances in
air conditioners and refrigerators, or as aerosol propellants, and bromofluorocarbons (halons), used in fire
extinguishers.

As a result of depletion of the ozone layer, more ultraviolet (UV) radiation comes to Earth and causes
damage to living organisms. UV radiation seems responsible for skin cancer in humans; it also lowers
production of phytoplankton and thus affects other aquatic organisms. It can also influence the growth of
terrestrial plants. A reduction of approximately 5 per cent in the ozone layer was detected from 1979 to
1990. Since the ozone layer prevents most harmful wavelengths of ultraviolet light from passing through the
Earth’s atmosphere, observed and projected decreases in ozone have generated worldwide concern.

This led to the adoption of the Montreal Protocol banning the use of chlorofluorocarbon (CFC)
compounds, as well as other ozone depleting chemicals such as carbon tetrachloride, trichloroethane (also
known as methyl chloroform), and bromine compounds known as halons.

With population explosion and with the advent of industrial revolution to meet the growing needs of the
expanding population, things changed.

The result was that the demand for resources for both production and consumption went beyond the rate of
regeneration of the resources; the pressure on the absorptive capacity of the environment increased
tremendously — this trend continues even today. Thus what has happened is a reversal of supply-demand
relationship for environmental quality — we are now faced with increased demand for environmental
resources and services but their supply is limited due to overuse and misuse. Hence the environmental issues
of waste generation and pollution have become critical today.

STATE OF INDIA’S ENVIRONMENT

India has abundant natural resources in terms of rich quality of soil, hundreds of rivers and tributaries, lush
green forests, plenty of mineral deposits beneath the land surface, vast stretch of the Indian Ocean, ranges of
mountains, etc. The black soil of the Deccan Plateau is particularly suitable for cultivation of cotton, leading
to concentration of textile industries in this region. The Indo-Gangetic plains — spread from the Arabian
Sea to the Bay of Bengal — are one of the most fertile, intensively cultivated and densely populated regions
in the world. India’s forests, though unevenly distributed, provide green cover for a majority of its
population and natural cover for its wildlife. Large deposits of iron-ore, coal and natural gas are found in the
country. India alone accounts for nearly 20 per cent of the world’s total iron-ore reserves. Bauxite, copper,
chromate, diamonds, gold, lead, lignite, manganese, zinc, uranium, etc. are also available in different parts
of the country.

However, the developmental activities in India have resulted in pressure on its finite natural resources,
besides creating impacts on human health and well-being.

The threat to India’s environment poses a dichotomy—threat of poverty-induced environmental degradation

and, at the same time, threat of pollution from affluence and a rapidly growing industrial sector.
Air pollution, water contamination, soil erosion, deforestation and wildlife extinction are some of the most
pressing environmental concerns of India.
The priority issues identified are (i) land degradation (ii) biodiversity loss (iii) air pollution with special
reference to vehicular pollution in urban cities (iv) management of fresh water and (v) solid waste
management.

Land in India suffers from varying degrees and types of degradation stemming mainly from unstable use and
inappropriate management practices.

Some of the factors responsible for land degradation are

(i) loss of vegetation occuring due to deforestation
(ii) unsustainable fuel wood and fodder extraction
(iii) shifting cultivation
(iv) encroachment into forest lands
(v) forest fires and over grazing
(vi) non-adoption of adequate soil conservation measures
(vii) improper crop rotation
(viii) indiscriminate use of agro-chemicals such as fertilisers and pesticides
(ix) improper planning and management of irrigation systems
(x) extraction of ground water in the competing uses of land for forestry, agriculture, pastures, human
settlements and industries exert an enormous pressure on the country’s finite land resources.
(xi) open access resource and
(xii) poverty of the agriculture-dependent people.

The per capita forest land in the country is only 0.08 hectare against the requirement of 0.47 hectare to meet
basic needs, resulting in an excess felling of about 15 million cubic metre forests over the permissible limit.
Estimates of soil erosion show that soil is being eroded at a rate of 5.3 billion tonnes a year for the entire
excess of the recharge capacity India supports approximately 17 per cent of the world’s human and 20 per
cent of livestock population on a mere 2.5 per cent of the world’s geographical area. The high density of
population and livestock and country as a result of which the country loses 0.8 million tonnes of nitrogen,
1.8 million tonnes of phosphorus and 26.3 million tones of potassium every year.

According to the Government of India, the quantity of nutrients lost due to erosion each year ranges from
5.8 to 8.4 million tonnes.

In India, air pollution is widespread in urban areas where vehicles are the major contributors and in a few
other areas which have a high concentration of industries and thermal power plants. Vehicular emissions are
of particular concern since these are ground level sources and, thus, have the maximum impact on the
general population. The number of motor vehicles has increased from about 3 lakh in 1951 to 67 crores in
2003. In 2003, personal transport vehicles (two-wheeled vehicles and cars only) constituted about 80 per
cent of the total number of registered vehicles thus contributing significantly to total air pollution load.
India is one of the ten most industrialised nations of the world. But this status has brought with
it unwanted and unanticipated consequences such as unplanned urbanisation, pollution and the risk of
accidents. The CPCB (Central Pollution Control Board) has identified seventeen categories of
industries (large and medium scale) as significantly polluting.
SUSTAINABLE DEVELOPMENT

Environment and economy are interdependent and need each other. Hence, development that ignores its
repercussions on the environment will destroy the environment that sustains life forms. What is needed is
sustainable development: development that will allow all future generations to have a potential average
quality of life that is at least as high as that which is being enjoyed by the current generation. The concept of
sustainable development was emphasised by the United Nations Conference on Environment and
Development (UNCED), which defined it as: ‘Development that meets the need of the present generation
without compromising the ability of the future generation to meet their own needs’. The use of the concept
‘needs’ in the definition is linked to distribution of resources.

The Brundtland Commission emphasises on protecting the future generation. This is in line with the
argument of the environmentalists who emphasise that we have a moral obligation to hand over the planet
earth in good order to the future generation; that is, the present generation should bequeath a better
environment to the future generation.

At least we should leave to the next generation a stock of ‘quality of life’ assets no less than what we have
inherited.
The present generation can promote development that enhances the natural and built environment in ways
that are compatible with (i) conservation of natural assets (ii) preservation of the regenerative capacity of the
world’s natural ecological system (iii) avoiding the imposition of added costs or risks on future generations.

According to Herman Daly, a leading environmental economist, to achieve sustainable development, the
following needs to be done (i) limiting the human population to a level within the carrying capacity of the
environment. The carrying capacity of the environment is like a ‘plimsoll line’ of the ship which is its load
limit mark. In the absence of the plimsoll line for the economy, human scale grows beyond the carrying
capacity of the earth and deviates from sustainable development (ii) technological progress should be input
efficient and not input consuming (iii) renewable resources should be extracted on a sustainable basis, that
is, rate of extraction should not exceed rate of regeneration (iv) for non-renewable resources rate of
depletion should not exceed the rate of creation of renewable substitutes and (v) inefficiencies arising from
pollution should be corrected.

STRATEGIES FOR SUSTAINABLE DEVELOPMENT

• Use of Non-conventional Sources of Energy: India, as you know, is hugely dependent on thermal
and hydro power plants to meet its power needs. Both of these have adverse environmental impacts.
Thermal power plants emit large quantities of carbon dioxide which is a green house gas. It also
produces fly ash which, if not used properly, can cause pollution of water bodies, land and other
components of the environment. Hydroelectric projects inundate forests and interfere with the natural
flow of water in catchment areas and the river basins. Wind power and solar rays are good examples
of conventional but cleaner and greener energy sources but are not yet been explored on a large scale
due to lack of technological devices.
• LPG, Gobar Gas in Rural Areas: Households in rural areas generally use wood, dung cake or other
biomass as fuel. This practice has several adverse implications like deforestation, reduction in green
cover, wastage of cattle dung and air pollution. To rectify the situation, subsidised LPG is being
provided. In addition, gobar gas plants are being provided through easy loans and subsidy. As far as
liquefied petroleum gas (LPG) is concerned, it is a clean fuel — it reduces household pollution to a
large extent. Also, energy wastage is minimised. For the gobar gas plant to function, cattle dung is
fed to the plant and gas is produced which is used as fuel while the slurry which is left over is a very
good organic fertiliser and soil conditioner.
• CNG in Urban Areas: In Delhi, the use of Compressed Natural Gas (CNG) as fuel in public
transport system has significantly lowered air pollution and the air has become cleaner in the last few
years.
• Wind Power: In areas where speed of wind is usually high, wind mills can provide electricity
without any adverse impact on the environment. Wind turbines move with the wind and electricity is
generated. No doubt, the initial cost is high. But the benefits are such that the high cost gets easily
absorbed.
• Solar Power through Photovoltaic Cells: India is naturally endowed with a large quantity of solar
energy in the form of sunlight. We use it in different ways. For example, we dry our clothes, grains,
other agricultural products as well as various items made for daily use. We also use sunlight to warm
ourselves in winter. Plants use solar energy to perform photosynthesis. Now, with the help of
photovoltaic cells, solar energy can be converted into electricity. These cells use special kind of
materials to capture solar energy and then convert the energy into electricity. This technology is
extremely useful for remote areas and for places where supply of power through grid or power lines
is either not possible or proves very costly. This technique is also totally free from pollution.
• Mini-hydel Plants: In mountainous regions, streams can be found almost everywhere. A large
percentage of such streams are perennial. Mini-hydel plants use the energy of such streams to move
small turbines. The turbines generate electricity which can be used locally. Such power plants are
more or less environment-friendly as they do not change the land use pattern in areas where they are
located; they generate enough power to meet local demands. This means that they can also do away
with the need for large scale transmission towers and cables and avoid transmission loss.
• Traditional Knowledge and Practices: Traditionally, Indian people have been close to their
environment. They have been more a component of the environment and not its controller. If we look
back at our agriculture system, healthcare system, housing, transport etc., we find that all practices
have been environment friendly. Only recently have we drifted away from the traditional systems
and caused large scale damage to the environment and also our rural heritage. Now, it is time to go
back. One apt example is in healthcare. India is very much privileged to have about 15,000 species of
plants which have medicinal properties. About 8,000 of these are in regular use in various systems of
treatment including the folk tradition. With the sudden onslaught of the western system of treatment,
we were ignoring our traditional systems such as Ayurveda, Unani, Tibetan and folk systems. These
healthcare systems are in great demand again for treating chronic health problems. Now a days every
cosmetic produce — hair oil, toothpaste, body lotion, face cream and what not — is herbal in
composition. Not only are these products environment friendly, they are relatively free from side
effects and do not involve large-scale industrial and chemical processing.
• Bio composting: In our quest to increase agricultural production during the last five decades or so,
we almost totally neglected the use of compost and completely switched over to chemical fertilisers.
The result is that large tracts of productive land have been adversely affected, water bodies including
ground water system have suffered due to chemical contamination and demand for irrigation has
been going up year after year. Farmers, in large numbers all over the country, have again started
using compost made from organic wastes of different types. In certain parts of the country, cattle are
maintained only because they produce dung which is an important fertiliser and soil conditioner.
Earthworms can convert organic matter into compost faster than the normal composting process.
This process is now being widely used. Indirectly, the civic authorities are benefited too as they have
to dispose reduced quantity of waste.
• Bio-pest Control: With the advent of green revolution, the entire country entered into a frenzy to
use more and more chemical pesticides for higher yield. Soon, the adverse impacts began to show;
food products were contaminated, soil, water bodies and even ground water were polluted with
pesticides. Even milk, meat and fishes were found to be contaminated. To meet this challenge,
efforts are on to bring in better methods of pest control. One such step is the use of pesticides based
on plant products. Neem trees are proving to be quite useful. Several types of pest controlling
chemicals have been isolated from neem and these are being used. Mixed cropping and growing
different crops in consecutive years on the same land have also helped farmers. In addition,
awareness is spreading about various animals and birds which help in controlling pests. For example,
snakes are one of the prime group of animals which prey upon rats, mice and various other pests.
Similarly, large varieties of birds, for example, owls and peacocks, prey upon vermin and pests. If
these are allowed to dwell around the agricultural areas, they can clear large varieties of pests
including insects. Lizards are also important in this regard. We need to know their value and save
them.
 UNIT8- COMPARATIVE DEVELOPMENT OF INDIA AND ITS NEIGHBOURS (6 MARKS)

DEVELOPMENTAL PATH — A SNAPSHOT VIEW

While India and Pakistan became independent nations in 1947, People’s Republic of China was established
in 1949.

All the three countries had started planning their development strategies in similar ways. While India
announced its first Five Year Plan for 1951-56, Pakistan announced its first five year plan, called, the
Medium Term Plan, in 1956. China announced its First Five Year Plan in 1953.

India and Pakistan adopted similar strategies such as creating a large public sector and raising public
expenditure on social development. Till the 1980s, all the three countries had similar growth rates and per
capita incomes.

CHINA

After the establishment of People’s Republic of China under one party rule, all the critical sectors of the
economy, enterprises and lands owned and operated by individuals were brought under government control.
The Great Leap Forward (GLF)

This campaign was initiated in 1958 and aimed at industrialising the country on a massive scale. People
were encouraged to set up industries in their backyards.

In rural areas, communes were started. Under the Commune system, people collectively cultivated lands.

In 1958, there were 26,000 communes covering almost all the farm population.

GLF campaign met with many problems- A severe drought caused havoc in China killing about 30 million
people. When Russia had conflicts with China, it withdrew its professionals who had earlier been sent to
China to help in the industrialisation process.

THE GREAT PROLETARIAN CULTURAL REVOLUTION

In 1965, Mao introduced the Great Proletarian Cultural Revolution (1966-76) under which students and
professionals were sent to work and learn from the countryside.

INTRODUCTION OF REFORMS (1978)

The present-day fast industrial growth in China can be traced back to the reforms introduced in 1978. China
introduced reforms in phases.

In the initial phase, reforms were initiated in agriculture, foreign trade and investment sectors.

In agriculture, for instance, commune lands were divided into small plots which were allocated (for use not
ownership) to individual households. They were allowed to keep all income from the land after paying
stipulated taxes.
In the later phase, reforms were initiated in the industrial sector. Private sector firms, in general, and
township and village enterprises, i.e. those enterprises which were owned and operated by local collectives,
in particular, were allowed to produce goods.

At this stage, enterprises owned by government (known as State Owned Enterprises—SOEs) were made to
face competition.

The reform process also involved dual pricing. This means fixing the prices in two ways; farmers and
industrial units were required to buy and sell fixed quantities of inputs and outputs on the basis of prices
fixed by the government and the rest were purchased and sold at market prices.

Over the years, as production increased, the proportion of goods or inputs transacted in the market was also
increased. In order to attract foreign investors, special economic zones were set up.

PAKISTAN

While looking at various economic policies that Pakistan adopted, you will notice many similarities with
India.

Pakistan also follows the mixed economy model with co-existence of public and private sectors.

In the late 1950s and 1960s, Pakistan introduced a variety of regulated policy framework (for import
substitution industrialisation). The policy combined tariff protection for manufacturing of consumer goods
together with direct import controls on competing imports.

The introduction of Green Revolution led to mechanisation and increase in public investment in
infrastructure in select areas, which finally led to a rise in the production of food grains. This changed the
agrarian structure dramatically.

In the 1970s, nationalisation of capital goods industries took place. Pakistan then shifted its policy
orientation in the late 1970s and 1980s when the major thrust areas were denationalisation and
encouragement to private sector.

During this period, Pakistan also received financial support from western nations and remittances from
continuously increasing outflow of emigrants to the Middle-east. This helped the country in stimulating
economic growth. The then government also offered incentives to the private sector. All this created a
conducive climate for new investments. In 1988, reforms were initiated in the country.

DEMOGRAPHIC INDICATORS

DENSITY : Though China is the largest nation among the three, its density is the lowest though
geographically it occupies the largest area.

GROWTH RATE OF POPULATION: The population growth as being highest in Pakistan, followed by
India and China. Scholars point out the one-child norm introduced in China in the late 1970s as the major
reason for low population growth. They also state that this measure led to a decline in the sex ratio, the
proportion of females per 1000 males.

SEX RATIO: However, from the table, you will notice that the sex ratio is low and biased against females in
all the three countries. Scholars cite son preference prevailing in all these countries as the reason.
In recent times, all the three countries are adopting various measures to improve the situation. One-child
norm and the resultant arrest in the growth of population also have other implications. For instance, after a
few decades, in China, there will be more elderly people in proportion proportion to young people. This will
force China to take steps to provide social security measures with fewer workers.

FERTILITY RATE: The fertility rate is also low in China and very high in Pakistan.

URBANISATION: Urbanisation is high in both Pakistan and China with India having 28 per cent of its
people living in urban areas.

GROSS DOMESTIC PRODUCT AND SECTORS

China has the second largest GDP (PPP) of $7.2 trillion whereas India’s GDP (PPP) is $3.3 trillion and
Pakistan’s GDP is roughly about 10 per cent of India’s GDP. When many developed countries were finding
it difficult to maintain a growth rate of even 5 per cent, China was able to maintain near double-digit growth
for more than two decades.

Note: PPP stands for Purchasing power parity.

100/2 =50

1$=Rs 50

GDP= Rs 2000/50=$40

S= exchange rate of currency 1 to currency 2

P1= Cost of the basket of goods in currency 1

P2= Cost of basket of goods in currency 2

S=P1/P2

S=75/1

S=75

Also notice that in the 1980s Pakistan was ahead of India; China was having double-digit growth and India
was at the bottom.

In the 1990s, there is a marginal decline in India and China’s growth rates whereas Pakistan met with drastic
decline at 3.6 per cent. Some scholars hold the reform processes introduced in 1988 in Pakistan and political
instability as the reason behind this trend.

In China due to topographic and climatic conditions, the area suitable for cultivation is relatively small —
only about 10 per cent of its total land area. The total cultivable area in China accounts for 40 per cent of the
cultivable area in India.

Until the 1980s, more than 80 per cent of the people in China were dependent on farming as their sole
source of livelihood. Since then, the government encouraged people to leave their fields and pursue other
activities such as handicrafts, commerce and transport.

In 2000, with 54 per cent of its workforce engaged in agriculture, its contribution to GDP in China is 15 per
cent (see Table 10.3).
In both India and Pakistan, the contribution of agriculture to GDP is the same, at 23 per cent, but the
proportion of workforce that works in this sector is more in India.

In Pakistan, about 49 per cent of people work in agriculture whereas in India it is 60 per cent.

The sectoral share of output and employment also shows that in all the three economies, the industry and
service sectors have less proportion of workforce but contribute more in terms of output.

In China, manufacturing contributes the highest to GDP at 53 per cent whereas in India and Pakistan, it is
the service sector which contributes the highest.

In both these countries, service sector accounts for more than 50 per cent of GDP. In the normal course of
development, countries first shift their employment and output from agriculture to manufacturing and then
to services. This is what is happening in China.

The proportion of workforce engaged in manufacturing in India and Pakistan were low at 16 and 18 per cent
respectively. The contribution of industries to GDP is also just equal to or marginally higher than the output
from agriculture.

In India and Pakistan, the shift is taking place directly to the service sector. Thus, in both India and
Pakistan, the service sector is emerging as a major player of development. It contributes more to GDP and,
at the same time, emerges as a prospective employer.

If we look at the proportion of workforce in the1980s, Pakistan was faster in shifting its workforce to service
sector than India and China. In the 1980s, India, China and Pakistan employed 17, 12 and 27 per cent of its
workforce in the service sector respectively.

In 2000, it has reached the level of 24, 19 and 37 per cent respectively. In the last two decades, the growth
of agriculture sector, which employs the largest proportion of workforce in all the three countries, has
declined.

In the industrial sector, China has maintained a double-digit growth rate whereas for India and Pakistan
growth rate has declined. In the case of service sector, India has been able to raise its rate of growth in the
1990s while China and Pakistan reduced their service sector growth. Thus, China’s growth is mainly
contributed by the manufacturing sector and India’s growth by service sector. During this period, Pakistan
has shown deceleration in all the three sectors.

HUMAN DEVELOPMENT INDEX

INDICATORS OF HUMAN DEVELOPMENT

China is moving ahead of India and Pakistan. This is true for many indicators — income indicator such as
GDP per capita, or proportion of population below poverty line or health indicators such as mortality rates,
access to sanitation, literacy, life expectancy or malnourishment.

Pakistan is ahead of India in reducing proportion of people below the poverty line and also its performance
in education, sanitation and access to water is better than India.

But neither of these two countries have been able to save women from maternal mortality.

In China, for one lakh births, only 50 women die whereas in India and Pakistan, more than 500 women die.

Surprisingly India and Pakistan are ahead of China in providing improved water sources.
You will notice that for the proportion of people below the international poverty rate of $1 a day, both China
and Pakistan are in similar positions whereas the proportion is almost two times higher for India.

Along with these, we also need what may be called ‘liberty indicators’. One such indicator has actually been
added as a measure of ‘the extent of democratic participation in social and political decision making’ but it
has not been given any extra weight.

Some obvious ‘liberty indicators’ like measures of ‘the extent of Constitutional protection given to rights of
citizens’ or ‘the extent of constitutional protection of the Independence of the Judiciary and the Rule of
Law’ have not even been introduced so far. Without including these (and perhaps some more) and giving
them overriding importance in the list, the construction of a human development index may be said to be
incomplete and its usefulness limited.

We know that reforms were initiated in China in 1978, Pakistan in 1988 and India in 1991. Let us briefly
assess their achievements and failures in pre- and post-reform periods.

Why did China introduce structural reforms in 1978?

• China did not have any compulsion to introduce reforms as dictated by the World Bank and
International Monetary Fund to India and Pakistan.
• The new leadership at that time in China was not happy with the slow pace of growth and lack of
modernisation in the Chinese economy under the Maoist rule. They felt that the Maoist vision of
economic development based on decentralisation, self-sufficiency, and shunning of foreign
technology, goods, and capital had failed. Despite extensive land reforms, collectivisation, the Great
Leap Forward and other initiatives, the per capita grain output in 1978 was the same as it was in the
mid-1950s.
• It was found that the establishment of infrastructure in the areas of education and health, land
reforms, the long existence of decentralised planning and existence of small enterprises had helped
positively in improving the social and income indicators in the post-reform period.
• Before the introduction of reforms, there had already been a massive extension of basic health
services in rural areas. Through the commune system, there was more equitable distribution of food
grains. Experts also point out that each reform measure was first implemented at a smaller level and
then extended on a massive scale. The experimentation under decentralised government enabled to
assess the economic, social and political costs of success or failure. For instance, when reforms were
made in agriculture, as pointed out earlier by handing over plots of land to individuals for cultivation,
it brought prosperity to a vast number of poor people. It created conditions for the subsequent
phenomenal growth in rural industries and built up a strong support base for more reforms. Scholars
quote many such examples on how reform measures led to rapid growth in China.
PAKISTAN
• Scholars argue that in Pakistan the reform process led to worsening of all the economic indicators.
• We have seen in an earlier section that compared to the 1980s, the growth rate of GDP and its
sectoral constituents have not yet improved.
• Though the data on international poverty line for Pakistan is quite healthy, scholars using the official
data of Pakistan indicate rising poverty there. The proportion of poor in 1960s was more than 40 per
cent which declined to 25 per cent in 1980s and started rising again in the recent decades.
• The reasons for the slow-down of growth and re-emergence of poverty in Pakistan’s economy, as
scholars put it, are agricultural growth and food supply situation were based not on an
institutionalised process of technical change but on a good harvest. When there was a good harvest,
the economy was in good condition, when it was not, the economic indicators showed stagnation or
negative trends.
 • If a country is able to build up its foreign exchange earnings by sustainable export of manufactured
goods, it need not worry. In Pakistan most foreign exchange earnings came from remittances from
Pakistani workers in the Middle-east and the exports of highly volatile agricultural products; there
was also growing dependence on foreign loans on the one hand and increasing difficulty in paying
back the loans on the other.
• However, during the last few years, Pakistan has recovered its economic growth and has been
sustaining. In 2017-18, the Annual Plan 2019-20 reports that, the GDP registered a growth of 5.5 per
cent, highest when compared to the previous decade. While agriculture recorded growth rate far from
satisfactory level, industrial and service sectors grew at 4.9 and 6.2 per cent respectively. Many
macroeconomic indicators also began to show stable and positive trends.
What are we learning from the developmental experiences of our neighbours? India, China and Pakistan
have travelled seven decades of developmental path with varied results.

• Till the late 1970s, all of them were maintaining the same level of low development. The last three
decades have taken these countries to different levels. India, with democratic institutions, performed
moderately, but a majority of its people still depend on agriculture.
• India has taken many initiatives to develop the infrastructure and improve the standard of living.
Scholars are of the opinion that political instability, over-dependence on remittances and foreign aid
along with volatile performance of agriculture sector are the reasons for the slowdown of the
Pakistan economy. Yet, last five years, many macroeconomic indicators began showing positive and
moderate growth rates reflecting the economic recovery.
• In China, the lack of political freedom and its implications for human rights are major concerns; yet,
in the last four decades, it used the ‘market system without losing political commitment’ and
succeeded in raising the level of growth along with alleviation of poverty.
• Unlike India and Pakistan, which are attempting to privatise their public sector enterprises, China has
used the market mechanism to ‘create additional social and economic opportunities’. By retaining
collective ownership of land and allowing individuals to cultivate lands, China has ensured social
security in rural areas. Public intervention in providing social infrastructure even prior to reforms has
brought about positive results in human development indicators in China.