The Dynamics of Mixed Economy and Welfare State

Sukumar Nandi

Indian Institute of Management Lucknow

Lucknow – 226013, India

The mainstream economics literature operates on the paradigm of pure and free
markets in which individuals guided by their self-interest pursue their own advantage so
that welfare at micro level increases. This they do under conditions of scarcity that set
one individual against another in a zero-sum game. This is the grand assumption of the
so-called economic man of whom Adam Smith (1776) wrote long ago:
[H]e intends only his own gain, and he in this, as in many other cases, led by an
invisible hand to promote an end which was no part of his intention. Nor is it always
worse for the society that it was not part of it. By pursuing his own interest he
frequently promotes that of the society more effectually than when he really intends
to promote it.

Adam Smith wrote the above passage in eighteenth century. That was more like seeing
the economy through the prism of a model. But if the world were really like this as
described, then the magnificent edifice of economic theory that is taught in universities
and researched in academic journals would provide as accurate prediction of economic
events as law of physics is able to provide. But unfortunately this is not the case. The
following paragraphs explain the reasons and also analyse the evolution of mixed
economy all over the world.

There may be markets at the micro level that are very close to the ideal perfectly
competitive one. Even in these markets the predictions based on standard theory are far
from perfect. The scientific basis of economics does not work very well even where the

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conditions are most conducive to the success. When we see the economic system as a
whole, the paradigm of free markets does not fit the real world even approximately. The
economies of India and most of the western countries contain large non-market structures
that are deliberately implanted in the system to achieve objectives that a free market
economy will not achieve or will not be realized within desirable time span. Their
presence in the system reveals the important objectives, goals and priorities that arise out
of political and ethical considerations. All these symbolize the role of state1 in the
economic arena of the society. Economics is not part of this edifice. Such a structure that
is a mixture of economic, political, social, ethical and cultural is called mixed economy.
The description of such a system and the political economy of its future course of action
cannot be found in economic theory alone. A large part of this structure is embedded in
the huge body of legislation of both central and state governments mandating certain type
of activity. Also these are found in the legislations of the central government that are
related to administered price mechanism providing cross subsidy to different target
groups that are rationalized on equity considerations. All these regulate the limit of
competitive behaviour of the economic system.

Sometimes the above mentioned intrusions into the classical free market
mechanism are justified with the argument that these protect the ordinary citizens from
exploitations by the market, as the weaker sections are unable to protect them against the
savaging of the environment by unlimited exploitation of new technology (Stiglitz,
1999). Again in the opposite spectrum the critics maintain that the increasing
socialization in the name of equity is strangulating the equilibrium market forces and
threatening personal liberty. The academics are at cross fire from these two opposite
stands, though proper analysis of both stands are important to understand the true nature
of interventions( Kastehndiek et al, 1991).

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There is an interesting dualism in economic theory regarding the role of state, which exists in a shadowy
form in microeconomics. Its main function is to intervene when market fails to function in the presence of
externalities in public goods. But Keynesian doctrine proved that there may be strong tendencies for
instability in the system for which state intervention might be necessary. So in macroeconomics state is
regarded as an active participant in the economy.

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 One source of interventions is the democratic set of government as the power that
be derives its real strength from different groups of stakeholders like labour, business,
farmers, builders, traders in export business and even organized consumers who are
articulate enough to mobilize their voting power to bring desired changes in the policies
of the government and in extreme cases the government itself. The bureaucracies that
operate the levers of power of the government have become a constituency for the
development of interventions, which often are in partial disregard of public interest. This
becomes evident in the experience of some transition economies as one section of state
machinery (bureaucracy) creates hurdles for reforms, as the latter implies removing many
restrictions it has created vested interest with (Angresano, 1992; Keane and Prasad,
2000).

The different categories of interventions exercised in the economy are rationalized

on the pretext that there are imperfections in the working of the market mechanism. This
comes more from a belief than objective assessment of reality. Many of the interventions
come with support from the electorate, and these conform to rational economic
prescriptions, but some are the reflections of deeply rooted ethical positions.

The experiences of booms and cycles of capitalist system have induced the
government to create some institutions that will help maintaining stability in the system.
The Planning Commission, Tariff Commission, The Commission for Agricultural Cost
and Prices, Foreign Investment Promotion Board, Monopoly Enquiry Commission,
Finance Commissions and the Securities and Exchange Board of India are some of the
important institutions in India that have wide power to intervene in the market operations
to maintain stability in economic growth, price movement and the movement of other
economic parameters. Also the apex bank of the country, the Reserve bank of India, has
wide power to intervene in both money and foreign exchange markets. The provision of
power to these institutions represents a broad public interest in reducing the instability
that are associated with the free operations of market mechanism as the overall
perceptions of general public have.

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 Many of the institutional interventions on the part of the state as mentioned in
earlier paragraph are costly in terms of government expenditure. These often go beyond
practical considerations to ethical justifications to serve the efforts to achieve a fair and
compassionate society and to avoid extremes in the distributions of economic and non-
economic goods. These interventions reflect some sort of social commitment. They
include subsidies in fertilizer, petro-products in which tax-payers money is used to help
the needy and also one particular sector (agriculture), unemployment benefits, cross-
subsidy in electricity distribution and progressive income tax in which high salaried
persons bear some burden of the poor. The programmes that carry the cost of all these
social commitments are very large and also very expensive in terms of burden on the
system. Apart from the debate whether these programmes reduce raw economic incentive
to work or not, these constitute a formidable portion of the budget of the central as well
as the state government. The resulting deficit in the budget has an adverse economic
impact and the society should be assured that the positive impact of these social
commitments outweighs the costs.
The quest for social justice in face of the belief that market mechanism cannot
protect the interest of the weak has led to increasing amount of interventions in the
system. A significant amount of energy used in introducing the ethical interventions in the
system has been used up in the institutional transformation of the past fifty five years
with periodic spurt of acceleration like the end of 1960s and whole 1970s. The rhetoric of
the attack on the free market mechanism has been blunted by the growth of non-market
distributive and social efforts to protect the target groups. While the ethical position of
this is beyond question, the large number of institutions created to see the implementation
of different programmes of social commitment has undergone little scrutiny except the
fact that these have placed huge financial burden on the state budget.
The question that is important today is whether the amount of interventions in the
system has reached the optimum level. If that is true, then any incremental intervention
will find their effects wasted by negative externalities like inflation and distortions in the
relative prices. The choice is clear. In the trade-off between ethically justified
interventions into the free market and the shape of the market institutions themselves,
there is no free lunch, as the economists are prone to say. In fact the price had increased

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in our over-enthusiasm in the 1970s, which we realized only in the middle of 1980s. Self-
interest2 is the source of energy in the free market operations and it is the principal
motivation behind efficient operation of the free market mechanism. This self-interest is
bound to be compromised if the level of interventions goes beyond the optimum level.

The experience of 1990s has shown that the lessening of the intervention has
resulted in the upswing of business activity and that has created opportunities to increase
the wellbeing of all sections of society. It seems that the state of mixed economy in India
has reached a condition of maturity and the economy has attained some type of
equilibrium with a well –developed structure of non-market activities. The total cost of
the latter is to be found in the budget of the central government.

The maturing of the structure of non-market activities that give the shape of the
social commitment has led to the adjustment of the market forces in India so much so that
it has enlarged the opportunity for stable and vigorous growth of the economy. The
growth and dynamism experienced in Indian economy since 1991 is a hard macro-
evidence of the new mixed economy in India. Policies pursued with this total perspective
in mind will help Indian economy reach still higher trajectory of growth. Indeed, some of
the successful reforms in post-1991 India have been possible due to the active help of the
regulatory institutions established by the state. Also for the cause of reforms Indian state
has given up some power and that is commendable. Another achievement of Indian state
is the stubborn persistence of democracy. Time and again Indian democracy revealed that
it is resilient and enduring. This disproves the old prejudice that people are incapable of
self-discipline and sobriety that make the effective self-government a reality. The self-
interest that is explained in earlier paragraph remains functional and active. There are
pitfalls like fragility of institutions and poor governance resulting in poor delivery of
basic public goods, but the show goes on. To improve the system is a challenge of over-
all macro management.

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According to Adam Smith (1776) under a system of free market individuals, acting in their own self-
interest as economic agents, would tend to dedicate themselves to those economic activities that brought
them the greatest reward in terms of income. The latter may be in the form wages, rent, or profit. Smith
proved that by engaging themselves to such highly rewarding economic activities in their own self
interest people would also be maximising the economic well-being of society.

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 The mixed economy in its present avatar is a complex structure. It is continuously
changing and keeps theories miles apart and thus it irritates theoretical purists of all
persuasions. It is a living reality that has evolved as a result of continuous resolutions of
the pressures between a democratic political system that is to see the interest of different
stake-holders and the apolitical forces of market-oriented economy. The contradiction
that is implicit here are being resolved and that makes the structure of the mixed
economy much more complex. This is a process and the evolution will continue in the
future. It is the challenge before the managers of the macro-economy to utilize the scarce
resources of the country to reach the bliss point so that society as a whole reaches a
higher turnpike of economic growth while no sections face a loss of welfare. This is a
challenge of the present century before the not-so-developed nations of the world.

A Case:

How the dynamics of the mixed economy operates in India? Here is a case how the
establishment intervenes to the economic report that they want to see. Dr. Shankar
Acharya , who had been Chief Economic Advisor , Government of India , write about the
resignation of Dr. Percy Mistry from the Chairmanship of the High Powered Expert
Committee ( HPEC)on developing Mumbai as International Finance Centre ( IFC) as a
section of the establishment wanted to change a section of the Report and they succeeded
but Dr. Mistry resigned ( Business Standard, May 24, 2007). According to Dr. Acharya,
HPEC fails to reveal the full range of benefits that would flow from Mumbai as an IFC
and in this case HPEC fails to make a clear and compelling case of establishing an IFC at
Mumbai. As the Report assert: “ In sustaining its trajectory as an emerging, globally
significant, continental economy, …….. India has no choice but to (a) become a producer
and exporter of IFS ( international financial services); and (b) capture an increasing
share of the rapidly growing global IFS market. To achieve these two goals, its financial
centre in Mumbai must become a successful IFC”. But it is a strong assertion, and it is
deduced not from any sound reasoning according to Dr. Acharya. In fact he is skeptical
about the claim of Mumbai considering the grossly inadequate infrastructure of the city,
and also lack of visibility of the attempt of the government in this regard.

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Then, why this HPEC is prepared? This is an interesting question in the context of the
operations of mixed economy.

References:

Angresano, J., "A Mixed Economy in Hungary? Lessons from the S wedish Experience",
Comparative Economic Studies, Vol. 34 No.1, pp.41-57 , 1992.

Jessop, B., H. Kastehndiek, K. Nielsen, and O.K. Pedersen, The Politics of Flexibility:
Restructuring State and Industry in Britain, Germany and Scandinavia, Edward Elgar, Cheltenham,
UK, 1991.

Keane and Prasad, "Inequality, Transfers and Growth: New Evidence from the Economic Transition in
Poland", IMF Working Paper 00/117, June 2000.

Smith, Adam, The Wealth of Nations, New York, Modern Library, 1776, ( 1937).

Stiglitz J., "Whither Reform? Ten Years of the Transition", Keynote address to the World Bank's
Annual Bank Conference on Development Economics, April 1999.

Sukumar Nandi