Economic Planning

Planning is defined as conceiving, initiating, regulating and controlling economic activity by the state
according to set priorities with a view to achieving well-defined objectives within a given time.

According to Professor Dickinson, economic planning is the making of major economic decisions by
a determinate authority on the basis of a comprehensive survey of the economy as a whole. Such
decisions include what and how much to produce; how, when and where it is to be produced; and to
whom it is to be allocated.

With reference to underdeveloped countries, Subrata Ghatak defines economic planning as a

conscious effort on the part of any government to follow a definite pattern of economic development
in order to promote rapid and fundamental change in the economy and society.

Essentials of Economic Planning

According to Arthur Lewis, a development plan may consist of the following parts:

1. Survey of current economic conditions

2. List of proposed public expenditures
3. Discussion of likely development in private sector
4. Macro economic projections of the economy
5. Review of government policies

1. Survey of current economic conditions: The economic survey shows the changes in
respect of population, NI, taxation, government expenditures and BOP, etc. It also tells us the
changes needed or expected to occur in these economic variables. The economic survey is
usually for one year.

2. List of proposed public expenditures: The proposals and suggestions for incurring public
expenditures on development projects are invited from various government departments and
agencies. After a thorough scrutiny of these recommendations, an order of priority is
determined deciding what is to be included, what is to be postponed or rejected as the financial
resources are less than required.

3. Discussion of likely development in private sector: It is said that both public and private
sectors are inter-related and rate of economic development depends more on the working of
the private sector than expenditures in public sector. The government reviews the
performance of major industries in economic planning, and sets quantitative targets for the
plan period. All this involves a brief in-depth analysis of the working and implications of market
structure.

4. Macro economic projections of the economy: It refers to the preparation of aggregate

models which are applied to the economy as a whole. These models deal with production and
consumption as single aggregates. Aggregate models are used to determine the possible
growth rates in NI, the division of national product among consumption, investment and
exports, the required volume of domestic savings, imports and foreign assistance needed to
carry out a given development programme. This involves massive calculations and paper
works.

5. Review of government policies: The government through development policy can influence
the decisions indirectly in the private sector.
Importance / Objectives of Economic Planning w.r.t. Mixed Economy & Under-
Developed Countries
In the following section we will discuss the economic planning with reference to mixed economies and
under-developed countries:

1. Efficient utilization of resources: The most essential function of economic planning is to

ensure the best use of given resources within the country. Maximum social benefits can only
be ensured when the available resources are allocated and utilized in the most efficient
manner. Unused or slack utilization of resources will adversely affect the employment and
productivity level of the economy. The government has to do some arrangements in order to
bring equality between demand and supply. In the market economy, there are wasteful
expenditures in the form of selling costs. Sometimes, few producers established their cartels
in order to control the market. All this can be undone by the government through effective
planning.

2. Market imperfections and price distortions: In market economies, there are certain market
imperfections and price distortions both in commodity market and factor market. These
distortions rise because of institutional arrangements. As the wage rate in some sectors of the
economy exceeds the opportunity cost of the labour. This may be due to trade unions’
influence. Moreover, the goods whose demand is less elastic their producers may pursue
monopolistic behaviour. There may be dualistic approach in the money market. In the
organized money market the rate of interest is kept artificially low or inexpensive credit facilities
are provided. While on the other hand, in less organized money market or in agriculture
market, the ROI is extraordinary high. This situation also creates price distortion. These
market imperfections can only be corrected by efficient economic planning.

3. Greater opportunities: The most common benefit that any democratic country enjoys is that
the greater market opportunities are and should be provided to the producer and consumers.
But this can be handicapped because of two reasons:

(a) Limited life span of an individual

(b) Limited resources at the disposal of an individual

4. Because of these common problems, the individuals undertake those projects which require
small amount of resources and the profit can be earned within a short period of time. In this
way, the individuals would hardly be prepared to launch big projects like construction of
highways, power-stations, land-reclamation, anti water logging and salinity schemes, rail-
roads, sea ports, telecommunication, etc. It is the duty of the modern government to provide
greater resources at the disposal of individuals. At the same time the government has to
reduce excessive-consumption or the disposal of resources in few hands. This can only be
ensured under efficient economic planning.

5. Maximisation of National Income and Raising Living Standard: It is the responsibility of

modern state to maximise the national income and raise the standard of living. It can only be
ensured when the government correctly addresses the economic needs of the country and
takes desired actions in economic planning.

6. Full Employment: In economically advanced countries, the government’s aim is to provide full
employment. All modern governments have, in fact, underwritten employment. If they cannot
provide work, they have to give doles. Unemployment is the biggest by product of any
 capitalist society. The government can redistribute labour and create more work opportunities
for both private and public sector.

7. Equitable distribution of income: Economic planning is the most powerful tool of equitable
distribution of income. The price-mechanism rewards people according to the resources they
possess but contains in itself no mechanism for equalization of the distribution of those
resources. Therefore, there is a wide gap between haves and have-nots. Shocking economic
inequalities are a marked feature of an unplanned economy. Reduction of economic
inequalities is now the avowed aim of a modern welfare state and is impossible without the
instrument of economic planning.

8. Public oriented goals: In market economy, only those goods are produced whose demands
are backed by money offers. As a result the production of public goods / services, including
health, research and education, old-age benefits, poor houses, orphan houses, clean water,
sewerage and drainage, free entertainment, art and culture, historical assets, wildlife, forests,
security, and defence, are altogether ignored or very less attention is paid. It is planning which
distributes the resources between present consumption and future consumption, social
development and economic development, etc. As a result the goals of planned economies are
more welfare and public oriented.

9. Price Stability: The purpose of economic planning is to reduce the price instability created by
business fluctuations. During the period of increasing demand, the price hikes are inevitable
due to supply shortages. In under-developed countries, because of low productive capacity,
low savings and investment, and traditional set up, the price starts rising very sharply, and its
impact on the developing society is very deep. In order to eliminate the adverse effects of
price instability and business fluctuations, the government comes forward and play a vital role
in creating a favourable economic condition. This can only be done through wise economic
planning.

10. Larger savings and investment: The ultimate task of any finance ministry is to boost up the
savings and investment, esp. foreign investment. In UDCs on one hand there is a vicious
circle of poverty, while on the other, there is an operation of international demonstration effect.
In UDCs, there is a general tendency of demonstration effect within the people, and the whole
economy’s growth is hampered by dualism. Savings remain at the lowest level. The boost in
investment, domestic or foreign, depends on the level and duration of economic stability. More
stable and viable economic growth planning may motivate the investors in investing and thus
increasing the level of employment in the economy.

11. Provision of Social Services: In UDCs, the provision of social services forms an important
objective of planning. In the fifth five year plan, two important objectives were:

(a) Development of rural areas through various programmes and policies alongwith
widespread extension of social services such as schooling, health and clean water
facilities.
(b) Easing of urban problems like water supply, sewerage and drainage, electricity, gas
supply, housing and transportation facilities, etc.

12. Aid to victims of catastrophe: The granting of assistance and the organisation of relief to
victims of natural catastrophes, such as flood, earthquakes, tsunamis, tropical storms, drought,
etc. are the main the responsibilities of any government.

Limitations of Economic Planning

The following obstacles come in the way of economic planning:

1. Measurement of labour force: In economic planning, the identification and enumeration of

gainfully employed population is a difficult task, esp. in agriculture, where the employment is of
part-time or seasonal nature. The important contributions to economic activities by women
and children raise further complications. In backward economies, it is very difficult to
distinguish between voluntary and involuntary unemployment.

2. Statistical data: The biggest problem with economic planning is that the planner has to work
with a limited statistical data provided. Moreover, the planner has to work with these data,
collected through different surveys, consensus, polls, etc., without much questioning about
their reliability and accuracy.

3. Unused natural resources: The UDCs are identified of their unused natural resources like
land, mines, rivers, forests, livestock, sea, etc. A resource such as land, a mineral deposit, a
forest or a rive may not be used in production because it is economically inaccessible. A
natural resource is valueless when its cost of extraction is greater than the price the product
can command in the market. Therefore, the fullest possible use of natural resources is not a
sensible aim of an economic planning, and the extent of the use of land or other natural
resources is not a measure of economic efficiency. There are four types of resource idleness:

(a) Idleness reflecting the inability of the resource to contribute to profitable production,
(b) Withholding of the resources in the interests of monopolistic exploitation of the market,
(c) Employment of resources for commercial or private use, and
(d) Withholding of a natural resource from current production because the owner believes
that it will make a more valuable contribution to production at a later date.

4. Population and real income: The biggest problem regarding human resources is that in
UDCs, the population is growing at a very high rate. Moreover, most of the UDCs population
heavily rely on agricultural income. The present rate of population growth in India and
Pakistan is not significantly greater than in the United States. But the significant point of
contrast is that in the South Asia and Central Asia, there is a heavy reliance on comparatively
backward agriculture. Real income is vitally affected by the quality of the population.

5. Economic repercussions of social institutions: Certain social institutions, such as extended

family system or joint family system, which are appropriate to a subsistence economy may
impede economic growth directly by reducing the rewards of individuals who take advantage of
the opportunities presented by wider markets. Subsistence economy is the economy in which
people strive for the minimum necessities to support life. The extended family system acts as
a serious obstacle to economic progress. A man is much less likely to be willing and able to
save and invest, when he knows that he would have to maintain a large number of distance
relatives. It minimises the inducement for people to improve their own position. It obstructs
the spreading of banking habit since people are unwilling to have banking accounts as there is
no willingness to save. However, the economic planner can overcome this situation by
introducing private or public insurance or other arrangements to replace the traditional
methods for the relief of personal distress or disability.

6. Implications of restrictive tendencies: Social, political and administrative restrictive

measures are directed against foreigners on the basis of racial, national or tribal differences.
Such restrictive measures are often directed also against the members of local population. It
may put restrictions on the movement of people or on the acquisition and exercise of goods or
services. It may also be connected with ‘xenophobia’, esp. in the tribal areas and villages.
 This problem is common in Pakistan and hampers the economic development in rural and
tribal areas.

7. Wage rates and unemployment: In UDCs, the wage rate is relatively low and there is a high
unemployment rate in the economy. Limited employment opportunities may create a pool of
urban unemployed. These urban members do not enjoy the security of the extended family
system, nor are they related to agricultural sector. They therefore are apt to constitute a more
serious social and political problem then the rural unemployed.

8. Monopsony in the labour market: It is a common situation in UDCs in which there are very
few employers and they exercise their monopsony powers in the labour market. Labour is
more exploited when the wage rate is below the equilibrium point indicating the unsatisfied
demands of labour. Whereas in advanced countries, the supply of labour is elastic and there
is little scope for monopsonistic exploitation. The planner must address the labour issues like
wage rates, overtime, bonus, allowances, perquisites, working hours, safety measures, health
and medical facilities, life insurance, transportation, children education, pension and
benevolent funds, old age benefits, income tax on salaries, etc.

9. Uneven distribution of entrepreneurial faculties: The material progress of a society is likely

to be assisted greatly when there are dynamic entrepreneurial abilities. In economically
backward countries, there are difficulties in the way of developing and utilising the
entrepreneurial qualities. The government can support small and medium enterprises to come
forward and develop new economic opportunities. The government must encourage, both on
private and public level, new agricultural or industrial techniques, adoption or adaptation of
new improved methods, innovative activities, internship, on-the-job training, etc. in order to
raise the level of economy.

10. Low level of capital in UDCs: The biggest problem of less developed countries is that there is
a dearth of capital, whether it is physical or financial. The low level of capital is also indicated
by statistics of consumption of energy for purposes of production. In developed countries,
there is a high consumption of energy, whereas in UDCs, the energy consumption is
considerably low. The general implication of low level of capital is a low level of output and a
low level of consumption per head. In such economies, there is no assurance of a continuity in
supply of goods. Transport costs are very high and limited availability of perishable or bulky
goods. Because of low level of working capital and storage facilities, there is a danger of acute
shortage of food crops.

11. Methods of production: The methods of production, farming, marketing and domestic
operation are not usually the same in all the countries. What is an economic use of resources
in one country may be uneconomic in another in which relative factor prices are comparatively
different. It follows that the economic efficiency of methods of production and economic
organisation in UDCs cannot be judged simply by comparing them with those familiar in
advanced countries. The planner has to jot out all the possible opportunities and focus on
major weaknesses, and must plan within the available resources.

12. International demonstration effect: In UDCs, there is a strong desire to enjoy as much of
attractive way of living in the advanced countries as incomes permit. There is an international
demonstration effect. Moreover, the under developed economy is divided into two extreme
sections – traditional section and modern section. There are old and new production methods,
educated and illiterate population, rich and poor, modern and backward, capitalistic and
socialistic, donkey carts and motor cars existing side by side. This situation creates great
atmosphere of conflict and contradiction, as a result the economic development is hampered.
 13. Political instability: Most of UDCs, especially Asian and African countries, are known of their
political instability, bureaucratic malfunctioning, corruption on administrative level, and
nepotism, like India, Pakistan, Sri Lanka, Bangladesh, Afghanistan, Vietnam, Cambodia,
Myanmar, Nigeria, Zimbabwe, Uganda, Somalia, Kenya, etc. Perhaps the biggest challenge
for any economic planner is the political and administrative malfunctioning in his way of
economic planning.

Elements of Economic Development

The economic development in advanced or under-developed countries depends on four elements:

1. Human resources: In poor countries GDP rises but at the same time the population also
grows. Several developing countries are facing high birth rates with stagnant national income
per head. It is hard for poor countries to overcome poverty with birth rates so high. In under-
developed countries, the economic planners emphasise the following specific programmes:

(a) Control disease and improve health and nutrition,

(b) Improve education, reduce illiteracy and train workers, and
(c) Ensure that the labour force is well-equipped with necessary and competing skills.

2. Natural resources: Many poor countries have enormous amount of natural resources, but
they are failed to explore them. The reason is that the government has not provided
necessary incentives to the farmers and landowners to invest in capital and technologies that
will increase their land’s yield.

3. Capital formation: Capital formation or inducement to invest depends on the propensity to

save. In less-developed countries, there is a very low saving tendency because of low
income. Developed countries managed to save 20% of their output in capital formation.
Whereas only 5% of the national income is saved in UDCs. Much of the savings goes to
housing and basic needs and, therefore, a very small amount is left over for development.

Capital formation is the basic tool for economic development. It may take decades to invest in
building up a country’s infrastructure, information technologies, power-generating plants, and
other capital goods industries. Developing countries must have to build up their infrastructure,
or social overhead capital in order to set path for economic glory.

If there are so many obstacles in finding domestic savings for capital formation, then the
country depends on foreign sources of funds. Less-developed countries have to welcomed the
flow of foreign capital or foreign borrowings. As long as the exports of these countries grew at
the same rate as borrowings, it is a favourable condition. But several poor countries needed
all their earnings simply to pay interest on their foreign debts. This is an adverse situation.
Such countries need to boost up their production in order to cope with their current
indebtedness.

4. Technological change and innovations: The developing countries have a potential

advantage in the economic development – i.e., they can be benefited from up-to-date
technologies developed by advanced countries. They can climbed up to industrialisation more
rapidly than those advanced countries who struggled for more than 500 years.

Vicious Cycle of Poverty

Many developing countries are caught up in vicious cycle of poverty. Low level of income prevents
savings, retards capital growth, hinders productivity growth, and keeps income low. Successful
development may require taking steps to break up the chain at many points. Other points in poverty
are also self-reinforcing. Poverty is accompanied by low levels of education, literacy and skill; these
in turn prevent the adaptation to new and improved technologies and lead to rapid population growth.
The vicious cycle of poverty is depicted as below:

Overcoming the barriers of poverty often requires a concentrated effort on many fronts and a ‘big-
push’ is required to break the ‘vicious cycle’ into ‘virtuous circle’. If the country has stepped to invest
more, improve health and education, develop labour skills, and curb population growth, she can break
vicious cycle of poverty and stimulate a virtuous circle of rapid economic growth.

Stages of Economic Development

W.W. Rustow has defined and analysed in his book ‘The Stages of Economic Growth’ the five stages
of economic development:

1. Traditional society,
2. Pre-conditions for take-off,
3. Take-off stage,
4. Drive to maturity, and
5. Stage of mass production and mass consumption.

1. Traditional society: In the traditional long-lived social and economic system, the output per
head is low and tends not to rise. Economic activities are static and national income is very
low. The examples are Somalia, Bangladesh, Afghanistan, etc.

2. Pre-conditions for take-off: The second stage is ‘Pre-take-off’. It is a period of transition in

which the traditional systems are overcome, and the economy is capable of exploiting the fruits
of modern science and technology. Pakistan, India, Sri Lanka, etc. are operating at this stage.

3. Take-off: Take-off represents the point at which the resistances to steady growth are finally
overcome and the growth is normally inevitable. The economy generates its own investment
and technological improvement at sufficiently high rates so as to make growth virtually self-
sustaining. South Africa, UAE, etc. are the examples.
 4. Drive to maturity: The fourth stage is the drive to maturity. It is the stage of increasing
sophistication of the economy. Against the background of steady growth new industries are
developed, there is less reliance on imports and more exporting activity. The economy
demonstrate its capacity to move beyond the original industries which powered its take off, and
to absorb and to apply efficiently the most advanced fruits of modern technology. China,
South Korea, Malaysia, etc. are the examples.

5. Stage of mass production and mass consumption: The fourth stage ends in the attainment
of fifth stage, which is the age of mass production. It is the stage in which there is an affluent
population, and durable and sophisticated consumer goods. There are huge capital and
technological intensive industries in such an economy. People are more quality conscious and
comfort lovers. Wage rates are high. Health and safety issues are addressed by the
government. The whole economy is dynamic. USA, UK, France, Germany, Japan, Canada,
Italy, Netherlands, Denmark, etc. are the examples.

Approaches to Economic Development

The following approaches are developed in recent years to explain the economic development and
answer the question how countries break out of the vicious cycle of poverty to virtuous circle of
economic development:

1. The Take-off Approach: Take-off is one of the stages of economic growth. Different
economies have been benefited from ‘take-off’ approach in different periods, including England
at the beginning of eighteenth century, the United States at the mid of nineteenth century, and
Japan in early twentieth century. The take-off is impelled by leading sectors such as a rapid
growing export market or an industry displaying large economies of scale. Once these leading
sectors begin to flourish, a process of self-sustained growth (i.e. take-off) occurs. Growth
leads to profits, profit are reinvested, capital, productivity and per capita income spur ahead.
The virtuous cycle of economic development is under way.

2. The Backwardness Hypothesis and Convergence: The second approach emphasises the
global context of economic development. Poor countries have important advantages that the
pioneers of industrialisation had not. Developing nations can draw upon the capital, skills and
technologies of advanced countries. Developing countries can buy modern textile machinery,
efficient pumps, miracle seeds, chemical fertilisers and medical supplies. Because they can
lean on the technologies of advanced countries. Today’s developing nations can grow more
rapidly than Great Britain, Western European Countries and United States in past. By drawing
upon more productive technologies of the leaders, the developing countries would expect to
see convergence towards the technological frontier.

3. Balanced Growth: Some writers suggest that growth is a balanced process with countries
progressing steadily ahead. In their view, economic development resembles the tortoise
making continual progress, rather than the hare, who runs in spurts and then rats when
exhausted. Simon Kuznets examined the history of thirteen advanced countries and
conceived that the balanced growth model is most consistent with the countries he studied.
He noticed no significant rise or fall in economic growth as development progressed.

Note one further important difference between these approaches. The ‘take-off’ theory suggests that
there will be increasing divergence among countries (some flying rapidly, while others are unable to
leave the ground). The ‘backward’ hypothesis suggests ‘convergence’, while the ‘balanced-growth’
model suggests roughly ‘constant’ differentials. In the following diagrams, advanced countries are
represented by curve A, middle income countries by curve B and low-income countries by curve C.
The curves show per capita income:
Issues in Economic Development
Following are the important issues in under developed countries:

1. Industrialisation vs. Agriculture: In most countries, incomes in urban areas are almost more
than double in rural areas. Many nations jump to the conclusion that industrialisation is the
cause rather than effect of affluence. To accelerate industrialisation at the expense of
agriculture has led many analysis to rethink the role of farming. Industrialisation tends to be
capital intensive, attract workers into crowded cities, and often produces high level of
unemployment. Rising productivity on farms may require less capital, while providing
productive for surplus labour.

2. Inward vs. Outward Orientation: This is a fundamental issue of economic development

towards international trade. Should the developing countries be self-sufficient? If yes, the
country has to replace imported goods and services with domestic production. This strategy is
known as ‘import substitution’ or ‘inward orientation’.

If the country decides to pay for imports it needs by improving efficiency and competitiveness,
developing foreign markets, and giving incentives for exporters. This is called ‘outward
orientation’ strategy. It is generally observed that by subsidising import substitution,
competition is limited, innovation is dampened, productivity growth is slow down and country’s
real income falls to a lower level. Whereas, the outward orientation sets up a system of
incentives that stimulates exports. This approach maintains a competitive FOREX rate,
 encourages exports, and minimises unnecessary government regulation of businesses esp.
small and medium sized firms.

3. State vs. Market: The cultures of many developing countries are hostile to the operation of
markets. Often competition among firms or profit seeking behaviour is contrary to traditional
practices, religious beliefs, or vested interest. Yet decades of experience suggest that
extensive reliance on markets provides the most effective way of managing an economy and
promoting rapid economic growth.

The government has a vital role in establishing and maintaining a healthy economic
environment. It must ensure law and order, enforce contracts, and orient its regulations
towards competition and innovation. The government plays a leading role in investment in
human capital through education, health and transportation, but the government should
minimise its intervention or control in sectors where it has no comparative advantage.
Government, should focus its efforts on areas where there are clear signs of market failure

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 Harrod Domar Growth Model
As we know that one of the principal strategies of development is mobilisation of
domestic and foreign saving in order to generate sufficient investment to accelerate
economic growth. The economic mechanism by which more investment leads to more
growth can be described in terms of Harrod-Domar growth model, often referred to as
the AK model.

Every economy must save a certain proportion of the national income, if only to replace
worn-out or impaired capital goods (buildings, equipment, and materials). However, in
order to grow, new investments representing net additions to the capital stock are
necessary. If we assume that there is some direct economic relationship between the
size of the total capital stock, K, and total GNP, Y – for example, if $3 of capital is
always necessary to produce a $1 stream of GNP – it follows that any net additions to
the capital stock in the forms of new investment will bring about corresponding
increases in the follow of national output, GNP. This relationship is known as ‘capital-
output ratio’ and is represented as ‘k’. in the above case ‘k’ is roughly 3:1.

If we further assume that the national savings ratio ‘S’ is a fixed proportion of national
output (e.g. 6%) and that total new investment is determined by the level of total
savings. We can construct the following simple model of economic growth:

· Saving (S) is some proportion, s, of national income (Y) such that we have
the simple equation:

S = s .Y ---------------------------- (i)

· Net investment (I) is defined as the change in the capital stock, K, and can be
represented by ΔK such that:

I = ΔK ----------------------------- (ii)

But because the total capital stock, K, bears a direct relationship to total national
income or output, Y, as expressed by the capital-output ratio, k, it follows that:

K = k

Or

ΔK = k

ΔY
 Or

ΔK = k.ΔY ------------------------------- (iii)

· Finally, because net national savings, S, must equal net investment, I, we

can write this equality as:

S = I ------------------------------- (iv)

But from equations (i), (ii) and (iii), we finally get the following equation:

I = ΔK = k. ΔY

Therefore, we can rewrite the equation (iv) as follows:

S = s.Y = k.ΔY = ΔK = I --------------- (v)

Or simply

s.Y = k.ΔY -----------------------------------(vi)

Dividing both the sides of equation (vi) first Y and then by k, we obtain the following
expression:

ΔY = s -------------------------------------- (vii)

Y k

Note that the left-hand side of the equation i.e., ΔY / Y represents the rate of change or
rate of growth in GNP (i.e., the percentage change in GNP).

The Harrod Domar Model, more specifically says that in the absence of government, the
growth rate of national income will directly or positively related to the savings ratio (i.e.,
the more an economy is able to save and invest out of a given GNP, the greater the
growth of that GNP will be. Harrod Domar Model further states that the growth rate of
national income will be inversely or negatively related to the economic capital-output
ratio (i.e., the higher k is, the lower the rate of GNP growth will be).

The additional output can be obtained from an additional unit of investment and it can
be measured by the inverse of the capital-output ratio, k, because this inverse, 1 / k, is
simply the output-capital or output-investment ratio. It follows that multiplying the rate of
new investment, s = I / Y, by its productivity, 1 / k, will give the rate by which
national income or GNP will increase.
For example, the national capital-output ratio in an under-developed country is, let say,
3 and the aggregate saving ratio (s) is 6% of GNP, it follows that this country can grow
at a rate of 2% (i.e., 6% / 3 or s / k or ΔY / Y). Now suppose that the national saving
rate increased from 6% to 15% through increased taxes, foreign aids, and / or general
consumption sacrifices – GNP growth can be transferred from 2% to 5% (15% / 3).

According to Rostow and other theorists, the countries that were able to save 15% to
20% of GNP could grow at a much faster rate than those that saved less. Moreover,
this growth would then be self-sustained. The mechanisms of economic growth and
development, therefore, are simply a matter of increasing national savings and
investment.

The main obstacle or constraint on development, according to this theory, was the
relatively low level of new capital formation in most poor countries. But if a country
wanted to grow at, let say, a rate of 7% per annum and if it could not generate savings
and investment at a rate of 21% (i.e., 7% × 3) of national income but could not only
manage to save 15%, it could seek to fill this saving gap of 6% through either foreign
aid or private foreign investment.

Limitations of the model:

1. Economic growth and economic development are not the same. Economic
growth is a necessary but not sufficient condition for development

2. Harrod Domar model was formulated primarily to protect the developed countries
from chronic unemployment, and was not meant for developing countries.

3. Practically it is difficult to stimulate the level of domestic savings particularly in

the case of LDCs where incomes are low.

4. It fails to address the nature of unemployment exists in different countries. In

developed countries, the unemployment is ‘cyclical unemployment’, which is due to
insufficient effective demand; whereas in developing countries, there is ‘disguised
unemployment’.

5. Borrowing from overseas to fill the gap caused by insufficient savings causes debt
repayment problems later.

6. The law of diminishing returns would suggest that as investment increases the
productivity of the capital will diminish and the capital to output ratio rise.

The Harrod-Domar model of economic growth cannot be rejected on the ground of

above limitations. With slight modifications and reinterpretations, it can be made to
furnish suitable guidelines even for the developing economies.

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 Models of Economic Growth
Classical Model of Economic Growth

Every nation strives after development. Economic progress is an essential component, but it is not
the only component. Economic development is not purely an economic phenomenon. In an ultimate
sense, it must encompass more than the material and financial side of people’s lives. Economic
development should therefore be perceived as a multidimensional process involving the
reorganization and reorientation of entire economic and social systems. In addition to improvements
in incomes and output, it typically involves radical changes in institutional, social, and administrative
structures. Finally, although development is usually defined in a national context, its widespread
realization may necessitate fundamental modification of the international economic and social system
as well.

The classical theories of economic development consist of following four schools of thought:

1. Linear-stages-of-growth model: Theorists of the 1950s and 1960s viewed the process of
development as a series of successive stages of economic growth through which all countries must
pass. It was primarily an economic theory of development in which the right quantity and mixture of
saving, investment, and foreign aid were all that was necessary to enable developing nations to
proceed along an economic growth path that historically had been followed by the more developed
countries. Development thus became synonymous with rapid, aggregate economic growth.

This linear-stages approach was largely replaced in the 1970s by two competing economic schools of
thought – theories of structural change and international-dependence theories.

2. Theories and patterns of structural change: Theories and patterns of structural change uses
modern economic theory and statistical analysis in an attempt to portray the internal process of
structural change that a “typical ”developing country must undergo if it is to succeed in generating and
sustaining a process of rapid economic growth.

Structural-change theory focuses on the mechanism by which under-developed economies transform

their domestic economic structures from a heavy emphasis on traditional subsistence agriculture to a
more modern, more urbanised, and more industrially diverse manufacturing and service economy. It
employs the tools of neo-classical price and resource allocation theory and modern econometrics to
describe how this transformation process takes place. Two well-known representative examples of
the structural-change approach are the ‘two-sector surplus labour’ theoretical model of Sir W. Arthur
Lewis, and the ‘patterns of development’ empirical analysis of Hollis B. Chenery and his co-authors.

3. International-dependence revolution: The international-dependence revolution was more radical

and political in orientation. It viewed underdevelopment in terms of international and domestic power
relationships, institutional and structural economic rigidities, and the resulting proliferation of dual
economies and dual societies both within and among the nations of the world. Dependence theories
tended to emphasize external and internal institutional and political constraints on economic
development. Emphasis was placed on the need for major new policies to eradicate poverty, to
provide more diversified employment opportunities, and to reduce income inequalities.

International-dependence models view developing countries as troubled by institutional, political, and

economic rigidities, both domestic and international, and caught up in a dependence and dominance
relationship with rich countries. Within this general approach there are three major streams of
thought – the neo-colonial dependence model, the false-paradigm model, and the dualistic-
development thesis.

4. Neoclassical or free-market counterrevolution: This theory is also known as neo-liberal theory.

Throughout of the 1980s and 1990s, the neoclassical or free-market counterrevolution approach
prevailed. It emphasizes the beneficial role of free markets, open economies, and the privatisation of
inefficient public enterprises. Failure to develop, according to this theory, is not due to exploitive
internal and external forces as expounded by dependence theorists. Rather, it is primarily the result
of too much government intervention and regulation of the economy.

In the 1980s, the political ascendancy of conservative governments in the United States, Canada,
Britain, and West Germany brought a neoclassical counterrevolution in economic theory and policy.
In developed nations, this counterrevolution favoured supply-side macroeconomic policies, rational
expectations theories, and the privatisation of public corporations. In developing countries it called for
freer markets and the dismantling of public ownership, central planning, and government regulation of
economic activities. Neo-classicists obtained controlling votes on the boards of the world’s two most
powerful international financial agencies — the World Bank and the International Monetary Fund. In
conjunction and with the simultaneous erosion of influence of organizations such as the International
Labour Organization (ILO), the United Nations Development Program (UNDP), and the United
Nations Conference on Trade and Development (UNCTAD), which more fully represent the views of
LDC delegates.

The neo-classical approach states that underdevelopment arises from:

• Poor resource allocation due to incorrect price policies, and

• Government’s intervention in the economic activities.

Neo-classical or neo-liberal approach states that economic growth can be put to spur by:

• Permitting competitive free markets to flourish,

• Privatising state-owned enterprises,
• Promoting free trade and export expansions,
• Welcoming investors from developed economies, and
• Eliminating the plethora of government regulations and price distortions in factor, product and
market.

1. Linear-stages-of-growth model:

Following are the growth models studied under linear-stages:

(a) Rostow’s Stages of Growth: The stages-of-growth model of development is taken by

most of the newly independent countries. According to Walt W. Rostow doctrine, the transition
from underdevelopment to development can be described in terms of a series of steps or
stages through which all countries must proceed. According to Rostow, it is possible to identify
all societies, in their economic dimensions, as lying within one of five categories:

• The traditional society,

• The pre-conditions to take-off into self-sustaining growth,
• The take-off,
• The drive to maturity, and
• The age of high mass-consumption.
 Rostow also clarified that these stages are not merely a way of generalising certain factual
observations about the sequence of development of modern societies. He argued that the
advanced countries had all passed the stage of take-off into self-sustaining growth and the
under-developed countries that were still in either the traditional society or the pre-conditions
stage. One of the principal strategies of development necessary for any take-off was the
mobilisation of domestic and foreign saving in order to generate sufficient investment to
accelerate economic growth.

(b) Harrod-Domar Model: This model, developed independently by RF Harrod and ED

Domar in the l930s, suggests savings provide the funds which are borrowed for investment
purposes.

The model suggests that the economy's rate of growth depends on:

• the level of saving

• the productivity of investment i.e. the capital output ratio

For example, if $10 worth of capital equipment produces each $1 of annual output, a capital-
output ratio of 10 to 1 exists. A 3 to 1 capital-output ratio indicates that only $3 of capital is
required to produce each $1 of output annually.

The Harrod-Domar model was developed to help analyse the business cycle. However, it was
later adapted to 'explain' economic growth.

2. Structural-change theory:

Following economic growth model represents the structural-change theory:

(a) Lewis Theory of Development: It is one of the best-known early theoretical models of
economic development that focused on the structural transformation of a primarily subsistence
economy was that formulated by Noble-prize winner Sir W. Arthur Lewis in the mid 1950s. His
theory was later modified by his followers. The Lewis two-sector economy model became the
general theory of the development process in surplus-labour Third-World nations during most
of the 1960s and 1970s. In the Lewis model, the underdeveloped economy consists of two
sectors:

• A traditional, overpopulated rural subsistence sector characterised by zero-marginal

labour productivity. Lewis classify this as ‘surplus-labour’ in the sense that it can be
withdrawn from the agricultural sector without any loss of output, and
• A high, productivity modern urban industrial sector into which labour from the
subsistence sector is gradually transferred.

The primary focus of the model is on both the process of labour transfer and the growth of
output and employment in the modern sector. Both labour transfer and modern-sector
employment growth are brought about by output expansion in that sector.

(b) Patterns of Development: The patterns of development analysis of structural change

focuses on the sequential process through which the economic, industrial and institutional
structure of an underdeveloped economy is transformed over time to permit new industries to
replace traditional agriculture as the engine of economic growth.
 In addition to the accumulation of capital both physical and human, a set of interrelated
changes in the economic structure of a country are required for the transition from a traditional
economic system to a modern one.

These structural changes involve virtually all economic functions, including the transformation
of production and changes in the composition of consumer demand, international trade and
resource use as well as changes in socio-economic factors such as urbanisation, and the
growth and distribution of a country’s population.

3. International-dependence revolution:

Within this general approach, there are three major streams of thought:

(a) Neo-Colonial Dependence Model: It is an indirect outgrowth of Marxist thinking. It refers

to the existence and continuance of underdevelopment in a highly unequal international
capitalist system. The international system is dominated by unequal power relationships
between the centre (the developed nations) and the periphery (the less developed countries).
The poor nations attempt to become self-reliant and independent but this system makes it
difficult and sometimes even impossible.

According to this theory, certain groups in the developing countries (including landlords,
entrepreneurs, military rulers, merchants, salaried public officials, and trade union leaders)
who enjoy high incomes, social status, and political power constitute a small elite ruling class
whose principal interests are in perpetuation of the international capitalist system of inequality.
Directly and indirectly, they serve (are dominated by)and are rewarded by (are dependent on)
international special-interest power groups including multinational corporations, national
bilateral-aid agencies, and multilateral assistance organizations like the World Bank or the
International Monetary Fund (IMF). Therefore, a major restructuring of the world capitalist
system is required to free dependent developing nations from the direct and indirect economic
control of their developed-world and domestic oppressors.

Curiously, a very similar but obviously non-Marxist perspective statement was expounded by
Pope John Paul II in his widely quoted 1988 encyclical letter:

“One must denounce the existence of economic, financial, and social mechanisms which,
although they are manipulated by people, often function almost automatically, thus
accentuating the situation of wealth for some and poverty for the rest. These mechanisms,
which are manoeuvred directly or indirectly by the more developed countries, by their very
functioning, favour the interests of the people manipulating them. But in the end they suffocate
or condition the economies of the less developed countries.”

(b) False-Paradigm Model: The second and less radical international-dependence approach
to development, the false-paradigm model, attributes underdevelopment to faulty and
inappropriate advice provided by well-meaning but often uninformed, biased, and ethnocentric
international ‘expert’ advisers from developed-country assistance agencies and multinational
donor organizations. These experts offer sophisticated concepts, elegant theoretical
structures, and complex econometric models of development that often lead to inappropriate or
incorrect policies. Because of institutional factors such as the central and remarkably resilient
role of traditional social structures (i.e., tribe, caste, class, etc.), the highly unequal ownership
of land and other property rights, the disproportionate control by local elites over domestic and
international financial assets, and the very unequal access to credit, these policies, based as
they often are on mainstream, Lewis-type surplus labour or Chenery-type structural-change
 models, in many cases merely serve the vested interests of existing power groups, both
domestic and international.

(c) Dualistic Development Thesis: Dualism is a concept widely discussed in development

economics. It represents the existence and persistence of increasing divergences between
rich and poor nations and rich and poor peoples on various levels. One of the elements of
dualism is that there is a coexistence of wealthy, highly educated elites with masses of illiterate
poor people within the same country or city. According to this theory, there is a coexistence of
powerful and wealthy industrialized nations with weak, impoverished peasant societies in the
international economy.

This coexistence is chronic and not merely transitional. It is not due to a temporary
phenomenon, in which with the capacity of time, the discrepancy between superior and inferior
elements would be eliminated.

4. Neo-classical counterrevolution:

This approach can be implemented through the following three models:

(a) Free-Market Analysis: Free-market analysis argues that markets alone are efficient if:

• Product markets provide the best signals for investments in new activities,
• Labour markets respond to these new industries in appropriate ways,
• Producers know best what to produce and how to produce it efficiently, and
• Product and factor prices reflect accurate scarcity values of goods and resources.

Under free-market, competition is effective not necessarily perfect. Technology is freely

available and nearly costless to absorb. Information is correct and nearly costless to obtain.

(b) Public-Choice Theory: Public-choice theory, also known as ‘new political economy
approach’, goes even further to argue that government can do nothing right. This is because
that politicians, bureaucrats, citizens and states act solely from a self-interested perspective,
using their powers and the authority of government for their own selfish needs. Citizens use
political influence to obtain special benefits (sometimes also referred to as ‘rent’) from
government policies, for example, import licenses, or rationed forex. Politicians use
government resources to consolidate and maintain positions of power and authority.
Bureaucrats use their positions to extract bribes from rent-seeking citizens and to operate
protected business on the side. And finally state uses its power to confiscate private property
from individuals. The net result is not only a misallocation of resources but also a general
reduction in individual freedoms. The conclusion, therefore, is that minimal government is the
best government.

(c) Market-Friendly Approach: The third approach is market-friendly approach, which is the
most recent variant on the neoclassical counterrevolution. It is associated principally with the
writings of the World Bank and its economists, many of whom were more in the free-market
and public-choice camps during the 1980s. This approach recognizes that there are many
imperfections in LDC product and factor markets and that governments do have a key role to
play in facilitating the operation of markets through ‘non-selective’ (market-friendly)
interventions — for example, by investing in physical and social infrastructure, health care
facilities, and educational institutions and by providing a suitable climate for private enterprise.
Karl Marx’s Model

Czarist Russia grew rapidly from 1880 to 1914; it was considerably less developed than industrialised
countries like US and Great Britain. World War I brought great hardship to Russia and allowed the
communists to seize power. From 1917 to 1933, the Soviet Union experimented with different
socialist models before settling on central planning. Most economists believed until recently that the
Soviet Union grew rapidly from 1928 until the mid 1960s. After the mid 1960s, growth in Soviet Union
stagnated and output actually began to decline. In the late 1980s and early 1990s, open inflation
erupted. Prices were well below market-clearing levels and acute shortages arose in what is called
‘repressed inflation’. The repressive political system was unacceptable to the people in Soviet Union
and some countries in Eastern Europe and was universally rejected in 1989.

The father of this repressive political system – Communism is Karl Marx (1818 – 1883). The
centrepiece of Marx’s work is an incisive analysis of the strengths and weaknesses of capitalism. He
argued that it is the only labour power that gives value to a commodity. By imputing all the value of
output to labour, Marx hoped to show that profits, which is the part of output that is produced by
workers but received by capitalists, amount to ‘unearned income’. According to Marx, this unearned
income is unjustly received by capitalists. This injustice can be eliminated by transferring the
ownership of factories and other means of production from capitalists to workers.

Marx saw capitalism as inevitably leading to Socialism. In Marx’s world, technology enables
capitalists to replace workers with machinery as a means of earning greater profits. As a result
unemployment increases with the increased use of technological advances. This increasing
accumulation of capital will reduce the rate of profit and investment opportunities, and therefore, the
ruling capitalists will become imperialists. Karl Marx believed that the capitalist system could not
continue this unbalanced growth. Marx predicted increasing inequality under capitalism. Business
cycles would become ever more violent as mass poverty resulted in macro-economic under-
consumption. Finally, a cataclysmic depression would sound the death knell of capitalism. The
economic interpretation of history is one of Marx’s lasting contributions to Western thought. Marx
argued that economic interests lie behind and determine our values. His arguments against
capitalism suggested communism would arise in the most highly developed industrial countries.
Instead, it was backward, feudal Russia that adopted the Marxist vision.

Features of Karl Marx’s Socialist Model:

1. Government ownership of productive resources,

2. Planning is centralised,
3. Equal distribution of income,
4. Peaceful and democratic evolution,
5. Labour theory of value – value of a product represents the human labour used in production,
and
6. Theory of surplus value.

Theory of Surplus Value:

Marx propounded his theory of surplus value on the basis of his theory of value. He said that in order
to enable labour to carry on the work of production, he should have some instruments of production
and other facilities but he lacks these facilities. Hence, he has to sell his labour to the capitalist. It is,
however, not necessary for the capitalist to pay labour the full value of the product produced by him.
Here Karl Marx supported his theory on the basis of a classical theory, viz., the subsistence theory of
value, according to which the level of wages is determined by the subsistence of the worker. The
work of labour force is not merely to produce value equal to its price but much more. This surplus
value is the difference between the market value of the commodity and the cost of the factors used in
the production of commodity. Karl Marx says that the manufacturer gets for his commodity more than
what he has spent on labour and other costs. The excess of market value over the costs is the
surplus value. This surplus is created because labour is paid much less than is due to it. He
characterises the appropriation of the surplus value by the capitalist as robbery and exploitation. The
capitalist class goes on becoming richer and richer through exploitation of the working class.

Top
 Planning Techniques
Methodology of Planning:

The planner is gone through the following steps in economic planning:

(a) Collecting information: The most important aspect of economic planning is the collection of
economic data. The data are not only comprised of economical data, but they also cover the
demographical, geographical, and political data. The planner also considers non-quantitative data for
economic planning. The planner or the team of planners must have an enough knowledge regarding
the fields like sociology, religion, politics and ethics in addition to economics.

(b) Deciding nature and duration of the plan: Once the planning authority gets the knowledge in
respect of the economy on the basis of necessary statistics, the next step is to determine the nature
and size of the plan. In this connection, the planner has to decide between the planning on micro-
basis and planning on macro-basis, functional or structural, centralised or decentralised, etc. Again it
is to be decided that whether the planning will be on short-term basis, medium term, or long term. In
most of the countries, the medium term plans are advocated. The medium term plan which mostly
lasts for the period of 5 years is neither too short nor too long. In the period of five years the ruling
party is in a position to implement upon its programmes, policies and manifesto.

(c) Setting the objectives: After the nature and the duration of plan, the next issue is of setting
the objectives. In other worlds, it is an important task before the planner to decide regarding the
social and economic objectives which will have to be attained in the specified period of the plan.
Most of the objectives or goals of the plan are concerned with the attainment of higher growth rate of
GNP, reduction of unemployment, removal of regional disparities, removal of illiteracy, development
of agriculture and industrial sectors, etc. After identifying such objectives, planner arranges these
objectives in order of their importance to the society and the economy as a whole.

(d) Determination of growth rate: This is the most important decision which the planner has to
make while formulating the plan. It is about to determine the growth rate during the plan period, i.e.,
at what rate the economy will grow during this period. The economists agree that the growth rate of
the economy should be one which could at least maintain the per capita income of the country. This
would be possible if the growth rate of the economy or growth rate of GNP and growth rate of the
population are equal. But this growth rate is least recommended. Rather, the planner will opt for that
growth rate which is greater than the population rate. For example, if Pakistan wants to maintain its
existing per capita income while population is growing at the rate of 3% p.a., then the required GNP
growth rate should not be less than 3%. If we want to grow GNP by 3%, NI should grow @ 6%. If the
capital output ratio (COR) is 1:3, then we will have to invest 18% of GNP. While determining the
growth rate, the planner must keep in view the growth rate of other neighbouring or developing
countries like India, China, Sri Lanka, Indonesia, Bangladesh, etc.

(e) Financial resources of the plan: The economic planner is aimed at utilising the resources of
the country in such a way that the pre-determined objectives are attained. The real resources of a
country consist of manpower, natural resources, technological advancement, infra-structure, good
governance, entrepreneurial skills, etc. The planner also has to consider the various optional external
resources in case the internal resources are short to fulfil the planning requirements. Such external
resources consist of foreign aid and assistance, foreign grants, foreign direct investment, and foreign
borrowings from various IFIs and rich countries.
 (f) Sectoral allocation or determination of priorities: The resources at the disposal of a
country are always short of the requirements. Therefore, a plan is aimed at utilising the resources in
such a way that the maximum social benefit could be attained. Accordingly, the planner has to
decide which project be taken-up and which project be postponed. In this way, the planner has to
prepare a schedule on the basis of relative importance of projects. Then a choice has to be made
regarding allocation of resources amongst different uses. Normally the planner has to decide
between industrial sector development or agricultural sector development, private sector or public
sector, labour-intensive technology or capital-intensive technology, etc. To settle the issue of ‘choice
of priorities’ amongst different alternatives, the planners have given the concept of ‘investment
criteria’.

(g) Role of the government: In most of the countries, the purpose of planning authority is to
prepare the draft of the plan consisting of lot of proposals, schemes and projects. When once the
plan is chalked out the proposals are sent to operating agencies, ministries and other government
departments which are to implement the plan. The government agencies are inquired of their
recommendations regarding the economic feasibility of different schemes and projects of the plan
keeping in view the sectoral allocation and size of the plan. The operating agency, i.e. the
government has to consider the role to be played by private sector and public sector. The
government has to inform the planning agency regarding the prospective bottlenecks in the way of
effective planning. These recommendations will be helpful in finalising the draft of the plan.

(h) Formulation of economic policies: The role of planners in planning methodology is not just
confined to preparation of schemes and projects, they also have to devise economic policies which
could provide a favourable atmosphere for the operation of the plan. Accordingly, economic policies
play an important role in economic planning, they provide fuel to the engine of economic
development.

(i) Plan execution: The last step is plan execution. For effective implementation of plan,
following conditions are the pre-requisites:

(i) the government should be stable, honest, sincere and constructive,

(ii) the administrative system must be efficient, i.e. free of favouritism, corruption,
bribery, red tapism, etc.

(iii) maintenance of law and order situation,

(iv) equal participation of private and public sectors in economic development,

(v) readily availability and computerised maintenance of government records, financial

statements and cost statements,

(vi) vigilant and constructive opposition, etc.

Types of Economic Policies:

Following are types of economic policies considered in the economic policy formulation:

(a) Budgetary Policy: The planner would suggest to devise such a budgetary policy which could
transfer the revenue surplus from revenue budget to capital budget. Moreover, the balanced budget
would provide a guarantee for price stability.
 (b) Tax Policy: The tax policy be stipulated in such a way that more revenues could be raised
from taxes for the sake of public expenditures. Moreover, the tax policy should aim at removing
income disparities and wasteful expenditures on luxurious consumption. Thus the taxes be imposed
in accordance with the ability to pay.

(c) Credit Policy: The credit policy be formulated in such a way that short-term, medium-term
and long-term credit could be made available to the different sectors of the economy. When the
funds are obtained by the needy sectors of the economy, the pace of development will be accelerated
and the plan targets will be realised.

(d) Foreign Trade and Foreign Exchange Policy: According to this policy a plan should seek to
earn the sufficient amount of foreign exchange by boosting the exports and reducing the imports.
When the foreign exchange resources of a country increase, the problem of debt repayment will also
be alleviated.

(e) Tariff Policy: An economic plan should devise such a tariff policy that the unnecessary and
luxurious imports could be checked. However, it should encourage the imports of essential consumer
goods, capital goods, raw stuff and machinery which would be helpful in accelerating the pace of
development. Moreover, tariff policy should aim at protecting the infant industries.

(f) Price Policy: The price stability provides guarantee to the success of a plan. Therefore, such
a policy should be devised by the planners that monopolies could not grow, the limits be imposed on
profit margins, government expenditures be controlled and competitive forces be restored in the
economy.

(g) Wage Policy: An economic plan should aim at protecting the rights of the labour. They must
be having job security, minimum wage laws and constitute labour unions. Civil and government
servants should be given reasonable emoluments to attract personnel to public services. Exploitation
of labour by producers should be discouraged.

(h) Manpower Policy: Manpower policy is an economic policy pursuing the regularisation of
skilled, semi-skilled and unskilled persons to bring a balance between the demand and supply of
labour. This will lead to maximum utilisation of manpower.

(i) Immigration Policy: Restrictions should be imposed on internal mobility of labour in

horizontal, vertical and geographical forms. Brain drain should be checked in the early stages of
development.

(j) Nationalisation Policy: As a result of severe market imperfections, the planner may pursue
nationalisation policy in economic planning. The sector or the sectors that are causing market
imperfections may be nationalised or taken into government control.

(k) Privatisation and Deregulation Policy: The purpose of this policy is to reduce the burden of
governmental expenditures and the operational inefficiencies caused by state-owned enterprises. To
improve investment conditions and to promote healthy competition, such state-owned enterprises are
given under the control of private hands.

Planning Techniques:

There are several planning techniques used in different stages of planning. Some of them are
discussed below:
 (a) Capital-Output Ratio (COR): The Capital-Output Ratio (COR) is used during the planning
stage of determination of growth rate. COR defines the relationship between capital and output. This
concept shows that how much of capital is required for how much of output. Broadly speaking, it tells
us that how much of investment is required to produce a certain level of consumption goods. We also
found its traces in Harrod-Domar Model of economic growth. According to COR, the sustained
growth rate can be represented by the following equation:

Where Gw = sustained growth rate;

s = saving ratio;

v = capital-output ratio (COR).

The above equation shows that if a developed country wishes to attain a sustained equilibrium growth
rate the national income must grow at the proportion of saving ratio (s) to capital-output ratio (v).

In planning, the planner is concerned with additional amount of capital required for additional output,
then the concept of marginal capital-output ratio (MCOR) or incremental capital-output ratio (ICOR) is
used. Its equation is shown as below:

Where w = marginal capital-output ratio (MCOR) or incremental capital-output ratio (ICOR);

∆K = change in capital stock;

∆Y = change in output;

∆I = change in investment.

For example, if the ratio is 3:1, then it shows that to produce the goods worth Re. 1 will require to
make the net investment worth Rs. 3. In other words, if the economy wants to increase the output by
Rs. 1 billion with the COR 3, then the required addition to the capital stock to be provided by new
investment will be Rs. 3 billion.

The economists and planners also use the concept of average capital-output ratio (ACOR). This
concept shows the ratio of existing stock of capital and the level of output which results from such
capital. In other words, if we divide the value of total capital stock by the total annual income, we will
get ACOR. It is represented as follows:

Where K = existing capital stock;

 Y = existing level of output.

For example, the existing capital stock of the economy is Rs. 6 billion, while the output of the
economy is Rs. 1.5 billion, then the value of ACOR will be equal to 4.

More is the value of ICOR, less will be the growth rate and vice versa. For example, if the COR is 3,
saving ratio is 18%, then the growth rate of the economy will be:

For COR 4 and 2, the growth rates at the same saving ratio will be 4.5% and 9% respectively.

COR Saving Growth Rate

Ratio
4 18% 4.5%
3 18 6
2 18 9

(b) Plan Consistency and Tabulation: A good plan must be having the elements of realism and
consistency in numbers. It means that it should not only represent true picture of the economy, but it
should have a balance in context with different sectors of the economy regarding numbers.
Therefore, to attain such arithmetic target it becomes necessary the resources be analysed
arithmetically. For this purpose ‘ex-ante’ (expected) tabulation of balances between demands and
supplies is made. All the estimations and projections are entered in interlocking tables in such a way
that they are linked with one another. The interlocking tables show different items along with their
statistics and importance. Following are the specimen of interlocking tables:

1. Projected Sector Growth

Sectors Growth in Zero Period Growth during 5 years

Agriculture
Industry
Services
GDP

2. Resources and their Uses

In In
Resources In 5 years Uses In 5 years
zero period zero period
GDP Capital
Surplus of FT sector Govt. expenditure
Private consumption
Total Total

3. Capital Account

In In
In 5 years In 5 years
zero period zero period
Fixed investment Capital
Stocks Corporate saving
Private saving
Govt. saving
Foreign saving
Total Total
 4. Government Current Account

In In
Revenues In 5 years Expenditures In 5 years
zero period zero period
Taxes Govt. expenditures
Other revenues Transfer payments
Saving
Total Total

(c) Input-Output Analysis: The purpose of Input Output (IO) Analysis is to provide a balance
between input, output and final demand. It is also connected with plan consistency. Efficient
planning requires that how much an industry produces must be equal to the demand for that
particular commodity. On the same lines, each industry wishes to have an assurance of the inputs
necessary for its output. It may happen that output of one industry may be an input of another
industry. Thus, the purpose of IO Analysis is to observe such input output relationships. In other
words, IO Analysis encompasses the inter-industry transactions. This technique was invented by
Professor Leontief in 1951. It is also known as ‘inter-industry analysis’.

The planner constructs input-output tables where the relevant transactions are recorded. Then with
the help of transaction data, the input-output co-efficients are derived. Finally, the ‘Leontief Matrix’ is
inverted to obtain a general solution. IO Table shows the values of the flows of goods and services
between different productive sectors especially inter-industry flows. In the following IO Table, we
have a 3-sector economy where there are two inter-industry sectors, i.e. agriculture and industry, and
one final demand sector:

Purchasing Sectors
(All figures in million rupees)
(1) (2) (3) (4)
Sectors Inputs to Inputs to Final demand Total Output
Agriculture Industry (Household) or Total Revenue
Agriculture 500 1500 1000 3000
Selli Industry 1000 2500 1500 5000
ng Value added 1500 1000 0 2500
Sect (Payment to factors)
ors Total Inputs
3000 5000 2500 10500
or Total Cost

(d) Linear Programming: In economic planning, the planners wish to include in plans those
methods, techniques and programmes which would ensure the optimal use of resources. Thus the
programming that is used for the best or optimum use of resources is known as ‘linear programming’.
It is programming because it has been formulated in mathematical mould and its results are shown in
terms of linear relationship. It is also known as ‘activity analysis’. It helps the planner to allocate
resources optimally among alternative uses within the specific constraints. It also helps to tackle the
problems of investment planning. Linear programming can be applied in case of number of economic
problems concerning with maximisation or minimisation subject to constraints. Through linear
programming the profit function can be formulated. For e.g., for a firm producing bicycles and motor
cycles, the profit maximisation function is construction as below:

Where = maximum profit

x1 = bicycles (profit of $45 per bicycle)

 x2 = motor cycles (profit of $55 per motor cycle)

Following are the given constraints:

While x 1 ,x 2 ≥0 (non-negativity condition)

If x 1 =0, then x 2 =30; and if x 2 =0then x 1 =20

This linear relationship can be built into a graph:

(e) Project Appraisal: Project appraisal is widely used both in the developed as well as in under-
developed countries both independently as well as an integrated scheme of national planning. The
government formulate and evaluate investment projects in such a way as to be able to compare and
evaluate alternative projects in terms of their contribution to the objectives of the nation. The team
preparing project report consists of engineers and economists specialised in investment analysis and
the relevant fields. The sociologists and natural environmentalists must also be included. There are
different techniques of project evaluation, such as cost-benefit analysis, LM method, and UNIDO
guideline:

(i) Cost-Benefit Analysis: This technique is also known as ‘social cost benefit analysis’. In
this technique, the costs of projects are evaluated. For the purpose of analysis the cost is
disintegrated into various categories, viz., project costs, associated costs, real and nominal costs,
primary or direct costs, secondary or indirect costs, etc. The benefits are also classified as real
benefits, direct and indirect benefits, etc. The next step is to find the present value of costs and
benefits applying a certain rate of interest. Then a comparison is made between the discounted
benefits with the costs of projects to get the ratio of costs and benefits. If this ratio is one or more
than one, the project is acceptable, otherwise rejected. This technique is known as ‘net present
value (NPV) method’. For this we need to calculate the present value (PV), which can be
calculated as below:
Where C = annuity amount

i = interest rate or discount rate

The decision rule for a project under NPV method is to accept the project if the NPV is positive
and reject if it is negative. Zero NPV implies that the government is indifferent between accepting
or rejecting the project. This method can also be used to make a choice between two or more
than two mutually exclusive projects. On the basis of NPV method, the various proposals would
be ranked in order of NPV. The project with highest NPV would be preferable to the project with
lowest NPV.

Suppose the government has two proposed projects, i.e. project A and project B.

Project A Project B
Initial investment 60,000 59,000
Cash inflow / profit:
2005 14,000 11,000
2006 15,000 14,000
2007 16,000 17,000
2008 18,000 18,000
2009 19,000 20,500
PV Factor 10% 10%

The NPV of both projects is calculated as below:

Net Present Value

Project A Project B
Years Cash PV factor Cash PV factor
PV PV
Inflow @ 10% Inflow @ 10%
2005 14,000 0.909 12,726 11,000 0.909 9,999
2006 15,000 0.826 12,390 14,000 0.826 11,564
2007 16,000 0.751 12,016 17,000 0.751 12,767
2008 18,000 0.683 12,294 18,000 0.683 12,294
2009 19,000 0.621 11,799 20,500 0.621 12,731
PV of Cash inflows 61,225 59,355
Less: Initial investment 60,000 59,000
Net Present Value 1225 355

In the above case, the planners will opt for project A, because the NPV of the project is
positive and is greater than the NPV of project B. The economy will benefit more from project A
than from project B.

(ii) The Little and Mirrless (LM) Method of Project Evaluation: There are two main
features of LM method:
 • Foreign exchange used as a ‘measuring rod’. Rather domestic prices, foreign
exchange measures the true costs and benefits of commodities produced.
Therefore, the net value of all the goods produced should be converted into its
foreign exchange equivalents.
• The amount of savings in LDCs is less than the socially optimal level. Hence,
one additional unit of investment is more valuable than an extra unit of consumption
at the margin.

(iii) UNIDO Guideline: LM method tries to convert all the benefits and costs to an index of
government income, UNIDO translates such all benefits and costs to an index of present
consumption. Thus the UNIDO method tries to find out the NPV of all consumption flows because
of an additional unit of investment.

(f) Investment Criteria for Allocation of Resources: The 'investment criteria' is a useful
planning technique used in sectoral allocation. Investment criteria refers to pattern of investment,
choice of investment, choice of projects in various sectors, and choice of technique for a particular
project.

(i) Capital Turn-Over Criterion: The H-D model hints out the values of different variables
which would guarantee the UDCs to maximise their growth. According to it, the growth rate is
represented as follows:

Where g = growth rate of output

S = saving income ratio

C = capital-output ratio (COR)

This equation states that to raise the growth, we are required to raise S or to lower the value of
C. Professor Polak and Buchnan argued that given the scarcity of capital in LDCs the C should
be minimised. This is called ‘capital turn-over criterion’. According to Polak and Buchnan those
investment projects should be chosen which have low C, i.e. high rate of capital turn over.

(ii) Social Marginal Productivity (SMP) Criterion: This criterion has been presented by
Kahn and Chenery. They are of the view that it is necessary to consider the total net contribution
of marginal unit of investment to national output, and not merely that portion of contribution which
is gotten by private investors.

Efficient allocation consists of maximisation of national product and the principle to obtain this
objective is to equate SMP of capital in different uses. SMP criterion is represented as:

Where V = annual value of total output

C = total annual cost of amortisation

 K = total investment

VB = variations in income because of changes in 1 unit of BOP.

(iii) Maximisation of the Rate of Creation of Investible Surplus (MRIS) Principle: The
objective of MRIS criterion is to maximise per capita real income at a future point of time. Thus to
achieve a higher rate of growth, it is stressed upon role of capital accumulation. According to
MRIS criterion, those projects should be selected which involve higher capital intensity. In other
words, those projects should be select which have higher COR.

(iv) Reinvestible Surplus (RS) Criterion: This criterion was suggested by Dobb and Sen. In
Sen’s model the economy is divided into two sectors, i.e. backward and modern. The modern
sector is again sub-divided into two, i.e. (A) producing machinery with labour only, and (B)
producing corn with labour and machines. In the backward economy the corn is produced by
labour alone. Sen assumes that wages in the modern sector are determined by corn output by
sector B. But since it takes sometime to set-up the modern sector, wages in the modern sector
would have to be paid of with the surplus in backward sector. Sen describes how a conflict can
arise between current output maximisation principle and criterion to maximise the rate of growth of
output.

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 Schumpeter’s Model of Economic Growth
Joseph Schumpeter was a famous Austro-Hungarian economist, but never followed Austrian school
of thought. His famous book was the Theory of Economic Development (1912), in which he first
outlined his famous ‘theory of entrepreneurship’. He argued that only daring entrepreneurs can create
technical and financial innovations in the face of competition and falling profits, and that it was these
spurts of activity which generated economic growth. After the World War I, Schumpeter joined the
German Socialization Committee in Berlin - which then was composed of several Marxian scholars,
and the Kiel School economists.

In 1919, Schumpeter became the Austrian Minister of Finance - unfortunately, presiding over the
hyperinflation of the period, and thus was dismissed later that year. Schumpeter migrated in 1921 to
the private sector and became the president of a small Viennese banking house. Ill luck dogged him:
his bank collapsed in 1924. He drifted once again back into academia - taking up a teaching position
at Bonn in 1925. In 1932, Schumpeter took up a position at Harvard, succeeding the Marshallian
F.W. Taussig. Schumpeter ruled Harvard during the period of the ‘depression generation’ of the
1930s and 1940s - when Samuelson, Tobin, Heilbroner, and Bergson were his students. His famous
publications include Theory of Economic Development (1912), Business Cycles (1939), Capitalism,
Socialism and Democracy (1942) and History of Economic Analysis (1954). He presented the theory
of entrepreneurship, theory of business cycles, and theory of evolutionary economics.

In order to understand the Schumpeter’s theory of economic development, it is necessary to

understand the theory of evolutionary economics. The concept of evolution is an offspring of late
18th and early 19th century debates within philosophy and the social sciences. The theory of
evolutionary economics is much more inspired by the Darwinian theory of natural selection. The
general definition of evolution is the self-transformation process over time of a system. Such a
system may be a population of living organisms, a collection of interacting individuals as in an
economy or some of its parts, or even the set of ideas produced by the human mind. Therefore, an
evolutionary theory is:

• Dynamic — such that the dynamics of the processes, or some of their parts, can be
represented;
• Historical — in that it deals with historical processes which are irrevocable and path-
dependent;
• Self-transformation — in that it includes hypotheses relating to the source and driving force of
the self-transformation of the system.

Schumpeter’s theory of economic development is considered as a radical theory. It is considered

radical in the context that it described the capitalist system as an evolutionary system. According to
Schumpeter, capitalism is the system that internally generates changes and technological
progresses. According to him, the process of economic development is inherently dynamic, as
opposite to static nature of the theory of equilibrium. This does not mean that Schumpeter is against
the theory of equilibrium. On the contrary it is the underlying base for his own capitalist dynamic
model.

Schumpeter’s model of economic development is not a substitute for the theory of equilibrium but
rather a necessary complement. Without it, it is impossible to understand the functioning of an
economic system. Schumpeter started through the ‘circular flow’ as an essential block for building
dynamic model. Schumpeter describes the circular flow with the following assumptions:

• somewhere in the economic system a demand is ready awaiting every supply, and
 • nowhere in the system are there commodities without complements.

Under these conditions, all goods find a market, and the circular flow of economic life is closed. In a
steady state, costs in this closed system are the price totals of the services of the production factors.
Prices obtained for the products must equal these price totals. The ultimate logical consequence of
this ideal model of the clearing market is that production must flow on essentially profitless – profit is
a symptom of imperfection.

Schumpeter defines production as the combinations of materials and forces that are within our reach.
The producer is not an inventor. All components that he needs for his product or service, whether
physical or immaterial, already exist and are in most cases also readily available. The basic driving
force behind structural economic growth is the introduction of new combinations of materials and
forces, not the creation of new possibilities.

Development in the Schumpeterian sense is defined by the carrying out of new combinations. This
concept covers the following five cases:

(i) The introduction of a new good – that is one with which consumers are not yet familiar –
or a new quality of a good.

(ii) The introduction of a new method of production – that is one not yet tested.

(iii) The opening of a new market – that is a market into which the country in question has not
previously entered.

(iv) The conquest of a new source of supply of raw materials or half-manufactured goods.

(v) The carrying out of the new organisation of any industry, like the breaking up of a
monopoly position.
The basic structure from Schumpeter’s model of economic development has two distinctive spheres.
On the one hand is the semi-closed system of the circular flow that is either in equilibrium or striving
for it. And, on the other hand, is the symbiotic pair of the entrepreneur and the sponsor that is always
looking for ways to induce change in the peaceful yet boring routine-life of the circular flow. Both
spheres function within an endless reservoir of new combinations, for example, scientific knowledge
and technological inventions, but it is only the entrepreneur – backed by the capitalist – who is able to
introduce new combinations and new routines in the circular flow.

According to Schumpeter, entrepreneur who initiates the process of innovation is the central of the
process of economic development. Entrepreneurs are neither capitalists nor inventors; they see the
potential of inventions and assume risk in innovating. Schumpeter regarded the entrepreneur as
something of a social deviant and noted that migrants or aliens in any society have great potential to
behave entrepreneurially. Schumpeter noted that increases of taxes, public policies favouring labour
organisations, price controls, and licensing requirements that increase the costs of doing business
are the greatest impediments to entrepreneurship. Under oppressive conditions, for example, the
former Soviet Union, China, and present day Islamic societies, very few people innovate.

The creation of something new usually requires that something old be eliminated, for example,
changes in the structure of demand or production result in structural unemployment. Economic
growth cannot proceed without structural changes, i.e., economic development. Most technological
progress is a result of activity specifically undertaken to develop new products, reduce costs, improve
quality, or develop new markets.

Economic evolution is based on cyclical disruptions and breaks of economic structures, an

endogenous transformation that results from the ‘process of creative destruction’ as an essential
feature of modern capitalism. This points at the internal logic of the cyclical restructuring of modern
capitalism for evolutionary change.

Business cycle refers to regular fluctuations in economic activity. In the 19th century, business cycles
were not thought of as cycles at all but rather as spells of "crises" interrupting the smooth
development of the economy. In later years, economists and non- economists alike began believing
in the regularity of such crises, analysing how they were spaced apart and associated with changing
economic structures. Schumpeter divided a business cycle into four process – boom, recession,
depression and recovery. He also classified the business cycles in the following classes:

(a) Seasonal cycles – for a year

(b) Kitchin cycles – covering a period of 3 years

(c) Juglar cycles – covering a period of 10 years

(d) Kuznets cycles – covering a period of 15 to 20 years

(e) Kondratiev cycles – covering a period of 48 to 60 years, for example, Industrial Revolution
(1787 – 1842), Bourgeois Kondratiev (1843 – 1897), and Neo-Mercantilist Kondratiev (1898 –
1950) with the expansion of electric power and the automobile industry.

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Intelligence

Types of Economic Planning

Planning by Inducements
Planning by inducement is often referred to as ‘indicative planning’ or ‘market incentives’. In such
type of planning, the market is manipulated through incentives and inducements. Accordingly, in this
system there is persuasion rather than compulsion or deliberate enforcement of orders. Here the
consumers are free to consume whatsoever they like, producers are free to produce whatsoever they
wish. But such freedom of consumption and production are subject to certain controls and
regulations. The consumers, producers and other factors of production are induced with the help of
various fiscal and monetary devices. For example, if the planning authority wishes to boost the
production of corn oil in Pakistan it will provide subsidies, tax holidays and loans to the firms involved
in production of corn oil. To encourage savings and investment and discourage consumption a
suitable package of fiscal and monetary policies can be introduced in the market. Therefore, the
desirable results can be attained with the help of incentives and without the imposition of orders and
instructions. Moreover, in such planning there is less sacrifice and less loss of liberty – economic as
well as non-economic.

Merits of Planning by Inducements:

(a) Consumers’ sovereignty remain intact. Planning by inducements is more democratic as
compare to planning by directions.
(b) There is a freedom of choice of profession.
(c) In planning by inducements, there is freedom of enterprise. Produces are free to produce
whatever they like but within in the capacity of given rights.
(d) Planning by inducements is smooth and flexible. It is more popular because it enables to
incorporate the changes in resources, technology and taste etc. even after the finalisation and
implementation of plan.
(e) Under this sort of planning, the inertia attached with standardisation can be put to an end and
producers are free to produce in accordance with the desire of consumers. Therefore, there is
a variety of goods and services in the market.
(f) There are less administrative costs involved in planning by inducements.
(g) The problem of shortages and surpluses is solved as there is an existence of automated
market system. The demand and supply is automatically adjusted and remain in balance
under market economy.

Demerits of Planning by Inducements:

(a) It also fails to achieve 100% targets of economic planning.
(b) Under planning by inducements, there are profit motives more than welfare of public.
Private entrepreneurs care for those products which yield high profits. Products or services
with less profit or no profit do not attract private entrepreneurs. Such products or services
include education, health, defence, security, etc.
(c) The producers may find the government policies regarding economic affairs not
attractive enough to follow. There may be disputes among entrepreneurs and the
government regarding tax rates, investment policies, interest rates, etc.
(d) The mechanism of market economy may cause the prices to inflate esp. with reference to
under-developed countries or in case of oligopoly where there is a shortage of certain products
like petroleum and gas.
(e) There may be disharmony between labour and producer, and there may be serious
industrial disputes.
Planning by Directions
This type of planning is practised in socialist countries like China, Former USSR, Cuba, North Korea,
etc. Under planning by direction, there is one central authority which plans, directs and orders the
execution of the plan in accordance with the pre-determined targets and priorities. It determines the
production figures, delivery schedules, quotas regarding the production of the goods, price controls,
use of foreign exchange and allocation of resources like labour, etc. amongst different competing
uses. Thus, such planning is comprehensive and encompasses the whole economy. Planning by
directions is similar to military or defence plans which are carried through orders and instructions.
Thus the strategy of planning through directions coincides with the military strategy. Alongwith the
disintegration of former Soviet Union, the methodology of planning by directions has received certain
serious setbacks. Now most of the UDCs are tend to adopt market economic system.

Demerits of Planning by Directions:

(a) Planning by direction is undemocratic since the people are ignored all along.
(b) It is bureaucratic and totalitarian. Under bureaucratic system, the individual’s sovereignty is
completely abolished. Corruption, red tapism, VIP system, tyranny and austerity are the by
products of bureaucracy.
(c) Rationing and control result in black marketing.
(d) There are shortages of some goods and as well as surpluses of other goods. That is, there is
an imbalance in production output.
(e) This sort of planning is inflexible. Once the plan is prepared, there is no room for alterations
in later phases of planning. A part of the plan cannot be changed without simultaneous
changes in many interconnected activities. Planning by direction is so complex that it is
impossible to change even a part of it as it will involve in altering the whole plan.
(f) The fulfilment of plan cannot be guaranteed, as the planning by direction is hampered by
black marketing and corruption.
(g) Planning by direction also leads to excessive standardisation which impinges on consumer
sovereignty. In other words, under planning by direction the goods produced are standardised
lacking the variety. As in case of USSR, the produced TV, Fridges and Automobiles were
identical having no differentiation.
(h) It also involves huge administrative costs, as the planning by direction involves in elaborate
census, numerous forms and army of clerks.

Physical and Financial Planning

Physical planning is concerned with physical allocation of resources on the one side, while with the
product yields on the other side. Its aim is to bring physical balance in between investment and
output. Accordingly, investment coefficients are computed. These coefficients show how much
amount of investment will be required for a given amount of output. Moreover, in such planning it is
also analysed that what will be the composition of investment to obtain an increase in output. As,
how much iron, how much coal, oil and electricity will be required to produce some specific amount of
steel. While making physical planning, an overall assessment is made regarding the real resources
of the economy like raw material and manpower.

In financial planning, equilibrium is established between demand and supply to avoid inflation and
bring economic stability. The difference between physical planning and financial planning is that the
physical planning tells us the size of investment in terms of real resources, whereas the financial
planning tells us the size of investment in terms of money. In financial planning, the planner
determines how much money will have to be invested in order to achieve the pre-determined
objectives. Total outlay is fixed in terms of money on the basis of growth rate to be achieved, the
various targets of production, estimates of the required quantity of consumer goods and the various
social services, expenditure on the necessary infra structure, etc. as well as revenue from taxations,
borrowings and savings.

Centralised Planning and Decentralised Planning

Under centralised planning, all the economic decisions are taken by the central authority or the
government. It is the government which formulates economic plans, determines objectives, sets
targets and priorities. Every member has simply to carry out the instructions without questioning
about its viability. There are more chances of failure as the individuals are not allowed to carryout the
plans in accordance to their needs and preferences. It is the government who takes responsibility of
the success or failure of the plan. It is the government who takes all the decisions of consumption,
production, wages and prices. What amount of investment is to be made?, What should be the
price?, What should be the output?, How the products are to be distributed?, How much amount of
loans is to be granted?, What should be the rate of interest?, etc. Centralised planning is mostly
executed in socialist or communist countries.

Decentralised planning is connected with the capitalistic economies. The decentralised planning is
implemented through market mechanism. Decentralised planning empowers the individuals or small
groups to carryout their plans for achievement of a common goal. Under decentralised planning, the
operation is from bottom to top. The planning authority formulates the plan by having made
consultation with different administrative units of the economy. The plans regarding different
industries are designed by the representatives of these industries. In such type of planning, the
planning authority issues the instructions to central and local bodies regarding incentives given over
to private sectors.

Structural and Functional Planning

The planning which is aimed at bringing changes in socioeconomic set-up of a country is termed as
structural planning. This type of planning is attributed to the planning which was made in USSR in
1929 when the existing land-lord-system was abolished, collective farming was introduced, trade,
industries and transport system was nationalised.

While functional planning is a type of planning where hardly any big change is brought about in the
existing socio-economic set-up of the country. It means when planning is made in the presence of
existing institutions is termed as functional planning. In France, Germany, UK, etc planning is being
made in the existing framework of capitalism.

Indicative and Imperative Planning

Indicative or planning by inducements has already been discussed in a previous section. In the
following section we will discuss the three components or approaches regarding indicative planning:

(a) Forecasting Approach: Under forecasting approach, the individuals are provided with the
information, through making certain forecasts. Such forecasting serve as a guide to their decision
making. The forecasting not only indicate about the feasible future, but they also specify a
desirable future in terms of growth rate of the economy.

(b) Policy Approach: The second component of the indicative planning is concerned with policy
approach. Through policy approach, the inconsistent policies of government departments are co-
ordinated within a coherent model framework keeping in view the set objectives. Moreover, when
once the policies are co-ordinated, they will provide guidelines to the people, consumers and
producers.
 (c) Corporate Approach: The third way to demonstrate indicative planning is through corporative
approach. This approach is practised in France. Here the co-ordination function of indicative
planning envisages at two level. In the first place, it requires co-ordination of the behaviour of
economic groups like business enterprises and trade unions, etc. which hold power in the market.
In the second place, it co-ordinates the relation between private and public activities.

Imperative planning is the planning where the formulation and implementation of the plan is made by
the central planning authority. It is also known as ‘directive planning’. Under imperative planning, it is
the duty of the state to provide necessary supplies like raw material, machines, manpower and
entrepreneurs as all such resources are owned by the state. Under socialist economies, where the
imperative planning is in practice the planners always prefer future consumption over present
consumption. Thus under imperative planning the priorities laid down by the planners always
supersede those of masses. There is no consumer sovereignty under imperative planning.

Democratic and Totalitarian Planning

Under democratic planning, the philosophy of democracy is followed. Since formulation to the
execution of the plan, the people are taken into confidence. Whenever the plan is prepared, the
ruling party makes a dialogue with the public firms and even with opposition party. The purpose of
such arrangements is to satisfy different segments of the economy regarding growth and welfare
programmes. After the formulation of the plan, an open discussion is make in the parliament. Under
democratic planning, whole of the economic activities are performed through price mechanism. The
government influences the private sector through fiscal and monetary policies. Moreover, the
government passes anti-monopoly laws to protect the consumer’s sovereignty.

In totalitarian planning, there is a central control, and all economic activities are governed by the
central authority. In totalitarian planning, all of consumption, production, distribution and exchange
like activities are controlled by the central planning authority. Totalitarian allows no consumer
sovereignty and democratic freedom.

Fixed Plan and Rolling Plan

Fixed Plan
In a fixed plan, the contents of the plan are fixed in relation to a fixed time period. These contents
consisting of targets, priorities, strategies and resources, etc. will not be changed during the particular
time period for which the plan has been prepared except for severe unforeseen events.

Merits of Fixed Planning:

(a) There is a boldness in planning. This is the essence of planning that the planners and
implementing machinery will not bow down before the obstacles.
(b) There is effective implementation of plan.
(c) The targets of fixed plan are certain and this certainty in objectives brings stability to the
economy.
(d) Fixed plans ensure discipline for the planning process.

Demerits of Fixed Planning:

(a) Fixed plans are inflexible plan. They cannot be altered in later phases.
(b) There is no revision of economic objectives and targets as there is no alteration allowed under
fixed planning.
(c) If the state is an under-developed country, the fixed plan would give the economy a hard time
to achieve the basic objectives like employment, industrialisation, education, health, etc.
(d) Fixed plans, if not properly formulated and implemented, lead to wastage of resources.
Rolling Plan
Rolling planning refers to the rolling of a plan at intervals usually one year, so that it continues to be a
plan of certain number of years. It is usually the medium term plan.

Merits of Rolling Plan:

(a) Rolling plans are flexible and can be altered in later phases.
(b) The rolling plan allows for revisions and adjustments. In rolling plan, review of the plan is a
continuous exercise.
(c) Rolling plans enable the planners to keep the time horizon moving, alongwith making revisions
and adjustments so as to prepare a new plan every year in accordance with the changing
circumstances.

Demerits of Rolling Plan:

(a) Rolling plan is furnished with uncertainty, as there is no fixation of economic objectives.
(b) In rolling plans, the planners are always reluctant in taking difficult decisions or taking
courageous decisions.
(c) Under rolling plan, there is a lack of commitment. As there is no fixity attached with the plans,
the enthusiasm on the part of planning and administrative machinery will hardly be found.

Short-term, Medium and Long-term Planning

Short-term plans are also known as ‘controlling plans’. They encompasses the period of one year,
therefore, they are also known as ‘annual plans’. In annual plans or budgets the financial aspects of
the plan, i.e., financial sources and applications are shown. In the annual developmental plans the
items pertaining to capital budgets, i.e., the capital revenue and expenditure are listed. The main
objectives of short-term planning is to raise the revenue, attain the short-term economic targets, bring
price stability, and remove deficit in BOP.

The medium-term plans last for the period of 3 to 7 years. But normally, the medium term plan is
made for the period of five years. The medium-term planning is not only related to allocation of
financial resources but also physical resources. The main objectives of medium-term economic
planning are to raise per capita income, raise the level of employment, create self-sufficiency in the
economy, reduce dependence over foreign aid and raise revenues through domestic sources, and to
remove regional and intra-regional disparities.

Long-term plans last for the period of 10 to 30 years. They are also known as ‘perspective plans’.
The origin of long-term planning goes back to USSR where Goelro Plan 1920-35 was first formulated
and implemented in 1920. The basic purpose of that plan was to electrify the rural areas. The basic
philosophy behind long-term planning is to bring structural changes in the economy. Under long-term
planning, there is greater freedom of choice and there is a wide scope of planning.

Corrective and Developmental Planning

The planning consisting of fiscal and monetary measures with the aim of removing the imbalances of
the economy is known as ‘corrective planning’. As to control inflation, if the government follows a
very strict fiscal and monetary package; controls aggregate demand by checking consumption,
investment and government expenditure – this will be the case of corrective planning.

On the other hand, the planning which is aimed at developing the whole economy is known as
developmental planning. Development planning involves the application of a rational system of
choices among feasible courses of investment and other development actions.

Capitalist and Socialist Planning

Capitalistic economy is also known as ‘free-enterprise economy’. Under capitalism, there was no
authority governing the planning activity. All the economic activities were controlled by the private
sector. The state function was limited to tax collection and defence. There was no public welfare
measures, no developmental planning and no labour rights. But with the capacity of time esp. after
the great depression of 1930s and development of economic, social and political economic thoughts,
the capitalist economies adopt the modern functions like:

(a) formulating and implementing monetary, fiscal and trade policies,

(b) promulgating anti-monopoly and anti-cartel laws,
(c) working for the sake of community’s benefits,
(d) formulating and implementing development plans
(e) providing basic facilities of health, education, transportation, communication, and recreation,
etc.

In socialism, the central planning board formulates the plan which covers the whole economy. The
central planning board has unlimited powers regarding allocation of resources and production of
goods and services. The central planning authority determines the goals and priorities regarding
distribution of national income, employment, economic needs, capital accumulation and economic
growth. Under socialism all factories, resources, financial institutions, shops, stores, ware houses,
foreign and domestic trades, means of communication and transportation are under government
control.

Planning under Mixed Economy

Most economists suggest the operation of mixed economy because both extreme capitalistic and
socialistic system are not suitable. Capitalistic or free enterprise economy are characterised by lot of
problems including misallocation of resources, market imperfections, monopolies, oligopolies, labour
exploitation, widening gap between haves and have-nots, and consumer’s exploitation. On the other
hand, socialistic form of economy may create the problems like State’s monopoly and supremacy,
bureaucratic hold, corruption, red tapism, VIP-system, loss of consumer’s sovereignty,
standardisation of products, poor quality of products, less foreign trade, etc.

While in case of mixed economy, consumer’s sovereignty, private property ownership and operation
of price mechanism are ensured. The public sector also works parallel to private sector. The public
sector in a mixed economy consists of those projects which require heavy funds like railways, air
transportation, roads, bridges, fly-overs, underpasses, power generation, irrigation,
telecommunication, research, etc. The government also addresses people’s basic needs like
employment, health, and education. In under-developed countries, the government also provides
housing facilities to poor families. To avoid labour exploitation and consumer’s exploitation, the
government promulgates anti-monopoly and anti-cartel laws. In mixed economies, the government
even adopts safety measures against pollution and unhealthy working conditions in factories, offices,
etc. In case of agricultural sector, the government provides short term loans to farmers, and imports
farm machines.

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 WTO and the Developing Countries
In the World Trade Organisation, there are around 146 members from developing countries, i.e.,
about 2/3rd majority of the WTO. They play an increasingly important and active role in the WTO
because of their numbers, because they are becoming more important in the global economy, and
because they increasingly look to trade as a vital tool in their development efforts. Developing
countries are a highly diverse group often with very different views and concerns. The WTO deals
with the special needs of developing countries in three ways:

• the WTO agreements contain special provisions on developing countries

• the Committee on Trade and Development is the main body focusing on work in this area in
the WTO, with some others dealing with specific topics such as trade and debt, and technology
transfer
• the WTO Secretariat provides technical assistance (mainly training of various kinds) for
developing countries.

The WTO agreements include numerous provisions giving developing and least-developed countries
special rights or extra leniency — ‘special and differential treatment’. Among these are provisions that
allow developed countries to treat developing countries more favourably than other WTO members.

The least-developed countries receive extra attention in the WTO. All the WTO agreements recognize
that they must benefit from the greatest possible flexibility, and better-off members must make extra
efforts to lower import barriers on least-developed countries’ exports.

The specific work on developing countries within the WTO can be divided into two broad areas:

1. the work of the WTO committees, and

2. the training for government officials and others.

1. WTO Committees:

The WTO consists of the following committees:

(a) Trade and Development Committee: The WTO Committee on Trade and Development has
a wide-ranging mandate. It has the following priorities regarding the developing countries:

· implementation of provisions favouring developing countries,

· guidelines for technical cooperation,

· increased participation of developing countries in the trading system, and

· the position of least-developed countries.

Member-countries also have to inform the WTO about special programmes involving trade
concessions for products from developing countries, and about regional arrangements among
developing countries.
 (b) Sub-Committee on Least-Developed Countries: The Subcommittee on Least-Developed
Countries reports to the Trade and Development Committee, but it is an important body in its
own right. Its work focuses on two related issues:

· ways of integrating least-developed countries into the multilateral trading system

· technical cooperation.

The subcommittee also examines periodically how special provisions favouring least-
developed countries in the WTO agreements are being implemented. The following are the
WTO member countries categorized as least-developed countries by the UN:

Angola, Bangladesh, Burundi, Cambodia, Central African Republic, Chad, Congo, Djibouti,
Gambia, Guinea, Guinea Bissau, Haiti, Madagascar, Malawi, Maldives, Mali, Mauritania,
Mozambique, Myanmar, Nepal, Niger, Rwanda, Senegal, Solomon Islands, Tanzania, Uganda,
Zambia, etc.

Some additional least-developed countries are in the process of accession to the WTO. They
are: Bhutan, Ethiopia, Laos, Sudan, and Yemen.

2. WTO Technical Cooperation:

The second area of working on developing countries within the WTO is associated with the technical
cooperation or the training of government officials and businessmen from developing countries. It is
devoted entirely in helping developing countries and countries in transition from centrally-planned
economies to operate successfully in the multilateral trading system. The objective is to help build the
necessary institutions and to train officials. The subjects covered deal both with trade policies and
with effective negotiation.

The WTO holds regular training sessions on trade policy in Geneva. In addition, it organizes about
400 technical cooperation activities annually, including seminars and workshops in various countries
and courses in Geneva.

Targeted are developing countries and countries in transition from former socialist or communist
systems, with a special emphasis on African countries. Seminars have also been organized in Asia,
Latin America, the Caribbean, Middle East and Pacific.

Funding for technical cooperation and training comes from three sources: the WTO’s regular budget,
voluntary contributions from WTO members, and cost-sharing either by countries involved in an event
or by international organizations.

Challenges to the Developing World

The developing countries under the new WTO regime are faced with a considerable increase in their
obligations particularly in respect of government procurements, subsidies, anti-dumping, customs
valuation and import licensing procedures. Again, the new obligations that they have accepted in the
area of services and intellectual property rights could have adverse economic impact on their
development.

The developing world, which consists of two-third majority of the total WTO membership, has not
reaped plausible benefits under WTO regime. They also have a strong feeling that their voice is not
being heard, and the issues raised by them are not being addressed. However, some noticeable
change of strategy at the WTO seems to have taken place in recent years.

Major share of the world trade is controlled by the developed world. According to a survey only 17
countries control 72% of the world trade. A major dilemma faced by the developing countries in the
trade liberalisation process is that a country may be able to control the speed of trade liberalisation,
but cannot determine by itself how fast its exports should grow. Exports performance depends on
quality, price and competitiveness of exportable commodities. Also, to become competitive,
investment is required in developing the infrastructure, technology, human resources, and enterprise
capacity for new exports, which is a long-term process and not easily achieved. The interesting
phenomenon is that the developed world continues to insist on free trade and services and bringing
down the tariffs in order to ensure fair competition between local and imported products. While, on
the other hand, the developed world itself continues to follow protectionist policies in the case of
agriculture to safeguard its costly products against cheaper foodstuff from the developing world.

Suggestions to the Developing Countries:

The developing world has tried to raise its voice on various forums but without much success. Apart
from raising hue and cry for better treatment by the WTO and the developed world it should have its
own strategy for economic development. Following are the suggestions for the developing countries:

• Identification of core strengths and competitive edge,

• Concentrate mainly on industries which use local raw material,
• Improve efficiencies, lower costs and upgrade quality of products in order to be able to make
them export oriented to earn valuable foreign exchange,
• Develop small and medium enterprises,
• Continue to improve productivity in agriculture / fishing in order to remain self reliant in food
production and earn good value for their exports,
• Develop human resource through education, training, healthcare and social justice, and
• The Government should reduce its role in running business.

But, unfortunately, most of the developing countries to-day is plagued by inefficiency, corruption,
dishonesty, low productivity and a lack of will and desire on the part of elected representatives to
improve the status quo. The developing countries cannot prosper on the prescriptions laid down by
the World Bank, IMF or regular dole from rich nations. South Asian economies, especially Malaysia,
Singapore, South Korea and China are a glaring example of what can be achieved through following
a pragmatic path. Even the Indian economy has grown rapidly over the past decade with real GDP
growth averaging some 6% annually, in part due to continued structural reform, including trade
liberalisation. In recent years, though, Pakistan has also shown a remarkable performance in real
GDP growth rate: 8.4% during the fiscal year 2004-05, 6.4% during 2003-04 and 5.1% during 2002-
03, but yet there are many reforms to be made especially in manufacturing and service sectors.

The developing countries have a tough task ahead. If they do not take corrective measures they will
be rendered producers of raw materials and operating locally produced agro-based industries only.
They will, obviously, miss the opportunity to benefit from global trade. According to a research report
by David Dollar of the World Bank, the growth rate of the developing countries during 1990s has been
5% (3.5% excluding China against 2% of the rich countries. He believes that there is solid evidence
available to prove that this has happened due to participation in the free trade and globalisation
process.

According to WTO Annual Report 2002, poor countries need to grow their way out of poverty and
trade can serve as a key engine of that growth. But currently products of developing countries face
many obstacles in entering the markets of rich countries. Rich counties need to do more to reduce
trade-distorting subsidies and dismantle their existing barriers on competitive exports from developing
countries.

Challenges faced by Pakistan

Two schools of thought prevail in Pakistan in regard to impact of WTO regime on the economy. One
group favours WTO Trade Agreements completely as it believes that free trade will have a strong
positive effect in enabling conditions for poverty reduction through employment opportunities, social
welfare services, and infrastructure that can potentially benefit the poor. On the other hand, the
second school of thought believes that everything going wrong in the developing world is the result of
the WTO regime. They feel that the WTO has been formed to further the interests of the developed
world only. The fact of the matter is that we lack any empirical study and the different opinions are
based on assumptions only.

Major challenges faced by Pakistan are as follows:

• Lowering of tariffs leading to cheaper imports would pose serious threat to the local industry,
which, in spite of inefficiencies, has thrived to-date owing to protectionist policies,
• An end to the quota system in textiles in early 2005 poses a serious challenge to our key
foreign exchange driver,
• Due to lowering of tariffs the taxes earned by the Government on imports are constantly
showing a marked reduction as a percentage to total taxes collected,
• Lack of a clear and transparent policy by the Government towards WTO regime – and lack of
understanding of implications of Trade Agreements on our economic life.

Considering the challenges, the Government has identified the following industries with core
strengths that need most attention for development:

• Oil, gas and energy,

• Chemical, fertiliser and pharmaceuticals,
• Textile and allied industries,
• Light engineering,
• Information technology,
• Small and medium enterprises.

Other industries, which have been identified for improvements, are sports, surgical, cement, sugar,
automobile, etc. These industries will cater both for local and export markets. Needless to mention
that a number of industries will be at the risk of partial or complete closure, as they will not be able to
compete with the onslaught of cheaper imports. The local electronics industry, where product
replacements are extremely rapid, faces the risk of being phased out.

The industry, which needs our utmost attention, is textiles, as it contributes almost 60% to our
exports. With the start of new open trade policy from January 2005, Pakistan is facing a serious
problem of tough competition from China, India, Bangladesh and a number of other countries. Our
machinery is old, productivity is low, costs are higher and the manpower is not well-trained. We need
to invest at least US $ 6 to 7 billion in order to overcome these problems, and remain competitive in
the world market through exporting value added products.

It is heartening to note that the Government is well aware of this problem, and constant efforts are
being made to produce contamination free cotton, and modernise the present outdated machinery
and infrastructure. However, both the Government and the industry will have to move much faster in
order to meet the foreign demands. If we are competitive with better quality of products and
acceptable prices, we may be able to gain a greater share of the textile trade in the world market.

Conclusion

In the present scenario of the global trade, both developing and developed worlds have their roles to
play. The WTO and the developed world must make further concessions for the developing
countries, which are in majority and have a very small portion of the total world trade, and are not in a
position to compete with the advanced industrialised nations. On the other hand, the developing
world has its own responsibilities to share. They cannot continue to live on grant-in-aids and consider
others responsible for all their ills, while squandering their own resources. They have to put in
serious efforts for overall improvement in the quality of life of their impoverished masses, through
sustained economic growth. This would help them achieve their due share in the global trade, rather
than see it marginalized further.

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 World Trade Organisation
History

At the United Nations conference held at Geneva in 1947, twenty three countries including United
States of America signed General Agreement on Tariffs and Trade (GATT). During the same year,
a charter was put on the table for setting up, within the United Nations Organisation, of a new agency
to be called International Trade Organisation (ITO). Fifty nations signed the charter in Havana the
following year, but it was never subsequently ratified by the required number of countries. The
purpose of the agreement was to promote international trade free of barriers in the aftermath of World
War II, and to draw up proposals for the implementation of policies based on those principles set in
the agreement. It covered all the issues like tariffs, quotas, taxes, international commodity
agreements and whatever was considered to have a bearing on the development of international
trade, and was based on policies of non-discrimination and tariff reductions.

GATT has been expanded and updated through a series of multi-year conferences. The most famous
have been the Kennedy Round (1963-1967), the Tokyo Round (1973-1979), and the Uruguay Round
(1986-1994). The Uruguay Round ended with the decision to dissolve GATT and establish the more
powerful and more institutionalised World Trade Organization (WTO) in 1995. The WTO replaced
GATT as an international organization, but the General Agreement still exists as the WTO’s umbrella
treaty for trade in goods. Trade lawyers distinguish between the GATT 1994, the updated
agreement, and the GATT 1947, the original agreement which is still the heart of GATT 1994.

Introduction

The WTO has nearly 150 members, accounting for over 97% of world trade. Around 30 others are
negotiating membership. By definition, the World Trade Organization (WTO) deals with the rules of
trade between nations at a global or near-global level. But there is more to it than that. There are a
number of ways of looking at the WTO. It’s an organization for liberalizing trade. It’s a forum for
governments to negotiate trade agreements. It’s a place for them to settle trade disputes. It operates
a system of trade rules. (But it is not a Superman, just in case anyone thought it could solve — or
cause — all the world’s problems!). The WTO is like a table. People sit round the table and
negotiate, and resolve trade disputes.

Essentially, the WTO is a place where member governments try to sort out the trade problems they
face with each other. Therefore, the first step is to talk. The WTO was born out of negotiations, and
everything the WTO does is the result of negotiations. Where countries have faced trade barriers and
wanted them lowered, the negotiations have helped to liberalize trade. But the WTO is not just about
liberalizing trade, and in some circumstances its rules support maintaining trade barriers — for
example to protect consumers or prevent the spread of disease.

WTO also ensures that individuals, companies and governments know what the trade rules are
around the world, and gives them the confidence that there will be no sudden changes of policy. In
other words, the rules have to be “transparent” and predictable.

Principles / Characteristics of WTO Trading System

The World Trade Organisation is based on the following core-principles or characteristics:

1. Trade without discrimination:

The main principle in the charter of the World Trade Organisation is to promote international trade
without any discrimination. This principle is further elaborated into two – MFN and national treatment:

(a) Most-favoured-nation (MFN) – treating other people equally: Under the WTO
agreements, countries cannot normally discriminate between their trading partners. If a
member country grants a special favour (such as a lower customs duty) to another member
country, she has to do the same for all other WTO members.

This principle is also known as most-favoured-nation (MFN) treatment. It is so important that it

is the first article of the GATT, which governs trade in goods. MFN is also a priority in the
General Agreement on Trade in Services (GATS) and the Agreement on Trade-Related
Aspects of Intellectual Property Rights (TRIPS).

However, some exceptions are allowed. For example, countries can set up a free trade
agreement that applies only to goods traded within the group —discriminating against goods
from outside. Or they can give developing countries special access to their markets. Or a
country can raise barriers against products that are considered to be traded unfairly from
specific countries. In general, MFN means that every time a country lowers a trade barrier or
opens up a market, it has to do so for the same goods or services from all its trading partners
— whether rich or poor, weak or strong.

(b) National treatment – Treating foreigners and locals equally: Imported and locally-
produced goods should be treated equally — at least after the foreign goods have entered the
market. The same should apply to foreign and domestic services, and to foreign and local
trademarks, copyrights and patents.

National treatment only applies once a product, service or item of intellectual property has
entered the market. Therefore, charging customs duty on an import is not a violation of
national treatment even if locally-produced products are not charged an equivalent tax.

2. Freer trade:

First of all it should be noted here that the WTO is not for free trade at any cost. It is all about
lowering trade barriers between trading countries. The barriers concerned include customs duties (or
tariffs) and measures such as import bans or quotas that restrict quantities selectively. From time to
time other issues such as red tape and exchange rate policies have also been discussed.

Opening markets can be beneficial, but it also requires adjustment. The WTO agreements allow
countries to introduce changes gradually, through ‘progressive liberalization’. Developing countries
are usually given longer to fulfil their obligations.

3. Predictability:

Sometimes, promising not to raise a trade barrier can be as important as lowering one, because the
promise gives businesses a clearer view of their future opportunities. With stability and predictability,
investment is encouraged, jobs are created and consumers can fully enjoy the benefits of competition
— choice and lower prices. The multilateral trading system is an attempt by governments to make the
business environment stable and predictable.

One way of making investment stable and predictable is to ‘bind’ the member countries to their
commitments. For example, ceilings on customs tariff rates, etc. However, a country can change its
bindings, but only after negotiating and compensating its trading partners.
There are other ways as well to improve predictability and stability. One way is to discourage the use
of quotas and other measures used to set limits on quantities of imports. Another way is to make
countries’ trade rules as clear and transparent as possible. Many WTO agreements require
governments to disclose their policies and practices publicly within the country or by notifying the
WTO. The regular surveillance of national trade policies through the Trade Policy Review Mechanism
provides a further means of encouraging transparency both domestically and at the multilateral level.

4. Promoting fair competition:

WTO is a system of rules dedicated to open, fair and undistorted competition. The rules on non-
discrimination — MFN and national treatment — are designed to secure fair conditions of trade. So
these rules also apply on dumping and subsidies. Many of the other WTO agreements aim to support
fair competition, for example, in agriculture, intellectual property, services, etc.

5. Encouraging development and economic reform:

The WTO system contributes to development. On the other hand, developing countries need flexibility
in the time they take to implement the system’s agreements. Over 3/4th of WTO members are
developing countries and countries in transition to market economies. During the seven and a half
years of the Uruguay Round, over 60 of these countries implemented trade liberalization programmes
autonomously. At the end of the Uruguay Round, developing countries were prepared to take on
most of the obligations that are required of developed countries. But the agreements did give them
transition periods to adjust to the more unfamiliar and, perhaps, difficult WTO provisions —
particularly for the poorest or ‘least-developed’ countries such as Bangladesh, Cambodia, Djibouti,
Central African Republic, Guinea, Madagascar, Myanmar, Nepal, Uganda, etc. A ministerial decision
adopted at the end of the round says better-off countries should accelerate implementing market
access commitments on goods exported by the least-developed countries, and it seeks increased
technical assistance for them. More recently, developed countries have started to allow duty-free and
quota-free imports for almost all products from least-developed countries.

Benefits of World Trade Organisation

The following common benefits of the WTO’s trading system doesn’t claim that everything is perfect,
otherwise there would be no need for further negotiations and for the system to evolve and reform
continually:

1. The system helps promote peace. Peace is partly an outcome of two of the most
fundamental principles of the trading system:

• helping trade to flow smoothly, and

• providing countries with a constructive and fair outlet for dealing with disputes over
trade issues.

It is also an outcome of the international confidence and cooperation that the system creates
and reinforces.

2. Disputes are handled constructively. As trade expands in volume, in the number of

products traded, and in the numbers of countries and companies trading, there is a greater
chance that disputes will arise. The WTO system helps resolve these disputes peacefully and
constructively.
 Around 300 disputes have been brought to the WTO since it was set up in 1995. Without a
means of tackling these constructively and harmoniously, some could have led to more serious
political conflict.

3. A system makes life easier for all. Decisions in the WTO are made by consensus. The WTO
agreements were negotiated by all members, were approved by consensus and were ratified
in all members’ parliaments. The agreements apply to everyone. This makes life easier for all,
in several different ways. Smaller countries can enjoy some increased bargaining power.
Without a multilateral regime such as the WTO’s system, the more powerful countries would
be freer to impose their will unilaterally on their smaller trading partners. Smaller countries
would have to deal with each of the major economic powers individually, and would be much
less able to resist unwanted pressure.

In addition, smaller countries can perform more effectively if they make use of the opportunities
to form alliances and to pool resources. Several are already doing this.

4. Freer trade cuts the costs of living. Protectionism is expensive as it raises prices through
imposition of import duties and quotas. The WTO’s global system lowers trade barriers
through negotiation and applies the principle of non-discrimination. The result is reduced costs
of production (because imports used in production are cheaper) and reduced prices of finished
goods and services, and ultimately a lower cost of living.

5. It provides more choice of products and qualities. This expands the range of final products
and services that are made by domestic producers, and it increases the range of technologies
they can use. When mobile telephone equipment became available, services sprang up even
in the countries that did not make the equipment. Sometimes, the success of an imported
product or service on the domestic market can also encourage new local producers to
compete, increasing the choice of brands available to consumers as well as increasing the
range of goods and services produced locally.

6. Trade raises incomes. Lowering trade barriers allows trade to increase, which adds to
incomes — national incomes and personal incomes. But some adjustment is necessary.
Trade also poses challenges as domestic producers face competition from imports. But the
fact that there is additional income means that resources are available for governments to
redistribute the benefits from those who gain the most — for example to help companies and
workers adapt by becoming more productive and competitive in what they were already doing,
or by switching to new activities.

7. Trade stimulates economic growth. This is a difficult subject to tackle in simple terms. There
is strong evidence that trade boosts economic growth, and that economic growth means more
jobs. It is also true that some jobs are lost even when trade is expanding. But the picture is
complicated by a number of factors. Nevertheless, the alternative – protectionism – is not the
way to tackle employment problems. In fact, the protectionism hurts the employment in the
long run. For example, the US car industry, when the US Government designed trade barriers
to protect the jobs by restricting imports of Japanese Cars, the American cars became more
expensive, fewer cars were sold and there were major job cuts.

8. The basic principles make life more efficient. One of the most important features of WTO is
that it provides efficiency in the international trade mechanism. It helps to cut costs because of
important principles enshrined in the system. Such principles include non-discriminatory trade,
transparency, increased certainty in trade conditions, simplification and standardisation of
 customs procedures, removal of red tapism, removal of bureaucracy, centralised databases of
information, and such other measures that come under the head ‘trade facilitation’.

9. Governments are shielded from lobbying. One of the lessons of the protectionism that
dominated the early decades of the 20th Century was the damage that can be caused if
narrow sectoral interests gain an unbalanced share of political influence. The result was
increasingly restrictive policy which turned into a trade war.

Superficially, restricting imports looks like an effective way of supporting an economic sector.
But it biases the economy against other sectors which shouldn’t be penalized — if you protect
your clothing industry, everyone else has to pay for more expensive clothes, which puts
pressure on wages in all sectors.

Governments need to be armed against pressure from narrow interest groups, and the WTO
system can help. The GATT-WTO system covers a wide range of sectors. So, if during a
GATT-WTO trade negotiation one pressure group lobbies its government to be considered as
a special case in need of protection, the government can reject the protectionist pressure by
arguing that it needs a broad-ranging agreement that will benefit all sectors of the economy.

10. The system encourages good government. Under WTO rules, once a commitment has
been made to liberalize a sector of trade, it is difficult to reverse. The rules also discourage a
range of unwise policies. For businesses, that means greater certainty and clarity about trading
conditions. For governments it can often mean good discipline.

The WTO agreements help in reducing corruption and bad government. But, quite often,
governments use the WTO as a welcome external constraint on their policies. This cannot be
done because it would violate the WTO agreements.

Criticism on World Trade Organisation

Criticisms of the WTO are often based on fundamental misunderstandings of the way the WTO
works. Following are most common misunderstandings or criticisms on WTO:

1. The WTO dictates policy. According to critics, the WTO dictates the trade policy on its
member countries. But that is not the case; in fact, it’s the governments who dictate to the
WTO. WTO is a member-driven organisation. The rules of WTO are based on agreements
resulting from negotiations among member governments. These rules are ratified by
members’ parliaments. And all the decisions taken in the WTO are virtually made by
consensus among all members.

2. The WTO is for free trade. There is another criticism on the World Trade Organisation is that
it promotes free trade. According to critics, free trade could hamper the domestic production
and serves the interests of giant global companies. Small domestic companies are unable to
compete with such multinational companies and would not be able to survive. As a result,
unemployment increases and national income decreases. It is true that it is one of the
principles of WTO system that the member countries should lower their trade barriers and
allow trade to flow more freely. But how low those barriers should go depends on the
bargaining of member countries.

Moreover, the rules written into the agreements allow barriers to be lowered gradually so that
domestic producers can adjust.
3. According to critics, the commercial interests take priority over development. Whereas,
the WTO agreements are full of provisions taking the interests of development into account.
Freer trade boosts economic growth and supports development. In that sense, commerce and
development are good for each other.

4. Environmental issues. In WTO system, commercial interests do not take priority over
environmental protection. Whereas, many provisions of WTO take environmental concerns
specifically into account. For example, the preamble of the Marrakesh (Morocco) Agreement
establishing the World Trade Organization includes among its objectives, optimal use of the
world’s resources, sustainable development and environmental protection.

5. Health and safety issues. Key clauses in the agreements (such as GATT Art. 20) specifically
allow governments to take actions to protect human, animal or plant life or health. But these
actions are disciplined, for example to prevent them being used as an excuse for protecting
domestic producers — protectionism in disguise.

6. The WTO destroys jobs and worsens poverty. Another accusation on WTO is that WTO
system destroys jobs and widens the gap between rich and poor. In other words, it promotes
economic inequalities internationally. The accusation is inaccurate and simplistic. Trade can
be a powerful force for creating jobs and reducing poverty. Sometimes adjustments are
necessary to deal with job losses, and here the picture is complicated. In any case, the
alternative of protectionism is not the solution. It should be borne in mind that the biggest
beneficiary is the country that lowers its own trade barriers.

7. Small countries are powerless in the WTO. But small countries are not powerless in WTO.
In fact, they would be weaker without WTO. The WTO increases their bargaining power. In
recent years, developing countries have become considerably more active in WTO
negotiations, submitting an unprecedented number of trade proposals. They expressed
satisfaction with the process leading to the Doha declarations. All of this bears testimony to
their confidence in the system.

8. The WTO is the tool of powerful lobbies. This is a common misunderstanding that the
system of the World Trade Organisation supports the powerful countries such as US, EU,
Japan, etc. Giant corporations get undue protection from the WTO. The answer is that the
WTO is a common platform for all the governments. The WTO treats all the countries equally.
Therefore, WTO is not the tool of powerful lobbies; in fact, it offers governments a means to
reduce the influence of narrow vested interests. The most common feature of the WTO is the
negotiations that took place between the governments. These negotiations create a balance
of interests. Governments can find it easier to reject pressure from particular lobbying groups
by arguing that it had to accept the overall package in the interests of the country as a whole.

The WTO does not support the giant multinational companies. The WTO is an organisation of
governments. The private sector, non-governmental organizations and other lobbying groups
do not participate in WTO activities except in special events such as seminars and
symposiums.

9. Weaker countries are forced to join the WTO. Another criticism about the WTO is that the
weaker or developing countries or poor countries are influenced by developed countries or by
the WTO itself to join the WTO. In fact, weaker countries do have a choice to join the WTO or
not. However, they are convinced to join the WTO, because they can enjoy the benefits that
all WTO members grant to each other. They have the opportunity to trade, negotiate, and
settle their disputes with advanced countries within the WTO. Whereas, outside the WTO, i.e.,
 under bilateral agreements, smaller countries are weaker and cannot increase their bargaining
power esp. with advanced countries.

10. The WTO is undemocratic. Some theorists claim that the system of the WTO is
undemocratic. Whereas, decisions in the WTO are generally by consensus. In principle, that’s
even more democratic than majority rule because no decision is taken until everyone agrees.

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