UNIT 1

 MICRO DIMENSIONS OF BUSINESS

The microenvironment is also called the operating, competitive or task environment. It consists of sets of forces
and conditions that originate with suppliers, distributors, customers, creditors, competitors, and shareholders, as
well as trade unions, and the community in which the business operates.  These forces, on a daily basis, impact
the organisation’s ability to obtain inputs and discharge of its outputs.  Factors in the microenvironment are
largely within the control of the managers.  In this way, organisations can be much more proactive in dealing
with the task environment than in dealing with the macro environment.
    
Forces in the microenvironment result from the actions of four main elements or groups, namely suppliers,
distributors, customers, and competitors.  These groups affect the manager’s or firm’s ability to produce on a
daily, weekly and monthly basis, and thus significantly impact short-term decision making.  Let’s examine these
main actors.

Suppliers

Suppliers are individuals or organisations that provide (supply) an enterprise with the various inputs (such as
raw materials, component parts, or employees) required for production.  It is important that the manager ensures
a reliable supply of input resources.  The effectiveness of the supply system determines the organisation’s long-
term survival and growth.

Changes in the nature, numbers, or types of any supplier result in forces that produce opportunities and threats
to which the managers must respond if their organisation is to prosper.  Another major supplier-related threat
that confronts managers pertains to prices of inputs.  When supplies bargaining position with an organisation is
so strong, they can raise the prices of inputs that they supply the organisation.  A supplier’s bargaining position
is especially strong if: 

(1) The supplier is the source of an input, and 

(2) The input is vital to the organisation

In addition to raising prices, suppliers can make operations difficult for an organisation by restricting its access
to important inputs.  For example, a reduction in government funding in terms of financial resources impact
universities.  In the same vain, a cut in quota of the supply of crude oil by OPEC member countries affect global
consumption of unrefined or refined petroleum.

Distributors

In the microenvironment of business, another group of actors are distributors.  Distributors are organisations
that help other organisations sell their goods and services to customers.  The decisions that managers make on
how to distribute products to customers can have an important effect on organisational performance.

1
The changing nature of distributors and distribution methods can also bring opportunities and threats for
managers.  If distributors are so large and powerful that they can threaten the organization by demanding that it
reduces the prices of its goods and services, then, the manager becomes constrained and challenged.  In
contrast, the power of the distribution may be weakened if there are many options or alternatives.

Customers 

Customers are another group of actors in the operating environment of business.  Customers are the individuals
and groups that buy the goods and services that an enterprise produces, changes in the numbers and types of
customers or changes in customers’ tastes and needs result in opportunities and threats.  A forward looking
organisation must meet the needs and wants of its customers or exceed the customers’ expectations.  The
organisation must have a customer orientation to succeed in this competitive, unpredictable and
challenging business environment.

Competitors 

Competitors are businesses that produce goods and services that are similar to a particular organisation’s goods
and services.  Put differently, they are organisations that are vying for same customers.  Rivalry between
competitors is potentially the most threatening force that managers must deal with.  A high level of rivalry often
results in price competition, and falling prices reduce access to resources and lower profit.

 MACRO DIMENSIONS OF BUSINESS ENVIRONMENT

This environment refers to the wide ranging economic, socio-cultural, political and legal, and technological
forces that affect the organisation and its operating environment.  These forces originate beyond the firm’s
operating situation.  The macroenvironment is also called the external or remote environment.  The
macroenvironment presents threats and opportunities that are often difficult tograpple with (that is, identify and
respond to), than with events in the microenvironment.

Economic Forces 

The economic forces have significant impact on the success of any organisation.  These forces on factors affect
the conditions of procurement (buying) and sales market.  For example, in Nigeria ( as elsewhere) where
the Naira is so devalued relative to foreign currencies (e.g. the dollar and pound), importation of required inputs
of production constitutes a major threat to the corporate managers.  In the same vein, during periods of
unhealthy economic growth occasioned by such factors as inflation, rising unemployment, high interest rates,
and high taxes, among others, individuals as well as businesses have problems.  This is more serious in the case
of emerging enterprises, or new entrants.

2
Political and Legal Forces 

The political and legal forces are paralleled to the social environment.  This is because, laws are ordinarily
passed following social pressures and problems.  In Nigeria, as else where, laws regulating the macro
environment include legislations on monetary and fiscal policies, percentage of industrial emission, into the air,
safety and health at work, wage and price control.  Others are equal employment opportunity, contract of
employment, and law of collective bargaining, among others.  These regulations influence business operations
either positively or negatively.

Legislation on fiscal and monetary policies, for example, might encourage favourable tax reliefs and financial
assistance for small-scale industry.  The challenge, though, is that considering the nature of our political
climate, legislations change at the whims and caprices of political and government leaders.  There is
political instability in Nigeria, this way, existing legislations change as new political and government leaders
emerge.  In this light, corporate managers should consider regulations both as threats and opportunities. 
Besides, political and government leaders, the actions or political activities by pressure groups and lobbying
groups should be taken into consideration, when considering investments or projects.

Technological Forces

Technological forces or factors could be said to be the most pervasive in the environment.  Technology refers to
the application of knowledge base which science provides.  It is a well established fact thatinformation and
communication technology has revolutionized business operations.  Consequently, organisations that apply
knowledge that is rapidly changing and complex are highly vulnerable.

These changes bring about new inventions and gradual improvements in methods, in design, in materials, in
application, in efficiency, and diffusion into new industries.  Corporate managers must adapt or adjust to these
changes, in order to survive and prosper in this competitive and challengingbusiness environment.  The changes
constitute threats and opportunities for any manager.

Socio-cultural Forces

Socio-cultural forces have to do with the attitudes and values of the society, and these to a great extent, shape
behaviour.  For example, in certain parts of Northern Nigeria (where Sharia Penal Code is “strictly” observed),
there are restrictions on the sales and consumption of tobacco, alcoholic liquorsand others.  A manager in these
parts faces unique challenges.  He has to undertake deliberate and planned strategy of market segmentation. 
Similarly, in Southern Nigeria, there are changes in attitude to the issue of environmental degradation or
pollution.  This has led to frequent restiveness or unrest in the Niger Delta.  The challenges before the managers
of the multinational oil companies are unimaginable.

Changes in socio-cultural factors also impact the business enterprise in its internal relations with employees
within the context of changes in attitude to work changes in political awareness, and cultural norms, among
others.

3
In sum, the impact of the social forces is felt in changing needs, tastes, and preferences of consumers, in relation
with employees, and in expectations of society form the company with regard to its social responsibility.

 IMPACT OF GLOBALISATION ON INDIAN ECONOMY

The various beneficial effects of globalization in Indian Industry are that it brought in huge amounts of foreign
investments into the industry especially in the BPO, pharmaceutical, petroleum, and manufacturing industries.
As huge amounts of foreign direct investments were coming to the Indian Industry, they boosted the Indian
economy quite significantly. The benefits of the effects of globalization in the Indian Industry are that many
foreign companies set up industries in India, especially in the pharmaceutical, BPO, petroleum, manufacturing,
and chemical sectors and this helped to provide employment to many people in the country. This helped reduce
the level of unemployment and poverty in the country. Also the benefit of the Effects of Globalization on Indian
Industry are that the foreign companies brought in highly advanced technology with them and this helped to
make the Indian Industry more technologically advanced. Since 1991, India has witnessed an explosion of new
media. Between 1990 and 1999, access to television grew from 10% of the urban population to 75% of the
urban population. Cable television and foreign movies became widely available for the first time.

1) Indian Agriculture: Indian farmers are offered no subsidiaries compared to the US Farmers. There
has been no encouragement from the government to ensure foreign companies to set up technologies
for the farmer's assistance. The US Farmers has opened the market for textile & China has already
set up factories & started production where in India hasn't woken up. On the other side of the medal,
there is along list of the worst of the time, the foremost casualty being the agriculture sector.
Agriculture has been & still remains the backbone of the Indian economy. It plays a vital role not
only in providing food & nutrition to the people, but also in the supply of raw materials to industries
& to export trade. The financial capital of India & the political of India are set to become the topmost
slum cities of the world.

2) Gross Domestic Product (GDP) Growth rate: The Indian economy is passing through a difficult
phase caused by several unfavorable domestic & external developments, Domestic O/P & DD
conditions were adversely affected by poor performance in agriculture in the post two years. The rate
of growth of GDP of India has been on the increase from 5.6% to 7% in the 1993-2001 periods. The
sectors attracting highest FDI inflows are electrical equipments including Computer software &
electronics (18 %), service sector (13%), telecommunication (10%), transportation industry (9%) etc.

3) Export & Import: India's export & import is increasing many Indian companies have started
becoming respectable players in international scenes. There are two alternative causes available. To
sell its product in the export market. To produce those type of commodities that the rich in India
could consume i.e. luxury consumption goods.

4
 4) Technologies: IT is given special status. The reason for this is because the Indian government
wants to promote it-s nation a as a technological advanced nation and in order to do this they must
stimulate the IT sector. The "special status- means the sector and investors (willing to invest in the
sector) will receive many benefits and incentives from the government to do so.

5) Poverty: The government of India has shown decline in people living in absolute poverty by
manipulating statistics. The "decline" happened when large number of industrial units have been
closed down, number of days of work available to workers has declined, downsizing of manpower
had taken place in most of the industrial undertakings and non-availability of jobs to the new entrant
in employment market is witnessed. Besides, there is an all round decline of prices of agricultural
products, forcing farmers to suicide. In sectors like plantation and tea, workers are virtually starving.
It is just not possible that people living in absolute poverty can decline in the country under these
circumstances.

6) Education: The growth of higher education and the impact of the global economies have
influenced the Indian education system over the last few years.

UNIT 2

 ECONOMIC GROWTH

There are mainly two types of determinants (factors) which influence the economic development of a
country.

A) Economic Factors in Economic Development:

In a country’s economic development the role of economic factors is decisive. The stock of capital and the
rate of capital accumulation in most cases settle the question whether at a juven point of time a country will
grow or not. There are a few other economic factors which also have some bearing on development but their

5
importance is hardly comparable to that of capital formation. The surplus of foodgrains output available to
support urban population, foreign trade conditions and the nature of economic system are some such factors
whose role in economic development has to be analyzed:

1) Capital Formation:
The strategic role of capital in raising the level of production has traditionally been acknowledged in
economics. It is now universally admitted that a country which wants to accelerate the pace of growth, has
m choice but to save a high ratio-of its income, with the objective of raising the level of investment. Great
reliance on foreign aid is highly risky, and thus has to be avoided. Economists rightly assert that lack of
capital is the principal obstacle to growth and no developmental plan will succeed unless adequate supply of
capital is forthcoming.

Whatever be the economic system, a country cannot hope to achieve economic progress unless a certain
minimum rate of capital accumulation is realized. However, if some country wishes to make spectacular
strides, it will have to raise its rate of capital formation still higher.

2)  Natural Resources:

The principal factor affecting the development of an economy is the natural resources. Among the natural
resources, the land area and the quality of the soil, forest wealth, good river system, minerals and oil-
resources, good and bracing climate, etc., are included. For economic growth, the existence of natural
resources in abundance is essential. A country deficient in natural resources may not be in a position to
develop rapidly. In fact, natural resources are a necessary condition for economic growth but not a sufficient
one. Japan and India are the two contradictory examples.

3)  Marketable Surplus of Agriculture:

Increase in agricultural production accompanied by a rise in productivity is important from the point of view
of the development of a country. But what is more important is that the marketable surplus of agriculture
increases. The term ‘marketable surplus’ refers to the excess of output in the agricultural sector over and
above what is required to allow the rural population to subsist.

The importance of the marketable surplus in a developing economy emanates from the fact that the urban
industrial population subsists on it. With the development of an economy, the ratio of the urban population
increases and increasing demands are made on agriculture for foodgrains. These demands must be met
adequately; otherwise the consequent scarcity of food in urban areas will arrest growth.

In case a country fails to produce a sufficient marketable surplus, it will be left with no choice except to
import foodgrains which may cause a balance of payments problem. Until 1976-77, India was faced with
this problem precisely. In most of the years during the earlier planning period, market arrivals of foodgrains
were not adequate to support the urban population.

If some country wants to step-up the tempo of industrialization, it must not allow its agriculture to lag
behind. The supply of the farm products particularly foodgrains, must increase, as the setting-up of
industries in cities attracts a steady flow of population from the countryside.

6
4)  Conditions in Foreign Trade:
The classical theory of trade has been used by economists for a long time to argue that trade between
nations is always beneficial to them. In the existing context, the theory suggests that the presently less
developed countries should specialize in production of primary products as they have comparative cost
advantage in their production. The developed countries, on the contrary, have a comparative cost advantage
in manufactures including machines and equipment and should accordingly specialize in them.

In the recent years, a powerful school has emerged under the leadership of Raul Prebisch which questions
the merits of unrestricted trade between developed and under-developed countries on both theoretical and
empirical grounds.

Foreign trade has proved to be beneficial to countries which have been able to set-up industries in a
relatively short period. These countries sooner or later captured international markets for their industrial
products. Therefore, a developing country should not only try to become self-reliant in capital equipment as
well as other industrial products as early as possible, but it should also attempt to push the development of
its industries to such a high level that in course of time manufactured goods replace the primary products as
the country’s principal exports.

In countries like India the macro-economic interconnections are crucial and the solutions of the problems of
these economies cannot be found merely through the foreign trade sector or simple recipes associated with
it.

5)  Economic System:

The economic system and the historical setting of a country also decide the development prospects to a great
extent. There was a time when a country could have a laissez faire economy and yet face no difficulty in
making economic progress. In today’s entirely different world situation, a country would find it difficult to
grow along the England’s path of development.

The Third World countries of the present times will have to find their own path of development. They
cannot hope to make much progress by adopting a laissez faire economy. Further, these countries cannot
raise necessary resources required for development either through colonial exploitation or by foreign trade.
They now have only two choices before them:

i) They can follow a capitalist path of development which will require an efficient market system supported
by a rational interventionist role of the State.

ii) The other course open to them is that of economic planning.

The latest experiments in economic planning in China have shown impressive results. Therefore, from the
failure of economic planning in the former Soviet Union and the erstwhile East European socialist countries
it would be wrong to conclude that a planned economy has built-in inefficiencies which are bound to arrest
economic growth.

7
B) Non-Economic Factors in Economic Development:
From the available historical evidence, it is now obvious that non- economic factors are as much important
in development as economic factors. Here we attempt to explain how they exercise influence on the process
of economic development:

1) Human Resources:
Human resources are an important factor in economic development. Man provides labour power for
production and if in a country labour is efficient and skilled, its capacity to contribute to growth will
decidedly be high. The productivity of illiterate, unskilled, disease ridden and superstitious people is gener-
ally low and they do not provide any hope to developmental work in a country. But in case human resources
remain either unutilized or the manpower management remains defective, the same people who could have
made a positive contribution to growth activity prove to be a burden on the economy.

2) Technical Know-How and General Education:

It has never been, doubted that the level of technical know-how has a direct bearing on the pace of
development. As the scientific and technological knowledge advances, man discovers more and more
sophisticated techniques of production which steadily raise the productivity levels.

Schumpeter was deeply impressed by the innovations done by the entrepreneurs, and he attributed much of
the capitalist development to this role of the entrepreneurial class. Since technology has now become highly
sophisticated, still greater attention has to be given to Research and Development for further advancement.
Under assumptions of a linear homogeneous production function and a neutral technical change which does
not affect the rate of substitution between capital and labour, Robert M. Solow has observed that the
contribution of education to the increase in output per man hour in the United States between 1909 and 1949
was more than that of any other factor.

3) Political Freedom:
Looking to the world history of modern times one learns that the processes of development and under-
development are interlinked and it is wrong to view them in isolation. We all know that the under-
development of India, Pakistan, Bangladesh, Sri Lanka, Malaysia, Kenya and a few other countries, which
were in the past British colonies, was linked with the development of England. England recklessly exploited
them and appropriated a large portion of their economic surplus.

Dadabhai Naoroji has also candidly explained in his classic work ‘Poverty and Un-British Rule in India’
that the drain of wealth from India under the British was the major cause of the increase in poverty in India
during that period, which in turn arrested the economic development of the country.

4) Social Organisation:
Mass participation in development programs is a pre-condition for accelerating the growth process.
However, people show interest in the development activity only when they feel that the fruits of growth will
be fairly distributed. Experiences from a number of countries suggest that whenever the defective social
organisation allows some elite groups to appropriate the benefits of growth, the general mass of people

8
develop apathy towards State’s development programs. Under the circumstances, it is futile to hope that
masses will participate in the development projects undertaken by the State.

India’s experience during the whole period of development planning is a case in point. Growth of
monopolies in industries and concentration of economic power in the modern sector is now an undisputed
fact. Furthermore, the new agricultural strategy has given rise to a class of rich peasantry creating
widespread disparities in the countryside.

5) Corruption:
Corruption is rampant in developing countries at various levels and it operates as a negative factor in their
growth process. Until and unless these countries root-out corruption in their administrative system, it is most
natural that the capitalists, traders and other powerful economic classes will continue to exploit national
resources in their personal interests.

The regulatory system is also often misused and the licenses are not always granted on merit. The art of tax
evasion has been perfected in the less developed countries by certain sections of the society and often taxes
are evaded with the connivance of the government officials.

6) Desire to Develop:
Development activity is not a mechanical process. The pace of economic growth in any country depends to
a great extent on people’s desire to develop. If in some country level of consciousness is low and the general
mass of people has accepted poverty as its fate, then there will be little hope for development. According to
Richard T. Gill, “The point is that economic development is not a mechanical process; it is not a simple
adding- up of assorted factors. Ultimately, it is a human enterprise. And like all human enterprises, its
outcome will depend finally on the skill, quality and attitudes of the men who undertake”.

 BIG PUSH THEORY

The theory of "Bigh push' is associated with the name of Professor Paul N. Rosenstein-Rodan. This theory is
needed in the form of a high minimum amount of investment to overcome to obstacles to development in an
underdeveloped economy and to launch it in the path of progress.
Rosenstein-Rodan distinguishes between three different kinds of indivisibilities and external economies.
One, indivisibilities in the production function, especially the indivisibility of the supply of social overhead
capital; two, indivisibility of demand; and three, indivisibility in the supply of savings. Let us analyze the
role of these indivisibilities in bringing economic development.

Indivisibilities in the Production Function:

According to Rosenstein-Rodan, indivisibilities of inputs, outputs or processes lead to increasing returns. He
regards social overhead capital as the most important instance of indivisibility and hence of external
economies on the supply side.

9
The services of social-overhead capital comprising basic industries like power, transport, and
communications are indirectly productive and have a long gestation period. They cannot be imported
installations require a "sizeable initial lump" of investment. So excess capacity is likely to remain in them
for some time.
They also excess "an irreducible minimum industry mix of different public ties, so that an underdeveloped
country will have to invest between K per cent of its total investment in these channels.
"Thus, social overhead capital is characterized by four indivisibilities, of, it is irreversible in time and,
therefore, must precede other directly productive investments. Second, it has a minimum durability, is
making it very lumpy.
Third, it has a long gestation period. Last, it is an irreducible minimum industry mix of different kinds of
public utilities. These indivisibilities of supply of social overhead capital are all of the principal obstacles to
development in underdeveloped countries.
Therefore, a high initial investment in social overhead capital IS necessary in order to pave the way for
quick-yielding directly productive investments.
Indivisibility of Demand:
The indivisibility or complementarily of demand requires simultaneous setting up of interdependent
industries in interdependent countries.
This is because individual investment projects have high risks as low incomes limit the demand for their
products. To illustrate, Rosenstein- Rodan takes first a closed economy where a hundred disguised
unemployed workers are employed in a shoe factory whose wages constitute an additional income.
If these workers spend all their income on shoes they manufacture, the shoe market will have a regular
demand and thus succeed. But the fact is that they would not like to spend all their additional income on
shoes, human wants being diverse. Nor will the people outside the factory buy-additional shoes when they
are poor.
Thus, the new factory will be abandoned for want of an adequate market. To vary the example, suppose that
ten thousand unemployed workers are engaged in one hundred factories (instead of hundred workers in one
factory) that produce a variety of consumer goods and spend their wages on buying them.
The new producers would be each others' customers and thus create market for their goods. The
complementarily of demand reduces the risk of finding a market and increases the incentive to invest.
In other words, it is the indivisibility of demand which necessitates a high minimum quantum of investment
in interdependent industries to enlarge the size of the market.
Indivisibility in the Supply of Savings:
A high income elasticity of saving is the third indivisibility in Rosenstein's theory. A high minimum size of
investment requires a high volume of savings.
This is not easy to achieve in underdeveloped countries because of low incomes. To overcome this, it is
essential that when incomes increase due to an increase in investment, the marginal rate of saving should be
very much higher than the average rate of saving.
Given these three indivisibilities and the external economies to which they give rise, a "big push" or a
minimum quantum of investment is required to overcome the obstacles to development in underdeveloped
countries.
"There may be finally a phenomenon of indivisibility in the vigor and drive required for a successful
development policy," writes Rodan. But proceeding bit by bit in an isolated and small way does not lead to a

10
sufficient impact on growth. A climate for development is only created when investment of a minimum
speed or size is made within an underdeveloped economy.

 ROSTOW STAGES OD DEVELOPMENT

In 1960, the American Economic Historian, WW Rostow suggested that countries passed through five
stages of economic development. This theory is an investment theory which stresses the conditions of
take-off. The argumentation is quite similar to the balanced growth theory but emphasis is put on the need
for a big push. The investments should be of a relatively high minimum in order to reap the benefits of
external economies. Only investments in big complexes will result in social benefits exceeding social
costs. High priority is given to infrastructural development and industry, and this emphasis will lead to
governmental development planning and influence.
Stage 1 Traditional Society
The economy is dominated by subsistence activity where output is consumed by producers rather than
traded. Any trade is carried out by barter where goods are exchanged directly for other goods. Agriculture
is the most important industry and production is labour intensive using only limited quantities of capital.
Resource allocation is determined very much by traditional methods of production.
Stage 2 Transitional Stage (the preconditions for takeoff)
Increased specialization generates surpluses for trading. There is an emergence of a transport
infrastructure to support trade. As incomes, savings and investment grow entrepreneurs emerge. External
trade also occurs concentrating on primary products.
Stage 3 Take Off
Industrialization increases, with workers switching from the agricultural sector to the manufacturing
sector. Growth is concentrated in a few regions of the country and in one or two manufacturing industries.
The level of investment reaches over 10% of GNP.
The economic transitions are accompanied by the evolution of new political and social institutions that
support the industrialization. The growth is self-sustaining as investment leads to increasing incomes in
turn generating more savings to finance further investment.
Stage 4 Drive to Maturity
The economy is diversifying into new areas. Technological innovation is providing a diverse range of
investment opportunities. The economy is producing a wide range of goods and services and there is less
reliance on imports.
Stage 5 High Mass Consumption
The economy is geared towards mass consumption. The consumer durable industries flourish. The service
sector becomes increasingly dominant.
According to Rostow development requires substantial investment in capital. For the economies of LDCs
to grow the right conditions for such investment would have to be created. If aid is given or foreign direct
investment occurs at stage 3 the economy needs to have reached stage 2. If the stage 2 has been reached
then injections of investment may lead to rapid growth.

 BALANCED GROWTH THEORY

The theory of 'Balanced Growth' has been put forward as a solution to the problem of vicious circle of
poverty that afflicts the demand side of capital formation. To break this vicious circle, the theory of

11
balanced growth advocates a simultaneous setting up of a large number of mutually complementary
industries that would generate demand for each other's products and thus expand the size of the market and
increase inducement to invest.
Rosenstein Rodan gave the earliest version of the balanced growth theory. He observed that in
underdeveloped countries, no new industry has a chance to survive due to limited size of market demand.
Thus, if for example, a shoe factory is set up employing a hundred workers, the chances are that it would
soon close down due to lack of demand for shoes. But if in place of one factory, we simultaneously set up,
say, one hundred factories employing thousands of workers, the chances are that all these factories would
survive.
This is because the additional income in the hands of these workers arising from their employment, will
create additional demand in the market as they spend money on various products produced by these
industries.
Thus demand for shoes, as well as for goods produced by other industries increases that enables all of them
to survive and grow. Nurkse agreed with Rosenstein Rodan and 
put forward the balanced growth theory on similar lines but enlarged the scope of the balanced growth
programme to include many more industrial sectors.
According to Nurkse, the only way to remove the obstacles arising out of the small size of the market is
"more or less synchronized application of capital to a wide range of different industries. Here is an escape
from the dead lock, here the result is an overall enlargement of the market ... most industries catering for
mass consumption is complementary in the sense that they provide a market for and thus support each
other."
The people working in these industries will be buyers of each others produce. Accordingly, each individual
industry shall create a demand for the goods of the others. The essence of Nurkse's theory is that if large
investment is undertaken in the mutually dependent industries, the vicious circle of poverty can be broken
and the country can look forward to the economic advancement.

Weaknesses of the Theory of Balanced Growth

The Theory of Balanced Growth suffers from inherent weaknesses. Singer has expressed his doubts about
the practicability of balanced growth doctrine. According to him, if underdeveloped countries are to launch
a large investment package in industries without paying much attention to agriculture, they are bound to run
into difficulties.
To avoid food and raw material shortage, the big push in industry will have to be accompanied by a big
push in agriculture as well. But when we think of such a large and varied package of industrial investment
and investment in agriculture at the same time, it creates serious doubts about the capacity of the
underdeveloped countries to follow the path of balanced growth.
As he says, "The resources required for carrying out the policy of balanced growth is of such order of
magnitude that a country disposing of such resources would infect not be underdeveloped."
In underdeveloped countries there is an acute shortage of capital and other resources. To suggest that they
can move on the path of economic progress by massive investment simultaneously in all sectors appears
totally impractical. In fact, the balanced growth doctrine requires huge amounts of precisely these resources
whose limited availability is the basic characteristic of the underdeveloped economies.

12
  UNBALANCED GROWTH THEORY
Prof. Hirschman, the leading exponent of the theory of unbalanced growth argues that a deliberate
unbalancing of the economy in accordance with predesigned strategy is the best way to achieve economic
growth. "An ideal situation obtains when one disequilibrium calls forth a development move which in turn
leads to. A similar disequilibrium and soon ad-infinitum".
He observes that development has proceeded in this way with "growth being communicated from the
leading sectors of the economy to the followers, from one industry to another, from one firm to another."
Development process is a chain of disequilibrium that must be kept alive and the task of development policy
is to maintain tension, disproportions and disequilibria.
Hirschman's theory of unbalanced growth is based on the following propositions:
(a) That technical complementarity is found among the various industries but in the case of some of them
the degree of complementarity is more than the other. Therefore, the programme for economic development
should aim at the establishment of those industries where these complementarities happen to be the greatest.
(b) That a simultaneous investment in a number of complementary industries according to the programme of
balanced growth may achieve a once for all increase in national income. But after this, the economy will
become stabilized at a higher level without any movement forward.
The objective of development is not only to achieve a once for all increase in national income, rather this
process of income propagation must continue year after year. In order to see that the development process
moves on continuously, it is necessary to create and maintain deliberate imbalances in the economy. To
create these imbalances Hirschman suggests investment either in Social Overhead Capital (SOC) or in
Directly Productive Activities (DPA).
Social Overhead Capital is defined as "comprising all those basic services without which primary,
secondary and tertiary productive activities cannot function". This includes investment in education, public
health, transport and communications, irrigation, drainage etc.
Large investment in SOC will encourage investment in DPA by providing cheap inputs to agriculture and
industry e.g., cheap electricity and power supply may encourage the development of industries both large
and small and may stimulate activity in other sectors as well. To quote Hirschman "Investment in SOC is
advocated not because of its direct effect on final output, but because it permits and in fact invites DPA to
come in some SOC investment as a prerequisite of DPA investment."
Imbalances in the economy can also be created by investment in directly productive activities such as
investment in manufacturing industries and constructional activities. Expansion in investment in DPA
without the corresponding expansion in SOC will lead to increase in cost of production in view of
inadequate availability of overhead facilities.
In such a situation, pressures are likely to be exerted and the government may step in and undertake
investment in SOC for creating the necessary infrastructure which would lead to an all-round development
of the economy.
The sequence of development from SOC to DPA is known as development via excess capacity. The second
sequence viz from DPA to SOC is called development via shortages. Development via excess capacity of
SOC is more continuous and smooth than development via shortages of SOC. According to Hirschman,
"development via shortages is an instance of disorderly compulsive sequence while that with excess SOC
capacity is essentially permissive."
Every investment project has both forward linkages (it may encourage investment in subsequent stage of
production) and backward linkages (it may encourage investment in earlier stages of production) and the

13
task of development policy is to find out projects with the maximum total linkage. Hirschman has worked
out the forward and the backward linkage in case of number of industries and on the basis of that, the
maximum linkage exists in the case of intermediate manufacturing industries. Therefore, if investment is
made in such industries, it is bound to affect the demand and supply positions in other sectors of the
economy and thus leading to their expansion as well.

 OBJECTIVES OF PLANNING
The Planning Commission, with the Prime Minister as the Chairman, has emerged as a powerful and
effective staff agency in India.
Functions of Planning Commission:
1. To make an assessment of the material, capital and human resources of the country, including technical
personnel and to investigate the possibilities of augmenting such of those resources as are found to be
deficient in relation to the nation’s requirements.
2. To formulate a plan for the most effective and balanced utilization of the country s resources.
3. To determine priorities as between projects and programmes accepted in the plan.
4. To indicate the factors that retard economic development and to determine conditions which should be
established for the success of the plan.
5. To determine the nature of the machinery to secure the successful implementation of the plan.
6. To appraise from time to time the progress of the plan and to recommend the necessary adjustments of
policy and measures; and
7. To make recommendations either for facilitating the discharge of its duties or tor a consideration of the
prevailing economic conditions, current policies, measures and development programmes; or for an
examination of problems referred to it for advice by the Central or State Government.
Organization of the Planning Commission:
The Planning Commission works through three major divisions-Programme advisors; General Secretariat;
and Technical divisions.
Programme Advisers:
There are four senior officers designated as advisers having the status of ex-office Additional Secretaries to
the Government of India. They assist the members of the Commission in matters concerning field-study and
observation of various schemes and projects and the progress of their implementation. The advisers also pay
specific attention to the problem of finance, public cooperation and administration connected with the
implementation of the plans.
General Secretariat:
It has four branches, namely—Administrative Branch, Plan Co-ordination Branch General Co-ordination
Branch and Information and Publicity Branch.
Technical Divisions:
The Commission has 20 Technical Divisions and Sections which tall broadly under two groups. Namely—
General Divisions and Branch of Subject Divisions. The General Divisions are concerned with the problem
of overall economic and social planning, each examining some speed of aspects of these problems.
The Subject Divisions, on the other hand, deal with specific sectors of the economy like Irrigation and
Power, Food and Agriculture, Education, Housing etc. The technical divisions are responsible for
scrutinizing and analyzing various schemes and projects to be incorporated in the plan; conducting technical

14
studies and research regarding plan projects and programmes preparing study material and reports on the
plan; following up of plan projects etc.
The heads of these Divisions are generally subject specialists designated as Chiefs or Directors who are
assisted by Deputy and Assistant Chiefs or Directors and some research staff.
Advisory Bodies:
Some of the important advisory bodies functioning in the Planning Commission are committee on Irrigation
and Power Projects, Coordination Committee and Research Programmes Committee.
Composition of the Commission:
The Planning Commission consists of a Chairman, Deputy Chairman and six members. The Prime Minister
is its Chairman. The Deputy Chairman is the full-time functional head of the Commission.
All cases involving policy are considered by the Commission as a whole. The formulation of the plans,
adjustments in the plans, matters involving departure from the plan; policies, important cases involving
disagreement with a Central Ministry or a State Governmental and differences of opinion between members
of the Commission are some of such cases.
There is a close liaison between the Cabinet and the Commission. The Chairman is the Prime Minister
himself. Other members of the Commission are invited, as and when necessary, to attend the meetings of the
Cabinet and its Committees. Important issues, economic in nature, arising in the Ministries are generally
discussed in the Commission before they are considered in the Cabinet. Thus, there is a regular stream of
ideas and suggestions flowing from the Commission to the Union Government and vice-versa.
Objective of Planning in India:
(i) To increase National income and per capita income.
(ii) To raise agricultural Production.
(iii) To industrialize the country.
(iv) To achieve balanced regional development.
(v) To expand employment opportunities.
(vi) To reduce inequalities of income and wealth.
(vii) To remove poverty.
(viii) To achieve self-reliance.

 ACHIEVEMENTS OF INDIAN PLANS

1. Increase in National Income:
During planning period national income has increased manifold. The average annual increase in national
income was registered to be 1.2 percent from 1901 to 1947.
This increase was recorded to be 3 percent in two decades i.e. 1950-70. Moreover, average annual growth
rate of national income was 4 per cent in 1970-80 which, further, increased to 5 percent in 1980-90. From
1980-81 to 2000-01, it increased to 5.8 per cent. Thus, a rise in national income has been key indicator for
economic development of India.
2. Increase in Per Capita Income:

15
Before independence, increase in per capita income was almost zero. But after the adoption of economic
planning in free India, per capita income has continuously been increased. In the first plan, it raised .by 1.8
per cent and in Second Plan, it was 2.0 per cent.
During Third Plan, it declined to (-) 6.8 per cent. In Three annual plans, growth of per capita income was
registered at 1.5 per cent.
In Fourth Plan, it came down to 1.0 per cent. In Fifth Plan, it was 2.7 per cent. During Sixth and Seventh
Plan, it was 3.2 per cent and 3.6 per cent respectively. In Eighth Plan, it rose to 4.6 per cent. In 2000-01, its
rise was registered at 4.9 at 1993-94 prices.
3. Development in Agriculture:
Agricultural productivity has also marked an upward trend during the plan period. The production of food
grains which has 510 lakh tonnes in 1950-51 increased to 1804 lakh tonnes in 1990-91 and further to 212.0
million tonnes in 2000-01.
Similarly, the production of cotton which was 21 lakh bales in 1950-51 was expected to be 10.1 million
bales in 2000-01. In the same period, the production of sugarcane was expected to be 300.1 lakh tonnes in
2000-01 against the 69 lakh in 1950-51.
Thus, agriculture production during planning period has increased. During the entire planning period,
growth rate of agricultural production remained 2.8 per cent per annum.
However, use of chemical fertilizer, better seeds, irrigation and improved methods of cultivation has
increased productivity per hectare and per worker many times. This development has laid the foundation of
green revolution and other institutional changes in agriculture sector.
4. Development of Industry:
In the first five year plan much of the capital was invested to develop the industry and defense. About fifty
percent of the total outlay of the plan was invested for their development.
As a result, industrial production increased to a great extent. For instance, the production of cotton cloth
which was 4210 million sq. meters in 1950-51 increased to 18989 million sq. metres in 1999-2000.
The production of finished steel increased to 31.1 million tones in 2001-02 from 10 lakh tonnes in 1950-51.
In the same fashion, the production of coal was recorded to be 3226 million tonnes in 2001-02 against the
323 million tonnes in 1950-51.
5. Development of Transport and Communication:
During the planning period, much attention has been paid towards the development of transport and
communication. In the first two plans, more than one-fourth of the total outlay was invested on the
development of transport and communication.
In 1990-91, the total length of roads increased to 1024.4 thousand kms from 157.0 thousand km. However,
further it increased to 1448.6 thousand km in 1998-99. In order to encourage trade goods rail was
developed.
6. Self Reliance:
During the last four decades, considerable progress seems to have been made towards the achievement of
self reliance. We are no longer dependent on other countries for the supply of food grains and a number of
agricultural crops.
In the same fashion, we have made substantial investment in basic and heavy industries. We are in a
position to produce all varieties of basic consumer goods.
7. Employment:

16
During the planning period, many steps have been taken to increase the employment opportunities in the
country. In the first five year plan employment opportunities to 70 lakh people were provided.
In the fourth and fifth plans about 370 lakh persons got employment. In the seventh five year plan,
provisions have been made to provide employment to 340 lakh people.
8. Development of Science and Technology:
In the era of planning, India has made much progress in the field of science and technology. In reality, the
development is so fast that India stands third in the world in the sphere of science and technology. Indian
engineers and scientists are in a position that they can independently establish any industrial venture.
9. Capital Formation:
In India due to the development of agriculture, industry and defense, the rate of capital formation has also
increased. In 1950-51, the rate of capital formation was 11.5 percent.
The rate of capital formation during Second, Third and Fourth plan was 12.7 per cent, 13.5 per cent and 14.5
per cent respectively. It was 24.1 per cent in seventh plan and 26 per cent in Eighth plan and 24 percent in
Ninth Flan.
10. Social Services:
Social services, like, education, health and medical facilities, I family planning and the like have also
expanded considerably.
As a result of these services: (i) Death rate reduced from 27 per thousand in 1951 to 8 per thousand in 2000-
01. (ii) Average life-expectancy increased from 32 years in 1951 to 638 in 2000-01. (iii) Several deadly
diseases like malaria etc. have been eradicated, (iv) The number of school going students has increased
three-fold and that of collegiate five-fold since 1951. The number of annual admissions to degree courses in
Engineering Colleges increased from 7100 in 1950 to 1, 33,000 and the number of universities increased
from 27 to 254 by now. (v) A chain of National Laboratories and Research Centers has been set up across
the country. (vi) Number of hospital-beds, doctors, nurses, medicines and family planning clinics and
medical facilities has greatly increased. Number of hospitals and dispensaries has increased to 68396. Now
there is one doctor per 5.2 per ten thousand.

 NATIONAL DEVELOPMENT COUNCIL

The N.D.C. was set up for the first time in 1951 with a view to bringing about a coordination of plans
between the Central Ministers and the State Governments.
In its original form it comprised of the Prime Minister as the Chairman, Chief Ministers of the State
Governments and the members of the Planning Commission.
So long as the same political party remained in power at the Centre as well as in the State Governments, the
National Development Council did not perform any effective role and only a General Election when
different political parties acquired power to become more effective and centralized planning became very
difficult to achieve.
In this context the role of N.D.C. has acquired new dimensions. The A.R.C. asked its Study Team to review
the working of the Council in the past and to suggest ways and means to make it more effective in the
future.
The Study Team made a number of recommendations regarding organization and functions of the Council,
which were endorsed by the Reforms Commission and were later on accepted by the Government of India
with some minor modifications by a resolution issued on October 7, 1967.

17
In the reconstituted Council, the Secretary of the Planning Commission acts as Secretary to the N.D.C. and
the Commission is expected to provide such administrative and other support as may be necessary.
The revised functions of the N.D. C are: To strengthen and mobilize the efforts and resources of the nation
in support of the Plan to promote common policies in vital spheres and to ensure the balanced and rapid
development of all parts of the country.
The Government of India set up a National Development Council on 6th August, 1952. The Council is
composed of the Prime Minister of India, the Chief Minister of States and Members of the Planning
Commission. Secretary of the Planning Commission is Secretary of the Council also.
Its functions are:
(1) To review the working of the National Plan from time to time,
(2) To consider important questions of social and economic policy affecting national development, and
(3) To recommend measures for the achievement of the aims and the targets set out in the National Plan,
including measures to secure the active participation and co-operation of the people, improve the efficiency
of the administrative services, ensure the fullest development of the less advanced regions and sections of
the community and, through sacrifice borne equally by all citizens, build up the resources for national
development.
N.D.C. consists of the Prime Minister, all Union Cabinet Ministers, Chief Ministers of all States and Union
Territories and the Members of the Planning Commission.
The Lt. Governor and the Chief Executive Councilor of the remaining Union Territories and the respective
Chief Ministers represent the Delhi Administration. It is also provided that other Union and States Ministers
may be invited to participate in the deliberations of the N.D.C.
(1) To prescribe guidelines for the formation of the National Plan, including the assessment of resources for
the Plan;
(2) To consider the National Plan as formulated by the Planning Commission;
(3) To consider the important questions of social and economic policy affecting national development; and
(4) To review the working of the plan from time to time and to recommend such measures as are necessary
for achieving the aims and targets set out in the National Plan, including measures to secure the active
participation and cooperation of the people, improve the efficiency of the administrative services, ensure the
fullest development of the less advanced regions and sections of the community and through sacrifice borne
equally by all the citizens build up resources for national development.
Thus, it is now the N.D.C., which prescribes the guidelines for the formulation of the National Plan. In this
new set-up the function of the Planning Commission is to prepare the Plan according to these guidelines.
In this way, the National Development Council has emerged as the top- most policy-laying agency in the
Government. Thus success of this new planning organization could depend mainly upon the tact and
sagacity of the Prime Minister and Chief Minister.

 India’s Eleventh Five-Year Plan (2007-2012)

The National Development Council (NDC) has approved the Eleventh Plan on 19th December 2007 to
raise the average economic growth rate to 9 percent from 7.6 percent recorded during the Tenth Plan.

18
The total outlay of the Eleventh Plan has been placed at Rs.3644718 crore which is more than double of the
total outlay of the previous Tenth Plan.

In this proposed outlay, the contribution of Central Government and State governments will be Rs.2156571
crore and Rs. 1488147 crore respectively. In order to make growth more inclusive, the Eleventh Plan
proposes to increase the agriculture sector growth rate to 4 percent from 2.13 percent in the Tenth Plan.
The growth targets for industry and services sectors have been pegged at 9 to 11 percent. The industrial
growth rate in the Tenth Plan was 8.74 percent, which the services sector grew by 9.28 percent. The basic
theme of this plan period is “Inclusive Growth”.

Salient Features of Eleventh Plan:

1. The investment rate has been proposed to be raised to 36.7 percent from 30.8 percent in the previous
plan.
2. The draft document has envisaged a savings rate of 34.8 percent, which is substantially higher than 30.8
percent recorded in the Tenth Plan.

3. The major thrust of the plan will be on social sector, including agriculture and rural development.

4. Important targets include reducing poverty by 10 percentage points, generating 7 crore new employment
opportunities and ensuring electricity connection to all villages.

5. More investment on infrastructure sector including irrigation, drinking water and sewage from 5 percent
of Gross Domestic Product (GDP) in 2005-06 to 9 percent by 2011-12.

Main Targets of the Eleventh Plan:

(a) Income and Poverty:
i. Accelerate GDP growth from 8% to 10% and then maintain at 10% in the 12th plan in order to double
per capita income by 2016-17.

ii. Create 70 Million new work opportunities.

iii. Reduce educated unemployment to below 5%.

iv. Reduce poverty by 10 percentage points.

(b) Education:
i. Reduce dropout rates of children from elementary school from 52.2% in 2003-04 to 20% by 2011-12.

ii. Increase literacy rate for persons of age 7 years or more to 85%.
iii. Lower gender gap in literacy to 10 percentage points.

(c) Health:
i. Reduce infant mortality rate to 28 and maternal mortality ratio to 1 percent 1000 live births.

19
 ii. Reduce Total Fertility rate to 2.1.

iii. Reduce malnutrition among children of age group 0-3 to half its present level.

(d) Infrastructure:
i. Ensure electricity connection to all villages by 2009 and round-the-clock power.

ii. Increase forest and tree cover by 5 percent points.

iii. Attain World Health Organization standard of air quality in all major cities by 2011-12.

iv. A telephone in every village by November 2007.

v. Broadband connectivity to all villages by 2011-12.

Growth Target:
According to the Eleventh Plan documents the task of achieving an average growth rate of around 9 percent
in the 11th plan is macro economically feasible. In fact, the scenarios show that even 10 percent growth
rate is achievable with a strong fiscal effort that is difficult but not impossible.

However, to achieve a more inclusive growth, substantial resources would have to be directed to setting
right t e neglect of rural infrastructure and provide education and health services to all. While these outlays
will eventually lead to faster growth

 India’s Eleventh Five-Year Plan

The government on 4th october approved the 12th five year plan (2012-17) document that seeks to achieve
annual average economic growth rate of 8.2 per cent, down from from 9 per cent envisaged earlier, in view
of fragile global recovery. The theme of the Approach Paper is “faster, sustainable and more inclusive
growth” .According to officials the projected average rate gross capital formation in the 12th Plan is 37 per
cent of GDP. The projected gross domestic savings rate is 34.2 per cent of GDP and the net external
financing needed for macro economic balance has been placed at 2.9 per cent of GDP. During the 11th
Plan (2007-12), India has recorded an average economic growth rate of 7.9 per cent. This, however, is
lower than the 9 per cent targetted in 11th Plan.Besides other things, the 12th Plan seeks to achieve 4 per
cent agriculture sector growth during 2012-17. The growth target for manufacturing sector has been pegged
at 10 per cent.The total plan size has been estimated at Rs.47.7 lakh crore, 135 per cent more that for the
11th Plan (2007-12).

The “strategy challenges” refer to some core areas that require new approaches to produce the desired results.
Thes are:

1.Enhancing the Capacity for Growth

2.Enhancing Skills and Faster Generation of Employment

20
3.Managing the Environment

4.Markets for Efficiency and Inclusion

5.Decentralisation, Empowerment and Information

6.Technology and Innovation

7.Securing the Energy Future for India

8.Accelerated Development of Transport Infrastructure

9.Rural Transformation and Sustained Growth of Agriculture

10.Managing Urbanization

11.Improved Access to Quality Education

12.Better Preventive and Curative Health Care

Highlights of 12th Five Year Plan (2012-17):

Average growth target has been set at 8.2 percent
Growth rate has been lowered to 8.2 percent from the 9.0 percent projected earlier in view adverse
domestic and global situation.
Areas of main thrust are-infrastructure, health and education
Growth rate has been lowered to 8.2 percent from the 9.0 percent projected earlier in view adverse
domestic and global situation.
The commission had accepted Finance Minister P. Chidambaram’s suggestion that direct cash transfer of
subsidies in food, fertilizers and petroleum be made by the end of the 12th Plan period
After the cabinet clearance, the plan for its final approval would be placed before the National
Development Council (NDC), which has all chief ministers and cabinet ministers as members and is
headed by the Prime Minister
Agriculture in the current plan period grew at 3.3 percent, compared to 2.4 percent during the 10th plan
period. The growth target for manufacturing sector has been pegged at 10 percent
During the 11th Plan period, the average annual growth was 7.9 percent
A full Planning Commission chaired by Prime Minister Manmohan Singh on September 15 endorsed the
document which has fixed the total plan size at Rs.47.7 lakh crore
The 12th Plan seeks to achieve 4 percent agriculture sector growth during the five-year period
On poverty alleviation, the commission plans to bring down the poverty ratio by 10 percent. At present, the
poverty is around 30 per cent of the population.
According to commission Deputy Chairperson Montek Singh Ahluwalia, health and education sectors are
major thrust areas and the outlays for these in the plan have been raised.
The outlay on health would include increased spending in related areas of drinking water and sanitation.

UNIT 3

21
  THE FEATURES OF NEW ECONOMIC POLICY 1991 – EXPLAINED
In 1990s the govt. of India in order to come out of the economic crisis decided to deviate from its previous
economic policies and learn towards Privatization . In July 1991 when the devaluation of Indian currency took
place the govt. started announcing its new economic policies one after another. Though these polices pertained
to different aspects of the economic field they had one thing in common. The economic element was to orient
the Indian system towards the world market it is in this context the govt. launched its new economic policy
which consisted of among other things three important features. Liberalization , Privatization and
Globalization .Liberalization of the economy means to free if from direct or physical control imposed by the
govt. economic reforms were based on the assumption that marten forces could guide the economy in a more
effective manner than govt.
The main characteristics of new Economic Policy 1991 are:
1. Delicencing. Only six industries were kept under Licencing scheme.
2. Entry to Private Sector. The role of public sector was limited only to four industries; rest all the industries
were opened for private sector also.
3. Disinvestment. Disinvestment was carried out in many public sector enterprises.
4. Liberalisation of Foreign Policy. The limit of foreign equity was raised to 100% in many activities, i.e., NRI
and foreign investors were permitted to invest in Indian companies.
5. Liberalisation in Technical Area. Automatic permission was given to Indian companies for signing
technology agreements with foreign companies.
6. Setting up of Foreign Investment Promotion Board (FIPB). This board was set up to promote and bring
foreign investment in India.
7. Setting up of Small Scale Industries. Various benefits were offered to small scale industries.
Three Major Components or Elements of New Economic Policy:
There are three major components or elements of new economic policy- Liberalisation, Privatisation,
Globalisation.
1. Liberalisation:
Liberalisation refers to end of licence, quota and many more restrictions and controls which were put on
industries before 1991. Indian companies got liberalisation in the following way:
(a) Abolition of licence except in few.
(b) No restriction on expansion or contraction of business activities.
(c) Freedom in fixing prices.
(d) Liberalisation in import and export.
(e) Easy and simplifying the procedure to attract foreign capital in India.
(f) Freedom in movement of goods and services
(g) Freedom in fixing the prices of goods and services.
2. Privatisation:
Privatisation refers to giving greater role to private sector and reducing the role of public sector. To execute
policy of privatisation government took the following steps:
(a) Disinvestment of public sector, i.e., transfer of public sector enterprise to private sector
(b) Setting up of Board of Industrial and Financial Reconstruction (BIFR). This board was set up to revive sick
units in public sector enterprises suffering loss.
(c) Dilution of Stake of the Government. If in the process of disinvestments private sector acquires more than
51% shares then it results in transfer of ownership and management to the private sector.

22
3. Globalisation:
It refers to integration of various economies of world. Till 1991 Indian government was following strict policy
in regard to import and foreign investment in regard to licensing of imports, tariff, restrictions, etc. but after new
policy government adopted policy of globalisation by taking following measures:
(i) Import Liberalisation. Government removed many restrictions from import of capital goods.
(ii) Foreign Exchange Regulation Act (FERA) was replaced by Foreign Exchange Management Act (FEMA)
(iii) Rationalisation of Tariff structure
(iv) Abolition of Export duty.
(v) Reduction of Import duty.
As a result of globalisation physical boundaries and political boundaries remained no barriers for business
enterprise. Whole world becomes a global village.
Globalisation involves greater interaction and interdependence among the various nations of global economy.

 INDIA’S NEW INDUSTRIAL POLICY 1991 ARE AS FOLLOWS

With the gradual liberalisation of the 1956 Industrial policy in the mid-eighties the tempo of industrial
development started picking up. But the industry was still feeling the burden of many controls and regulations.

For a faster growth of industry, it was necessary that even these impediments should be removed. The new
government by Shri Narasimha Rao, which took office in June 1991, announced a package of liberalisation
measures under its Industrial Policy on July 24, 1991.

Objectives:
The New Industrial Policy,1991 seeks to liberate the industry from the shackles of licensing system Drastically
reduce the role of public sector and encourage foreign participation in India’s industrial development.
The broad objectives of New Industrial Policy are as follows:

(i) Liberalising the industry from the regulatory devices such as licenses and controls.

(ii) Enhancing support to the small scale sector.

(iii) Increasing competitiveness of industries for the benefit of the common man.

(iv) Ensuring running of public enterprises on business lines and thus cutting their losses.

(v) Providing more incentives for industrialisation of the backward areas, and

(vi) Ensuring rapid industrial development in a competitive environment.

The New Industrial Policy has made very significant changes in four main areas viz., industrial licensing role of
public sector, foreign investment and technology and the MRTP act. The major provisions of this policy are
discussed below.

23
(1) Abolition of Industrial Licensing:
In the earlier industrial policy, industries were subjected to tight regulation through the licensing system.
Though some liberalisation measures were introduced during 1980’s that positively affected the growth of
industry. Still industrial development remained constrained to a considerable extent.

The new industrial policy abolishes the system of industrial licensing for most of the industries under this policy
no licenses are required for setting up new industrial units or for substantial expansion in the capacity of the
existing units, except for a short list of industries relating to country’s security and strategic concerns, hazardous
industries and industries causing environmental degradation.
To begin with, 18 industries were placed in this list of industries that require licenses. Through later amendment
to the policy, this list was reduced. It now covers only five industries relating to health security and strategic
concerns that require compulsory licensing. Thus the industry has been almost completely made free of the
licensing provisions and the constraints attached with it.

(2) De-reservation of Industries for Public Sector:

The public sector which was conceived as a vehicle for rapid industrial development, largely failed to do the job
assigned to it. Most public sector enterprises became symbols of inefficiency and imposed heavy burden on the
government through their perpetual losses.

Since a large field of industry was reserved exclusively for public sector where it remained a virtual non
performer (except for a few units like the ONGC). The industrial development was thus the biggest casualty.

The new industrial policy seeks to limit the role of public sector and encourage private sector’s participation
over a wider field of industry. With this view, the following changes were made in the policy regarding public
sector industries:

(i) Reduced reservation for public sector:

Out of the 17 industries reserved for the public sector under the 1956 industrial policy, the new policy de-
reserved 9 industries and thus limited the scope of public sector to only 8 industries.

Later, a few more industries were de-reserved and now the exclusive area of the public sector remains confined
to only 4 industrial sectors which are: (i) defence production, (ii) atomic energy, (iii) railways and (iv) minerals
used in generation of atomic energy.

However, if need be even some of these areas can be opened up for the private sector. The public sector can
also be allowed to set up units in areas that have now been thrown open for private sector, if the national interest
so demands.

(ii) Efforts to revive loss making enterprise:

Those public enterprises which are chronically sick and making persistent losses would be returned to the Board
of Industrial and Financial Reconstruction (BIFR) or similar other high level institutions created for this
purpose. The BIFR or other such institutions will formulate schemes for rehabilitation and revival of such
industrial units.

24
(iii) Disinvestment in selected public sector industrial units:
As a measure to raise large resources and introduce wider private participation in public sector units, the
government would sell a part of its share holding of these industries to Mutual Funds, financial institutions,
general public and workers.

For this purposes, the Government of India set up a ‘Disinvestment Commission’ in August 1996 which works
out the modalities of disinvestment. On the basis of recommendations of the ‘Disinvestment Commission’ the
government sells the shares of public enterprise.

(iv) Greater autonomy to public enterprises:

The New Industrial Policy seeks to give greater autonomy to the public enterprises in their day-to-day working.
The trust would be on performance improvement of public enterprises through a mix of greater autonomy
and more accountability.

(3) Liberalised Policy Towards Foreign Capital and Technology:

The inflow of foreign capital and import of technology was tightly regulated under the earlier Industrial policy.
Each proposal of foreign investment was to be cleared by the Government in advance. Wherever foreign
investment was allowed, the share of foreign equity was kept very low so that majority of ownership control
remains with Indians.

But such a policy kept the inflow of foreign capital very small and industrial development suffered for want of
capital resources and technology. The July, 1991 Industrial policy made several concessions to encourage flow
of foreign capital and technology into India, which are follows:

(i) Relaxation in Upper Limit of Foreign Investment:

The maximum limit of foreign equity participation was placed at 40 per cent in the total equity capital of
industrial units which were open to foreign investments under the 1991 policy; this limit was raised to 51 per
cent. 34 specified more industries were added to this list of 51 per cent foreign equity participation.

In some industries the ratio of foreign equity was raised to 74 percent. Foreign Direct Investments (FDI) was
further liberalised and now 100 per cent foreign equity is permitted the case of mining, including coal and
lignite, pollution control related equipment, projects for electricity generation, transmission and distribution,
ports, harbours etc.

Recent decision taken to further liberalise FDI include permission for 100 per cent FDI in oil refining, all
manufacturing activities in Special Economic Zones (SEZ’s), some activities in telecom see tor etc.

(ii) Automatic Permission for Foreign Technology Agreement:

The New Industrial Policy states that automatic permission will be granted to foreign technology agreements in
the high priority industries. Previously technology agreement by an Indian company with foreign parties for
import of technology required advance clearance from the government.

25
This delayed the import of technology and hampered modernisation of industries. Now the Indian companies
could enter into technology agreements with foreign companies and import foreign technology for which
permission would be automatically granted provided the agreements involved a lump sum payment of upto Rs.
1 crore and royalty upto 5 percent on domestic sales and 8 per cent on exports.

(4) Changes in the MRTP Act:

According to the Monopolies and Restrictive Trade Practices (MRTP) Act, 1969, all big companies and large
business houses (which had assets of Rs. 100 crores or more, according to the 1985 amendment to the Act) were
required to obtain clearance from the MRTP Commission for setting up any new industrial unit, because such
companies (called MRTP companies) were allowed to invest only in some selected industries.

Thus, besides obtaining a licence they were also required to get MRTP clearance. This was a big impediment
for industrial development as the big business firms which had the resources for development could not grow
and diversify their activities.

The Industrial Policy, 1991 has put these industries on par with others by abolishing those provisions of the
MRTP Act which mediate mandatory for the large industrial houses to seek prior clearance from MRTP
Commission for their new projects.

Under the amended Act, the MRTP Commission will concern itself only with the control of Monopolies and
Restrictive Trade Practices that are unfair and restrict competition to the detriment of consumer s interests. No
prior approval of or clearance from the MRTP Commission is now required for setting up industrial units by the
large business houses.

(5) Greater Support to Small-Scale Industries:

The New Industrial Policy seeks to provide greater government support to the small-scale industries so that they
may grow rapidly under environment of economic efficiency and technological upgradation. A package of
measures announced in this context provides for setting up of an agency to ensure that credit needs of these
industries are fully met.

It also allows for equity participation by the large industries in the small scale sector not exceeding 24 per cent
of their total shareholding. This has been done with a view to provide small scale sector an access to the capital
market and to encourage their upgradation and modernisation the government would also encourage the
production of parts and components required by the public sector industries in the small-scale sector.

(6) Other Provisions:
Besides above discussed measures, the Industrial Policy 1991 announced some more steps to promote rapid
industrial development. It said that the government would set up a special board (which was established as
Foreign Investments Promotion Board—FIPB) to negotiate with a number of international companies for direct
investment in industries in India.

26
It also announced the setting up of a fund (called National Renewal Fund) to provide socialsecurity to
retrenched workers and provide relief and rehabilitate those workers who have been rendered unemployed due
to technological changes.

The New Policy also removed the mandatory convertibility clause under which the Public Sector Financial
Institution were asked to convert the loans given by them to private industries in equity (shares) and thus
become partners in their management.

This removed a big threat to the private sector industries as they were always under threat that their
management and control could pass on into the hands of the Government owned financial institutions.

Evaluation of the New Industrial Policy:

The New Industrial Policy 1991 aims to unshackle Indian’s industrial economy from the cobwebs of
unnecessary bureaucratic control. According to this policy the rate of the government should change from that
of only exercising control over industries to that of helping it to grow rapidly by cutting down delays.

Removal of entry barriers and bringing about transparency in procedures. This policy therefore also at virtually
ending the ‘Licence-Permit Raj’ which has hampered private initiative and industrial development. The new
policy therefore throws almost the entire field of industry wide upon for the private sector.

The public sector’s role has been confined largely to industries of defence, strategic and environmental
concerns. Thus new policy is more market friendly and aims at making the best use of available entrepreneurial
talent in a congenial industrial environment. The industry is thus expected to grow faster under the new
industrial policy 1991.

 MRTP ACT

MONOPOLIES AND RESTRICTIVE TRADE PRACTICES ACT (MRTP ACT)

The principal objectives sought to be achieved through the MRTP Act are as follows:
Prevention of concentration of economic power to the common detriment, control of monopolies,
and Prohibition of monopolistic and restrictive and unfair trade practices.
The MRTP Act became effective in June 1970. With the emphasis placed on productivity in the Sixth Plan,
major amendments to the MRTP Act were carried out in 1982 and 1984 in order to remove impediments to
industrial growth and expansion. This process of change was given a new momentum in 1985 by an increase of
threshold limit of assets.
With the growing complexity of industrial structure and the need for achieving economies of scale for ensuring
high productivity and competitive advantage in the international market, the interference of the Government
through the MRTP Act in investment decisions of large companies has become deleterious in its effects on
Indian industrial growth. The pre-entry scrutiny of investment decisions by so called MRTP companies will no
longer be required.
Instead, emphasis will be on controlling and regulating monopolistic, restrictive and unfair trade practices rather
than making it necessary for the monopoly house to obtain prior approval of Central Government for expansion,
establishment of new undertakings, merger, amalgamation and takeover and appointment of certain directors.
The thrust of policy will be more on controlling unfair or restrictive business practices. The MRTP Act will be

27
restructured by eliminating the legal requirement for prior governmental approval for expansion of present
undertakings and establishment of new undertakings. The provisions relating to merger, amalgamation, and
takeover will also be repealed. Similarly, the provisions regarding restrictions on acquisition of and transfer of
shares will be appropriately incorporated in the Companies Act.
Simultaneously, provisions of the MRTP Act will be strengthened in order to enable the MRTP Commission to
take appropriate action in respect of the monopolistic, restrictive and unfair trade practices. The newly
empowered MRTP Commission will be encouraged to require investigation suo moto or on complaints received
from individual consumers or classes of consumers.

 FISCAL POLICY
In order to learn and understand fiscal policy or monetary policy it is important to whether an economy, no
matter where it may be in the world, can self regulate, or whether it needs an outside influence in order to
adjust. This is where Classical and Keynesian economics will come into play. If you are of the Keynesian
school of thought, you believe that the economy needs your influence in order to correct itself. This correction
can be in the form of fiscal policy.
Fiscal policy can be defined as government’s actions to influence an economy through the use of taxation and
spending. This type of policy is used when policy-makers believe the economy needs outside help in order to
adjust to a desired point. Typically a government has a desire to maintain steady prices, an employment level,
and a growing economy. If any of these areas are out of sorts, some type of fiscal policy may be in order.
Fiscal policy can be used in order to either stimulate a sluggish economy or to slow down an economy that is
growing at a rate that is getting out of control (which can lead to inflation or asset bubbles). Fiscal policy
directly affects the aggregate demand of an economy. Recall that aggregate demand is the total number of final
goods and services in an economy, which include consumption, investment, government spending, and net
exports.
Aggregate Demand = Consumption + Investment + Govt Spending + Net Exports
Fiscal policy has an effect on each of these categories. There are two types of fiscal policy: Expansionary and
Contractionary.
Expansionary Fiscal Policy
When an economy is in a recession, expansionary fiscal policy is in order. Typically this type of fiscal policy
results in increased government spending and/or lower taxes. A recession results in a recessionary gap –
meaning that aggregate demand (ie, GDP) is at a level lower than it would be in a full employment situation. In
order to close this gap, a government will typically increase their spending which will directly increase the
aggregate demand curve (since government spending creates demand for goods and services). At the same time,
the government may choose to cut taxes, which will indirectly affect the aggregate demand curve by allowing
for consumers to have more money at their disposal to consume and invest. The actions of this expansionary
fiscal policy would result in a shift of the aggregate demand curve to the right, which would result closing the
recessionary gap and helping an economy grow.
Contractionary Fiscal Policy
Contractionary fiscal policy is essentially the opposite of expansionary fiscal policy. When an economy is in a
state where growth is at a rate that is getting out of control (causing inflation and asset bubbles), contractionary
fiscal policy can be used to rein it in to a more sustainable level. If an economy is growing too fast or for
example, if unemployment is too low, an inflationary gap will form. In order to eliminate this inflationary gap a

28
government may reduce government spending and increase taxes. A decrease in spending by the government
will directly decrease aggregate demand curve by reducing government demand for goods and services.
Increases in tax levels will also slow growth, as consumers will have less money to consume and invest, thereby
indirectly reducing the aggregate demand curve.
Fiscal Policy Summary
To summarize, fiscal policy is a type of economical intervention where the government injects its policies into
an economy in order to either expand the economy’s growth or to contract it. By changing the levels of
spending and taxation, a government can directly or indirectly affect the aggregate demand, which is the total
amount of goods and services in an economy.
One thing to remember concerning fiscal policy is that a recession is generally defined as a time period of at
least two quarters of consecutive reduction in growth. It may take time to even recognize whether or not there is
a recession. With fiscal policy, there will be certain levels of lag time in which conditions will deteriorate before
being recognized. At the same time, fiscal policy takes time to implement due to legislative and administrative
processes, and those same policies will take time to show results after implementation.
Consumers can also react to these policies positively or negatively. Most consumers would have a positive
reaction per say to a policy that lowers taxes, while some will have an issue with a government spending more
which will increase the burden of debt on nations citizens.
Nevertheless, fiscal policy is a type of intervention that can help to control the direction of an economy.
Deciding if and when it should be used will certainly continue to be debated.

 MEANING OF UNION (CENTRAL) BUDGET OF INDIA:

According to Constitution of India, there is threetier system of government, namely. Central (or Union)
government.
State government and Local government (like Municipal Corporation, Municipal Committee, Zila Parishad,
etc.). Accordingly, these governments prepare their own respective budgets (called Union Budget, State Budget
and Municipal Budget) containing estimates of expected revenue and proposed expenditure.
The basic structure of government budget is almost the same at all levels of government but items of
expenditure and sources of revenue differ from budget to budget. Again, there is no clash with regard to sources
of revenue because functions of Central, State and local government have been clearly demarcated and laid
down in the Indian Constitution. However, we shall discuss here the budget of the Central Government.
Let it be noted that Central Government is constitutionally required to lay an “annual financial statement”
before both the houses of Parliament. This statement is conventionally called Government Budget. Accordingly,
in India, every year Central (or Union) Budget for the coming financial year is presented by the Union Finance
Minister in the Lok Sabha normally on the last working day of the month of February.
It gives item wise details of government receipts and expenditure for three consecutive years, i.e., Actuals for
the preceding year. Budget estimates for the current year. Revised estimates for the current year and Budget
estimates for the ensuing (coming) year .For Instance, Union Budget for the financial year 20092010 as
presented in the Parliament reflects this approach.
It contains details of government Receipts and Expenditure under the following four heads:
(i) Actual for the year 2008-09

29
(ii) Budget estimates formthe year 2009-10
(iii) Revised estimates for the year 200910
(iv) Budget estimates for the year 201011

Components of the Union (Central) Budget of India:

The budget is divided into two parts:
(i) Revenue Budget and
(ii) Capital Budget.
The Revenue Budget comprises revenue receipts and expenditure met from these revenues. The revenue
receipts include both tax revenue (like income tax, excise duty) and nontax revenue (like interest receipts,
profits). Capital Budget consists of capital receipts {like borrowing, disinvestment) and long period capital
expenditure (creation of assets, investment). Capital receipts are receipts of the government which create
liabilities or reduce financial assets, e.g., market borrowing, recovery of loan, etc. Capital expenditure is the
expenditure of the government which either creates assets or reduces liability. Capital budget is an account of
assets and liabilities of the government which takes into consideration changes in capital. Structure or
components of a government budget broadly consists of two parts—Budget Receipts and Budget Expenditure as
shown in the following chart
with their classification.

 DEFICIT FINANCING

30
Deficit financing is a method of meeting government deficits through the creation of new money. The deficit is
the gap caused by the excess of government expenditure over its receipts. The expenditure includes
disbursement on revenue as well as on capital account.
The receipts similarly comprise revenues on current account as well as capital account. Creation of new money
to meet the deficit in use for a long time. But it has now being given up. Instead a new scheme called ways and
Means Advances is being ushered in with effect from April 1997. Under this system the government can get
only temporary loans to overcome the mismatch between its receipts and expenditures.

Purpose of Deficit  Financing:

In India, the deficit financing resorted mainly to enable the government to obtain the necessary resources for the
plans. The levels of outlay laid down are of an order which cannot be met only by taxation and borrowing from
the public.

The gap in resources is made up partly through external assistance, but when external assistance is not enough
to fill the gap; deficit financing has to be resorted to. The targets of production and employment in the plans are
fixed primarily with reference to what is considered as the desirable rate of growth for the economy.
When these targets cannot be achieved by levels of expenditure possible with resources obtained from taxation
and borrowing, additional resources have to be found.

Advantages of Deficit Financing:
When the Government resorts to deficit financing, it usually borrows from the Reserve Bank. The interest paid
to the Reserve Bank actually comes back to the Government in the form of profits.

Through deficit financing, resources are used much earlier than they can be otherwise. The development is
accelerated. This technique enables the Government to get resources without much opposition.

Defects of Deficit Financing:
The defects of deficit financing are:
(i) It leads to increase in inflationary rise of prices of goods and services in the country.

(ii) Inflationary forces created by deficit financing are reinforced by increased creditcredition by banks.

(iii) Investment caused by inflation may not be of the pattern sought under the plan. It normally changed.

(iv) If as a result of deficit financing inflation goes too far, it becomes self-defeating.

instruments!
Meaning of Monetary Policy:
Monetary policy refers to the credit control measures adopted by the central bank of a country.

Image Courtesy : dhakatribune.com/sites/default/files/Monetary-policy.jpg

31
Johnson defines monetary policy “as policy employing central bank’s control of the supply of money as an
instrument for achieving the objectives of general economic policy.” G.K. Shaw defines it as “any conscious
action undertaken by the monetary authorities to change the quantity, availability or cost of money.”
Objectives or Goals of Monetary Policy:
The following are the principal objectives of monetary policy:

1. Full Employment:
Full employment has been ranked among the foremost objectives of monetary policy. It is an important goal not
only because unemployment leads to wastage of potential output, but also because of the loss of social standing
and self-respect.
2. Price Stability:
One of the policy objectives of monetary policy is to stabilise the price level. Both economists and laymen
favour this policy because fluctuations in prices bring uncertainty and instability to the economy.

3. Economic Growth:
One of the most important objectives of monetary policy in recent years has been the rapid economic growth of
an economy. Economic growth is defined as “the process whereby the real per capita income of a country
increases over a long period of time.”
4. Balance of Payments:
Another objective of monetary policy since the 1950s has been to maintain equilibrium in the balance of
payments.

Instruments of Monetary Policy:

The instruments of monetary policy are of two types: first, quantitative, general or indirect; and second,
qualitative, selective or direct. They affect the level of aggregate demand through the supply of money, cost of
money and availability of credit. Of the two types of instruments, the first category includes bank rate
variations, open market operations and changing reserve requirements. They are meant to regulate the overall
level of credit in the economy through commercial banks. The selective credit controls aim at controlling
specific types of credit. They include changing margin requirements and regulation of consumer credit. We
discuss them as under:

Bank Rate Policy:

The bank rate is the minimum lending rate of the central bank at which it rediscounts first class bills of
exchange and government securities held by the commercial banks. When the central bank finds that
inflationary pressures have started emerging within the economy, it raises the bank rate. Borrowing from the
central bank becomes costly and commercial banks borrow less from it.
The commercial banks, in turn, raise their lending rates to the business community and borrowers borrow less
from the commercial banks. There is contraction of credit and prices are checked from rising further. On the
contrary, when prices are depressed, the central bank lowers the bank rate.

It is cheap to borrow from the central bank on the part of commercial banks. The latter also lower their lending
rates. Businessmen are encouraged to borrow more. Investment is encouraged.
Output, employment, income and demand start rising and the downward movement of prices is checked.

32
Open Market Operations:
Open market operations refer to sale and purchase of securities in the money market by the central bank. When
prices are rising and there is need to control them, the central bank sells securities. The reserves of commercial
banks are reduced and they are not in a position to lend more to the business community.

Further investment is discouraged and the rise in prices is checked. Contrariwise, when recessionary forces start
in the economy, the central bank buys securities. The reserves of commercial banks are raised. They lend more.
Investment, output, employment, income and demand rise and fall in price is checked.
Changes in Reserve Ratios:
This weapon was suggested by Keynes in his Treatise on Money and the USA was the first to adopt it as a
monetary device. Every bank is required by law to keep a certain percentage of its total deposits in the form of a
reserve fund in its vaults and also a certain percentage with the central bank.

When prices are rising, the central bank raises the reserve ratio. Banks are required to keep more with the
central bank. Their reserves are reduced and they lend less. The volume of investment, output
and employment are adversely affected. In the opposite case, when the reserve ratio is lowered, the reserves of
commercial banks are raised. They lend more and the economic activity is favourably affected.

Selective Credit  Controls:
Selective credit controls are used to influence specific types of credit for particular purposes. They usually take
the form of changing margin requirements to control speculative activities within the economy. When there is
brisk speculative activity in the economy or in particular sectors in certain commodities and prices start rising,
the central bank raises the margin requirement on them.
The result is that the borrowers are given less money in loans against specified securities. For instance, raising
the margin requirement to 60% means that the pledger of securities of the value of Rs 10,000 will be given 40%
of their value, i.e. Rs 4,000 as loan. In case of recession in a particular sector, the central bank encourages
borrowing by lowering margin requirements.

Conclusion:
For an effective anti-cyclical monetary policy, bank rate, open market operations, reserve ratio and selective
control measures are required to be adopted simultaneously. But it has been accepted by all monetary theorists
that (i) the success of monetary policy is nil in a depression when business confidence is at its lowest ebb; and
(ii) it is successful against inflation. The monetarists contend that as against fiscal policy, monetary policy
possesses greater flexibility and it can be implemented rapidly

 LPG
Liberalization, Privatisation and Globalisation!
Economic environment is also called business environment and are used interchangeably. In order to solve the
economic problem of our country, the government has taken several steps including control by the State of
certain industries, central planning and reduced importance of the private sector.
Accordingly, the main objectives of India’s development plans set were to:
a. Initiate rapid economic growth to raise the standard of living, reduce the widespread unemployment and
poverty stalking the land;

33
b. Become self-reliant and set up a strong industrial base with emphasis on heavy and basic industries;
c. Achieve balanced regional development by establishing industries across the country;
d. Reduce inequalities of income and wealth;
e. Adopt a socialist pattern of development — based on equality and prevent exploitation of man by man.
With the above objectives in view, the Government of India as a part of economic reforms announced a new
industrial policy in July 1991.
The broad features of this policy were as follows:
1. The Government reduced the number of industries under compulsory licensing to six only.
2. Disinvestment was carried out in case of many public sector industrial enterprises.
3. Policy towards foreign capital was liberalized. The share of foreign equity participation was increased and in
many activities 100 per cent Foreign Direct Investment (FDI) was permitted.
4. Automatic permission was now granted for technology agreements with foreign companies.
5. Foreign Investment Promotion Board (FIPB) was set up to promote and channelise foreign investment in
India.
There were three major initiatives taken by the Government of India to introduce the much debated and
discussed economic reforms to transform Indian economy from closed to open market economy. These are
generally abbreviated as LPG, i.e. Liberalization, Privatization and Globalization.
Liberalization:
Liberalization of the Indian economy contained the following features:
a. The economic reforms that were introduced were aimed at liberalizing the Indian business and industry from
all unnecessary controls and restrictions.
b. They indicate the end of the license-permit-quota raj.
c. Liberalization of the Indian industry has taken place with respect to:
(i) Abolishing licensing requirement in most of the industries except a short list,
(ii) Freedom in deciding the scale of business activities i.e., no restrictions on expansion or contraction of
business activities,
(iii) Removal of restrictions on the movement of goods and services,
(iv) Freedom in fixing the prices of goods and services,
(v) Reduction in tax rates and lifting of unnecessary controls over the economy,
(vi) Simplifying procedures for imports and exports, and
(vii) Making it easier to attract foreign capital and technology to India.
Privatisation:
Privatization was characterized by the following features:
a. The new set of economic reforms aimed at giving greater role to the private sector in the nation building
process and a reduced role to the public sector.
b. To achieve this, the government redefined the role of the public sector in the New Industrial Policy of 1991.
c. The purpose of the same, according to the government, was mainly to improve financial discipline and
facilitate modernization.
d. It was also observed that private capital and managerial capabilities could be effectively utilized to improve
the performance of the PSUs.
e. The government has also made attempts to improve the efficiency of PSUs by giving them autonomy in
taking managerial decisions.
Globalisation:

34
Globalisation of the Indian economy contained the following characteristics:
a. Globalization is the outcome of the policies of liberalisation and privatization already initiated by the
Government.
b. Globalisation is generally understood to mean integration of the economy of the country with the world
economy. It is a complex phenomenon to understand and apply into practice.
c. It is an outcome of the set of various policies that are aimed at transforming the world towards greater
interdependence and integration.
d. It involves creation of networks and activities transcending economic, social and geographical boundaries.
e. Globalisation involves an increased level of interaction and interdependence among the various nations of the
global economy.
f. Physical geographical gap or political boundaries no longer remain barriers for a business enterprise to serve a
customer in a distant geographical market across the globe.

 ESSAY ON  INDIAN TRADE POLICY (EXIM POLICY)

The Export-Import Policy (EXIM Policy), announced under the Foreign Trade (Development and Regulation
Act), 1992, would reflect the extent of regulations or liberalization of foreign trade and indicate the measures
for export promotion. Although the EXIM Policy is announced for a five- year period, announcing a Policy on
March 31st of every year, within the broad frame of the Five Year Policy, for the ensuring year.
A very important feature of the EXIM policy since 1992 is freedom. Licensing, quantitative restrictions and
other regulatory and discretionary controls have been substantially eliminated.
The Union Commerce Ministry, Government of India announces the integrated Foreign Trade Policy FTP in
every five year. This is also called EXIM policy. This policy is updated every year with some modifications and
new schemes. New schemes come into effect on the first day of financial year, i.e., April 1, every year. The
Foreign Trade Policy which was announced on August 28, 2009 is an integrated policy for the period 2009-14.
Export-Import (EXIM) Policy frames rules and regulations for exports and imports of a country. This policy is
also known as Foreign Trade Policy. It provides policy and strategy of the government to be followed for
promoting exports and regulating imports. This policy is periodically reviewed to incorporate necessary changes
as per changing domestic and international environment. In this policy, approach of government towards
various types of exports and imports is conveyed to different exporters and importers.
Export refers to selling goods and services to other countries, while import means buying goods and services
from other countries. Now in the era of globalization, no economy in the world can remain cut-off from rest of
the world. Export and import play a significant role in the economic development of all the developed and
developing economies. With the growth of international organisations like WTO, UNCTAD, ASEAN, etc.,
world trade is growing at a very fast rate.
Objectives of EXIM Policy:
The principal objectives of this Policy are:
1) To facilitate sustained growth in exports to attain a share of atleast 1 % of global merchandise trade.
2) To stimulate sustained economic growth by providing access to essential raw materials, intermediates,
components, consumables and capital goods required for augmenting production and providing services.
3) To enhance the technological strength and efficiency of Indian agriculture, industry and services, thereby
improving their competitive strength while generating new employment opportunities, and to encourage the
attainment of internationally accepted standards of quality.

35
4) To provide consumers with good quality goods and services at internationally competitive prices while at the
same time creating a level playing field for the domestic produce.

 FEMA
The Foreign Exchange Management Act (FEMA) was an act passed in the winter session of Parliament in 1999,
which replaced Foreign Exchange Regulation Act. This act seeks to make offences related to foreign exchange
civil offences. It extends to the whole of India.
The Foreign Exchange Regulation Act (FERA) of 1973 in India was replaced on June 2000 by the Foreign
Exchange Management Act (FERA), which was passed in 1999. The FERA was passed in 1973 at a time when
there was acute shortage of foreign exchange in the country.
It had a controversial 27 years stint during which many bosses of the Indian corporate world found themselves
at the mercy of the Enforcement Directorate. Moreover, any offence under FERA was a criminal offence liable
to imprisonment. But FEMA makes offences relating to foreign civil offences.
FEMA had become the need of the hour to support the pro- liberalisation policies of the Government of India.
The objective of the Act is to consolidate and amend the law relating to foreign exchange with the objective of
facilitating external trade and payments for promoting the orderly development and maintenance of foreign
exchange market in India.
FEMA extends to the whole of India. It applies to all branches, offices and agencies outside India owned or
controlled by a person, who is a resident of India and also to any contravention there under committed outside
India by two people whom this Act applies.

The Main Features of the FEMA:

i. It is consistent with full current account convertibility and contains provisions for progressive liberalisation of
capital account transactions.
ii. It is more transparent in its application as it lays down the areas requiring specific permissions of the Reserve
Bank/Government of India on acquisition/holding of foreign exchange.
iii. It classified the foreign exchange transactions in two categories, viz. capital account and current account
transactions.
iv. It provides power to the Reserve Bank for specifying, in , consultation with the central government, the
classes of capital account transactions and limits to which exchange is admissible for such transactions.
v. It gives full freedom to a person resident in India, who was earlier resident outside India, to hold/own/transfer
any foreign security/immovable property situated outside India and acquired when s/he was resident.
vi. This act is a civil law and the contraventions of the Act provide for arrest only in exceptional cases.
vii. FEMA does not apply to Indian citizen’s resident outside India.
 COTTAGE AND SMALL SCALE INDUSTRIES
Next to agriculture, small-scale and cottage industries is the most important employment providing sector of the
economy. It also contributes a substantial part of manufacturing output.
We can discuss the role and performance of small-scale and cottage industries under the following headings:
1. Expansion of small-scale sector and its share in industrial output.
2. Employment generation.
3. Relative efficiency as compared with large-scale sector.
4. Equitable distribution of national income.

36
5. Mobilisation of capital and entrepreneurial skills.
6. Regional dispersal of industries.
7. Less industrial disputes.
8. Contribution to export earnings.
(1) Expansion of Small-Scale Sector and Contribution to Industrial Output:
As is clear from the discussion above, the definition of small-scale undertakings has changed over time.
Therefore, study of the expansion of small-scale sector over a long period of time is not possible. However, a
study of the data contained in Economic Survey 2001-02 gives the following results for the period 1993-94 to
2000- 01.
(a) The number of small-scale units stood at 23.9 lakh in 1993-94 and this rose to 33.7 lakh in 2000-01. This
shows that during the period eight years, the number of industrial units rose by as much as 41 percent.
(b) The output of small-scale units was Rs. 2, 41,648 crore in 1993-94 and this rose to Rs. 4, 50,450 crore in
2000-01 (at 1993-94 prices). This shows that the output of the small-scale industries increased by as much as
86.4 percent over the period 1993-94 to 2001-02.
(2) Relative Efficiency as Compared with Large-Scale Sector:
(i) Whether large-scale industries are more efficient or small-scale industries are more efficient, is a matter of
debate. The problem arises because of the fact that efficiency can be defined in many different ways. The study
on this issue was conducted by SIDBI (Small Industries Development Bank of India) Team in 1999 in
association with NCAER (National Council of Applied Economic Research).
The study covers the period 1980-1994. The study reveals that the small-scale industries, by investing only 7
percent to 15 percent of the total manufacturing sector’s capital, contribute to nearly one-fifth of industrial
output and 35 to 40 percent of total employment in the industrial sector.
Moreover, both labour productivity and capital productivity in small-scale sector grew at a faster rate than
large-scale sector during 1980-94. Thus, the small-scale sector has proved to be more efficient.
(3) Employment Generations:
The small-scale units employed 129.80 lakh people in 1991-92 and this number has consistently risen to 185.6
lakh people in 2000-01. Given the acute problem of unemployment in India, creation of employment
opportunities depend crucially on the development of small-scale and cottage industries.
There is already surplus labour in agriculture while the large-scale industrial sector, being capital-intensive in
nature, has limited employment opportunities. In fact, the employment argument is the strongest argument that
can be put forward in favour of small-scale and cottage, industries in India.
(4) Equitable Distribution of National Income:
The main arguments put forward in support of the small-scale and cottage industries is that they ensure a more
equitable distribution of national income and wealth. This happens because of the following two considerations:
(a) The ownership of small-scale industries is more widespread than the ownership of large- scale industries,
and
(b) They possess a much larger employment potential as compared to the large industries.
(5) Regional Dispersal of Industries:
There has been massive concentration of large-scale industries in the states of Maharashtra, West Bengal,
Gujarat and Tamil Nadu. As a result, disparity in industrial development have increased. Even within these
industrialized states, industries have tended to get concentrated in a few large cities like Mumbai and Chennai.

37
People migrate in large numbers from villages and lower order urban centres to these centres of industrial
development. This swells the population of slums and create various social and personal problems. The whole
urban environment gets polluted.
As against this, the small-scale industries are ostly set up to satisfy local demand and they can be dispersed
overall the state very easily. They can also effect a qualitative change in the economy of a state. The most
glaring example of this phenomenon is the economy of Punjab which has more small- scale industrial units than
even the industrially developed state of Maharashtra.
(6) Mobilisation of Capital and Entrepreneurial Skill:
Small-scale industries are at a distinct advantage as far as mobilisation of capital and entrepreneurial skill is
concerned. A number of entrepreneurs are spread over small towns and village industries are distributed over
the entire length and breadth of the country.
Similarly, large-scale industries cannot mobilise the savings done by people in areas far flung from the urban
centres. But this task can be effectively accomplished by getting up a network of small-scale and cottage
industries. In addition, a large number of other resources spread over the country can be put to an effective use
by the small-scale and cottage industries.
The rapid development of small-scale industries in the post-Independence period is a proof that given the
necessary credit, power and technical knowledge a large quantity of latent resources of the economy can be
mobilised for purposes of industrial development.
(7) Less Industrial Disputes:
A number of supporter of small-scale and cottage industries have argued that as compared with large-scale
units, these industries have less industrial disputes. While these are frequent strikes and lock-outs in large
industries, small-scale and cottage industries do not face such problem.
Therefore, there is no loss of output in small-scale and cottage industries. However, this point of view is not
totally correct. The fact is that workers in large scale units are organised and thus the strikes are well reported in
media.
As against this workers in small scale units are unorganised and cannot resort to strike. Any worker who shows
his resentment is immediately thrown out. Therefore, while in a small-scale unit relations between the employer
and employees appear to be normal on the surface but in fact they may be not.
In the case of cottage industries, the question of dispute does not arise at all since the main form of labour in
these industries is family labour.
(8) Contribution to Exports:
With the establishment of a large number of modem small-scale industries in the post-independence period, the
contribution of the small-scale sector in export earnings has increased by leaps and bounds.
What is heartening to observe is that the bulk of the exports of the small-scale industries (in fact, around 93
percent) consists of such non-traditional items like readymade garments sports-goods, finished leather, leather
products, woollen garments and knitwear, processed foods, chemicals and allied products, and a large number
of engineering; goods.
The total export of the small-sector industry products increased from Rs. 150 crore during 1971-72 to Rs.
48,979 crore in 1998-99. This implies, an increase in the share of small-scale industries in the total exports of
the country from 9.6 percent in 1971-72 to 34.9 percent in 1998-99. The share of the small-scale sector in
manufacturing exports is about 45 percent. Exports of the small scale sector are estimated at $ 13 billion in
2000-01 which was about 30 percent of total exports in that year.

38
DISINVESTMENT POLICY
The Government in July 1991 initiated the disinvestment process in India, while launching the New Economic
Policy (NEP). The Government had appointed the Krishnamurthy Committee in 1991 and Rangarajan
Committee in 1992.
Both the Committees, have recommended disinvestments to fulfill objectives of modernisation of the public
sector through strengthening R & D, initiating diversification/ expansion programmes, retraining and re-
employment of employees, funding genuine needs of expansion, widening the capital market basis and
mitigating fiscal deficit of the government.
These committees distinguished between the short-term and long-term goals of disinvestment and advised the
government not to sacrifice the long-term goals for the sake of fulfilling the short-term objectives. The
Government has announced in its NEP that mitigating the fiscal deficits is the only objective of disinvestment.
The crucial shift in the Government policy for disinvestment of PSU’s was mainly attributable to poor
performance of these enterprises and burden of financing their requirements through budget allocations.
Further the Government constituted a five member public sector Disinvestment Commission under the
chairmanship of G.K. Ramakrishna in 1996 for drawing a long-term disinvestment programme for the PSUs.
The Disinvestment Commission submitted its report covering 58 enterprises, out of 70 enterprises referred to it
by the Government Recommendations ranged from strategic sales in various proportions to disinvestments at
varying levels. The Commission’s recommendations are in various stages of implementation. The
Disinvestment Commission was ultimately abolished in November 1999.
In 2001, the Government reconstituted the Disinvestment Commission with R.H. Patil as its chairman. The
government has decided to refer all ‘non-strategic’ PSUs and their subsidiaries, excluding IOC, ONGC and
GAIL to the Commission for its independent advice.
The government set up a new Department of Disinvestment in 1999 to establish a systematic policy approach to
disinvestment and to give a fresh impetus to the program of disinvestment, which will increasingly emphasize
strategic sales of identified PSU’s.
The Objectives of Disinvestment:
The following are the main objectives of the disinvestment policy of the Government.
(i) To reduce the financial burden on the Government.
(ii) To improve public finances.
(iii) To encourage wider share of ownership.
(iv) To introduce, competition and market discipline.
(v) To depoliticise essential services.
(vi) To help public enterprises upgrade their technology to become competitive.
(vii) To rationalise and retrain their workforce.
(viii) To build competence and strengthen their R & D.
(ix) To initiate diversification and expansion programmes.
Thus, the disinvestment is aimed to reduce or mitigate fiscal deficit, bring about a measure of economic
stabilisation or to improve efficiency in public enterprises through structural adjustments initiated to improve
their efficiency and productivity.
The new Industrial Policy provides that, “In order to raise resources and encourage wide public participation, a
part of the government share holding in the public sector would be offered to mutual funds, financial
institutions, general public and employees”. This is a process for disinvestment in the public enterprises.

39
  PROBLEMS OF PUBLIC SECTOR

ndia suffer from several problems some of which are as follows:

1. Poor project planning:

Investment decisions in many public enterprises are not based upon proper evaluation of demand and supply,
cost-benefit analysis and technical feasibility.

Lack of a precise criterion and flaws in planning have caused undue delays and inflated costs in the
commissioning of projects. Sometimes, projects are launched without clear-cut objectives and serious thought.

Many projects in the public sector have not been finished according to the time schedule. Barauni Refinery was
commissioned two years behind schedule and the Trombay Fertilizer plant was delayed by three years thereby
causing an increase of Rs. 13 corers in the original cost estimates.

There is lack of clear-cut objectives and managers in the public sector often find themselves torn between
conflicting goals of profitability and social service.

2. Over-capitalization:

Due to inefficient financial planning, lack of effective financial control and easy availability of money from the
Government, several public enterprises suffer from over-capitalisation.

The Administrative Reforms Commission found that Hindustan Aeronautics, Heavy Engineering Corporation
and Indian Drugs and Pharmaceuticals Ltd., were overcapitalized. Such over-capitalization resulted in high
capital-output ratio and wastage of scarce capital resources.

3. High establishment costs:

Public enterprises incur heavy expenditure on social infrastructure such as schools, hospitals, etc. Location in
backward regions and the desire to make the undertaking a model employer lead to huge capital outlay on
housing and other amenities for labour.

Recurring expenditure is required to maintain these facilities. High establishment costs, overhead costs and
other expenses reduce the profitability of public enterprises.

4. Overstaffing:

Manpower planning is not effective due to which several State enterprises like Bhilai Steel have excess
manpower. Recruitment is not based on sound labour projections. On the other hand, posts of Chief Executives
remain unfilled for years despite the availability of required personnel.

5. Under-utilisation of capacity:

One serious problem of the public sector has been low utilisation of installed capacity.

40
In the absence of definite targets of production, effective production planning and control, proper assessment of
future needs, adequate supply of power and industrial peace, many undertakings have failed to make full use of
their fixed assets.

The average capacity utilisation in more than 50 per cent of the public enterprises has been less than 75 per
cent. There is considerable idle capacity. In some cases productivity is low on account of poor materials
management or ineffective inventory control.

6. Lack of a proper price policy:

There is no clear-cut price policy for State enterprises and the Government has not laid down guidelines for the
rate of return to be earned by different undertakings.

State enterprises are expected to achieve various socio-economic objectives and in the absence of a clear
directive, pricing decisions are not always based on rational analysis.

In addition to dogmatic price policy, there is lack of cost-consciousness,quality consciousness, and effective

control on waste and efficiency.

7. Unsatisfactory industrial relations:

In several State enterprises relations between management and labour are far from cordial. There has been
serious and frequent labour trouble in Durgapur Steel Plant, Bharat Heavy Electricals, Bhopal, and in
Bangalore-based undertaings.

Millions of days and output worth crores of rupees have been lost due to strikes and gheraos. Wage disparities
have been the main cause of labour trouble in the public sector.

The percentage increase in the per capita emoluments of public sector employees has been higher than the
percentage increase in consumer price index.

8. Lack of coordination:

Various state enterprises are dependent on one another as the output of one enterprise is the input of another.
For instance, the efficient functioning of power and steel plants depends on the production and transportation of
coal which in turn is dependent upon supplies of heavy equipment and machinery.

Despite such interdependence; effective coordination between different undertakings in the areas of personnel,
finance, materials management and research has not been achieved.

9. Lack of motivation:

Directors and managers of public enterprises have little personal stake. There is little incentive to work hard and
improve efficiency. Centralisation of authority and rigid bureaucratic control hamper initiative, quick decisions
and flexibility of operations. Personal touch with employees and sensitivity to consumers' needs are lacking.

10. Political interference:

41
There is excessive influence and interference by political leaders and civil servants in the functioning of public
enterprises. Parliamentary control reduces the autonomy of these enterprises

UNIT 4

 IMPORATANCE OF INTERNATIONAL BUSINESS

1. Earning valuable foreign currency: A country is able to earn valuable foreign currency by exporting
its goods to other countries.
2. Division of labor: International business leads to specialization in the production of goods. Thus,
quality goods for which it has maximum advantage.
3. Optimum utilization of available resources:International business reduces waste of national resources.
It helps each country to make optimum use of its natural resources. Every country produces those goods
for which it has maximum advantage.
4. Increase in the standard of living of people : Sale of surplus production of one country to another
country leads to increase in the incomes and savings of the people of the former country. This raises the
standard of living of the people of the exporting country.
5. Benefits to consumers: Consumers are also benefited from international business. A variety of goods of
better quality is available to them at reasonable prices. Hence, consumers of importing countries are
benefited as they have a good scope of choice of products.
6. Encouragement to industrialization: Exchange of technological know-how enables underdeveloped
and developing countries to establish new industries with the assistance of foreign aid. Thus,
international business helps in the development of industry.
7. International peace and harmony: International business removes rivalry between different countries
and promotes international peace and harmony. It creates dependence on each other, improves mutual
confidence and good faith.
8. Cultural development: International business fosters exchange of culture and ideas between countries
having greater diversities. A better way of life, dress, food, etc. can be adopted form other countries.
9. Economies of large-scale production: International business leads to production on a large scale
because of extensive demand. All the countries of the world can obtain the advantages of large-scale
production.
10. Stability in prices of products: International business irons out wide fluctuations in the prices of
products. It leads to stabilization of prices of products throughout the world.
11. Widening the market for products: International business widens the market for products all over the
world. With the increase in the scale of operation, theprofit of the business increases.
12. Advantageous in emergencies: International business enables us to face emergencies. In case of natural
calamity, goods can be imported to meet necessaries.
13. Creating employment opportunities: International business boosts employment opportunities in an
export-oriented market. It raises the standard of living of the countries dealing international business.
14. Increase in Government revenue: The Government imposes import and export duties for this trade.
Thus, Government is able to earn a great deal of revenue from international business.
15. Other advantages:

42
  Effective business education
 Improvement in production systems.
 Elimination of monopolies, etc.

 DISADVANTAGES OF INTERNATIONAL BUSINESS

1. Adverse effects on economy: One country affects the economy of another country through international
business. Moreover, large-scale exports discourage the industrial development of importing country.
Consequently, the economy of the importing country suffers.
2. Competition with developed countries: Developing countries are unable to compete with developed
countries. It hampers the growth and development of developing countries, unless international business
is controlled.
3. Rivalry among nations: Intense competition and eagerness to export more commodities may lead
rivalry among nations. As a consequence, international peace may be hampered.
4. Colonization: Sometimes, the importing country is reduced to a colony due to economic and political
dependence and industrial backwardness.
5. Exploitation: International business leads to exploitation of developing countries the developed
countries. The prosperous and dominant countries regulate the economy poor nations.
6. Legal problems: Varied laws regulations and customs formalities followed different countries, have a
direct b earring on their export and import trade.
7. Publicity of undesirable fashions: Cultural values and heritages are not identical in all the countries.
There are many aspects, which may not be suitable for our atmosphere, culture, tradition, etc. This,
indecency is often found to be created in the name of cultural exchange.
8. Language problems: Different languages in different countries create barriers to establish trade
relations between various countries.
9. Dumping policy: Developed countries often sell their products to developing countries below the cost
of production. As a result, industries in developing countries of the close down.
10. Complicated technical procedure: International business in highly technical and it has complicated
procedure. It involves various uses of important documents. It required expert services to cope with
complicate procedures at different stages.
11. Shortage of goods in the exporting country :Sometimes, traders prefer to sell their goods to other
countries instate of in their own country in order to earnmore profits. This results in the shortage of
goods within the home country.
12. Adverse effects on home industry: International business poses a threat to the survival of infant and
nascent industries. Due to foreign competition and unrestricted imports upcoming industries in the home
country may collapse.

 ABSOLUTE COST ADVANTAGE THEORY

According to this theory Trade between Nations took place if the traders saw an absolute advantage cost
advantage in buying a particular good from a foreign country rather than buying the same good domestically.

43
This can be illustrated through the following example –

Bread Cloth

India 100 50

England 50 100

The above table shows units of labor required to produce Cloth and Bread in 2 countries – India and England.

India can produce bread with 100 units of labor while England can produce the same quantity of bread with 50
units of labor. Clearly England can produce bread in a more efficient manner than India. India would therefore
import bread from England.

Further assuming that both countries have the same currency (say $) and same wage rates (say 1 $ per unit of
labor) – It can be seen that the cost of production of bread in India would be 100$ while that of producing the
same quantity of bread in England would be 50$. It would thus be advantageous for Indians to buy Bread from
England at anything less than 100$. The Englishmen will also be happy to sell bread to Indians at anything
more than 50$.

Thus we see that both countries stand to gain if India imports bread from England.

An exactly reverse logic can be applied to Cloth where it can be shown that India would end up exporting cloth
to England.

The trade here takes place because India enjoys a clear and absolute advantage in producing Cloth (50 units of
labor as against 100 unit required in England) and vice versa as regards production of Bread.

Assumptions of Absolute Cost Advantage Theory –

# 2 countries, 2 commodity model

# Labor as the only input

# Single currency assumed thereby eliminating effects of exchange rate changes

# Homogeneous factors of production – All labor units are of same type. They can be freely moved from
production of cloth to production of bread and vice versa. i.e. No specialized labor.

# Units of production are divisible in compact units.

# All factors of production are fully employed.

# No government restrictions on free trade.

Criticisms of Absolute Advantage Theory –

Most of the criticisms from absolute advantage theory would arise because of the unrealistic nature of its
assumptions.

44
However, an important incompleteness in the theory was the fact that it addressed only a situation where in one
country enjoyed an absolute advantage in production of a commodity over another country. It was pointed out
that such situations are rare.

 COMPARATIVE COST ADVANTAGE THEORY

This theory is developed by a classical economist David Ricardo. According to this theory, the international
trade between two countries is possible only if each of them has absolute or comparative cost advantage in the
production of at least one commodity. This theory is based upon following assumption

 There are only two countries and two commodities

 There is no governmental intervention in export and import
 Only labor is factor of production. Quantity of labor used gives cost of production
 There is perfect mobility of labor within the country but not between the countries
 There is no cost of transportation between the countries
 The law of constant returns to scale operates in production.
 The units of labor is homogeneous
 The units of each commodity in both countries are homogeneous

According to comparative cost advantage theory of international trade, each country exports the commodity in
which it has cost advantage and imports the commodity in which it has cost disadvantage. This theory can be
explained as following:
 Comparative cost advantage
If a country can produce both commodities with less cost than another country but in different ratio, the country
is said to have comparative cost advantage

country Labor required to produce clothe

Nepal 10

India 20

ratio 10/20=0.5

 
In the above table, the cost of production of clothe in Nepal is only 50% of cost of production of clothe in India.
In case of shoes, the cost of production is only 1/3rd of cost in India. It shows that Nepal can produce both
commodities with fewer cots than India. But in order to take advantage, it produces only shoes land let India
produce clothe for it. Nepal produces shoes and exports to India. India produces clothe and exports to Nepal. If
they do so, both of them can take benefits.

45
×Powered By shopperz130220161528

B. Absolute cost advantage:

If a country can produce a commodity with less cost but has to bear more cost in the production of another
commodity than another country then the country is said to have absolute cost advantage. In this case, both of
the countries produce and export the commodities in which they have absolute cost advantage

country Labor required to produce clothe

Nepal 10

India 20

ratio 10/20=0.5

 
×Powered By shopperz130220161528In the above table, the cost of production of clothe in Nepal is less than in
India. But cost of production of shoes is less in India than in Nepal. In this case, Nepal is said to have absolute
cost advantage in production of clothe but absolute cost disadvantage in production of shoes. India is said to
have absolute cost advantage in production of shoes but absolute cost disadvantage in production of clothe.
Therefore, Nepal produces only clothe and exports to India. India produces only shoes and exports to Nepal.
Doing it, both the countries can take benefit.
C. No cost advantage:
If a country can produce both commodities with less cost than another country but in equal ratio, the country is
said to have no cost advantage.

country Labor required to produce clothe

Nepal 10

India 20

ratio 10/20=0.5

 
In the above table, Nepal is shown able to produce both commodities with less cost than India in equal ratio. It
means Nepal has no cost advantage. It is loss to the Nepal to import any commodity form India. That’s why it
decides to produce both goods for itself. Therefore, India too produces both goods for itself. Hew is no trade
between them.
 
Criticisms

46
 This theory is not applicable if there are more than two countries and more than two commodities
 In every country there is more or les government intervention in international trade
 There is cost of transportation form one country to another country
 The units of labor are not homogeneous and the workers are paid more or less in different countries
 There may be increasing or decreasing returns to scale
 Labor is not perfectly mobile within the country too. In the modern era, there is mobility of labor form
one country to another
 The commodities produced in the different countries differ in quality, taste, size, quantity etc.

 OBJECTIVES OF GATT
Origin of GATT:
×Powered By shopperz130220161528Inspired by the success of agreement for internationalmonetary co-
operation as reflected in the formation of the IMF, similar co-operation as reflected ininternational trade also
was desired by many trading nations for expansion of world trade.
It was thought that for healthy world trade, attempt must be made to relax the existing trade restrictions, such as
tariffs.

As such, at the International Conference on Trade and Employment held in 1946 at Havana, a proposal for

establishing an agency called the International Trade Organisation (ITO) was made with the miscellaneous
and general objective of augmenting and maintaining world trade and employment.

Though the Havana Charter for ITO was designed as a sort of international trade constitution, it was not
translated into practice due to various difficulties and lack of common agreement.
×Powered By shopperz130220161528
However, some of the countries took up one of the important issues of the Havana Charterregarding relaxation
of trade restrictions by incorporating it into a General Agreement on Tariffs and Trade (GATT). This was
signed in 1947 by some twenty-three major trading nations, including India. GATT membership has now gone
up to more than 64.

As the name itself suggests, the General Agreement was concerned only with tariffs and trade restrictions and
related international matters. It serves as an important internationalforum for carrying on negotiations on tariffs.

Under GATT, member nations meet at regular intervals to negotiate agreements to reduce quotas, tariffs and
such other restrictions on internationaltrade. GATT, by its very nature, is a contractual agreement among parties
(or nations). It is a treaty that is collectively administered by the contracting nations.

47
However, it has become a permanent international organisation for safeguarding the conduct
of international trade and an institution for the multilateral expansion of trade.

Objectives of GATT:
By reducing tariff barriers and eliminating discrimination in international trade, the GATT aims at:
1. Expansion of international trade,

2. Increase of world production by ensuring full employment in the participating nations,

3. Development and full utilisation of world resources, and

4. Raising standard of living of the world community as a whole.

However, the articles of the GATT do not provide directives for attaining these objectives. These are to be
indirectly achieved by the GATT through the promotion of free (unrestricted) and
multilateral international trade.

As such, the rules adopted by GATT are based on the following fundamental principles:
1. Trade should be conducted in a non-discriminatory way;

2. The use of quantitative restrictions should be condemned; and

3. Disagreements should be resolved through consultations.

In short, members of GATT agree to reduce trade barriers and to eliminate discrimination in international trade
so that multilateral and free trade may be promoted, leading to wider dimensions of world trade and prosperity

 FUNCTIONS OF WTO

The former GATT was not really an organisation; it was merely a legal arrangement. On the other hand, the
WTO is a new international organisation set up as a permanent body. It is designed to play the role of a
watchdog in the spheres of trade in goods, trade in services, foreign investment, intellectual property rights, etc.
Article III has set out the following five functions of WTO;

(i) The WTO shall facilitate the implementation, administration and operation and further the objectives of this
Agreement and of the Multilateral Trade Agreements, and shall also provide the frame work for the
implementation, administration and operation of the plurilateral Trade Agreements.

(ii) The WTO shall provide the forum for negotiations among its members concerning their multilateral trade
relations in matters dealt with under the Agreement in the Annexes to this Agreement.

(iii) The WTO shall administer the Understanding on Rules and Procedures Governing the Settlement of
Disputes.

48
(iv) The WTO shall administer Trade Policy Review Mechanism.

(v) With a view to achieving greater coherence in global economic policy making, the WTO shall cooperate, as
appropriate, with the international Monetary Fund (IMF) and with the International Bank for Reconstruction
and Development (IBRD) and its affiliated agencies.

Objectives of WTO

Important objectives of WTO are mentioned below:

(i) to implement the new world trade system as visualised in the Agreement;

(ii) to promote World Trade in a manner that benefits every country;

(iii) to ensure that developing countries secure a better balance in the sharing of the advantages resulting from
the expansion of international trade corresponding to their developmental needs;

(iv) to demolish all hurdles to an open world trading system and usher in international economic renaissance
because the world trade is an effective instrument to foster economic growth;

(v) to enhance competitiveness among all trading partners so as to benefit consumers and help in global
integration;

(vi) to increase the level of production and productivity with a view to ensuring level of employment in the
world;

(vii) to expand and utilize world resources to the best;

(viii) to improve the level of living for the global population and speed up economic development of the
member nations.

 ORGANIZATIONAL STRUCTURE OF WTO

49
50
 UNIT 5

 MODES OF ENTRY
Exporting
Exporting allows small businesses to hold to their current model and product line, while sending goods into a
foreign market for distribution. Thanks to its low cost of implementation and its low level of risk for business
owners, exporting is one of the most basic and common types of entry into foreign markets for small businesses
throughout the world. While the reach of exportation is limited by transportation costs, government tariffs,
market competition and local customs and demand, it eliminates the need for repackaging, marketing, and
infrastructure development that other modes require. Exporting goods into a new market also allows a company
to judge how well items will sell and what if any adjustments are required to the existing product so that it
performs well.

Ownership
If you wish to own and operate your own business in a foreign market without partners or other outside
influence, ownership may be your best option. Ownership is as it sounds: the development and operation of a
business from the ground up. The pitfalls involved with ownership are many, including the political and
economic climate of a given region, the cost of development, the difficulties of infrastructure and distribution
and the risk that your product might not sell in a new and untested market. The potential rewards, however, are
limitless and can lead to further expansion into more markets and the highest levels of business success.

Licensing
The practice of licensing or franchising is a way to break into foreign markets while establishing a presence on
the ground. Licensing entails granting permission to a separate company to manufacture goods or provide
services in your company's name. You maintain control of the brand itself, the manufacturing process, the rates
and operation of the business, while handing over the right to operate and a large chunk of the profits to your
representative. While licensing eliminates many of the expenses and time involved with expanding overseas, it
does require constant monitoring, training, permits and renewal, and may even require a representative from
your company on site to manage the operation. In the end you can end up with satellite companies in markets
around the world and a global brand at little to no risk.

Joint Ventures
Parties to an international joint venture share the costs and burdens of operations while profiting equally from a
market share in both countries. Your partnership will allow you to sell your goods and services in your
partner's home country and vice versa. The results include doubled financial power, twice the marketing ability,
twice the sales in some cases and entry into a market that might not otherwise be open to you. On the other
hand, such an endeavor requires that you hand over some say in your business operations to a foreign partner
and permits another company to have some control over the state and sale of your brand in a location where you
may have little if any influence.

Export Processing Zones

Export processing zones are set up by foreign governments to promote business development and employment
among the population by using the success of outside businesses as a catalyst. Countries may provide outside

51
companies with tax breaks, cash incentives, low cost of labor, government subsidies, or any number of other
types of assistance as a reward for bringing products, business, skills and training to the table. The benefits for
your company include partnership with a foreign government, relatively pain-free entry into a new market and a
list of automatic incentives. Similar programs have been put in place by the U.S. government to further assist
small businesses looking to move into overseas markets. Taking advantage of programs on both sides of the
deal can help to maximize your potential for success while minimizing your risk.

Franchising / Licensing
Franchising is a form of licensing. As a franchisor or licensor, your business effectively gives the licensee of
franchisee permission to:

 Produce a patented product or patented production process.

 Use your manufacturing know-how.
 Receive your technical and marketing advice and know-how.
 Rights to use your trademark, brand etc.
Franchising and Licensing have many advantages as both are simple and quick to implement and offer the
advantage of minimal business costs as well as access to some markets which may otherwise have been closed
due to government policies etc.  The most obvious drawback of Franchising and Licensing is that revenues are
likely to be significantly lower than other market entry methods, as well as a possible lack of control over
production and marketing.

 COMPONENTS OF BALANCE OF PAYMENTS

According to the RBI, balance of payment is a statistical statement that shows the transaction in goods, services
and income between an economy and the rest of the world.
Definition: According to the RBI, balance of payment is a statistical statement that shows
1. The transaction in goods, services and income between an economy and the rest of the world,
2. Changes of ownership and other changes in that economy's monetary gold, special drawing rights (SDRs),
and financial claims on and liabilities to the rest of the world, and
3. Unrequited transfers.

Balance of Payments is generally grouped under the following heads 

i) Current Account 
ii) Capital Account 
iii) Unilateral Payments Account 
iv) Official Settlement Account. 

Current Account 
“The Current Account includes all transactions which give rise 
to or use up national income.” 
The Current Account consists of two major items, namely: 
i) Merchandise exports and imports, and 

52
ii) Invisible exports and imports. 
Merchandise exports, i.e., the sale of goods abroad, are credit entries because all transactions giving rise to
monetary claims on foreigners represent credits. On the other hand, merchandise imports , i.e., purchase of
goods from abroad, are debit entries because all transactions giving rise to foreign money claims on the home
country represent debits. Merchandise imports and exports form the most important international transaction of
most of the countries .Invisible exports, i.e., sales of services, are credit entries and invisible imports, i.e.
purchases of services, are debit entries. Important invisible exports include the sale abroad of such services as
transport, insurance, etc., foreign tourist expenditure abroad and income paid on loans and investments (by
foreigners)in the home country form the important invisible entries on the debit side. 

Capital Account 
The Capital Account consists of short- terms and long-term capital transactions A capital outflow represents a
debit and a capital inflow represents a credit. For instance, if an American firm invests Rs.100 million in India,
this transaction will be represented as a debit in the US balance of payments and a credit in the balance of
payments of India. The payment of interest on loans and dividend payments are recorded in the Current
Account, since they are really payment s for the services of capital. As has already been mentioned above, the
interest paid on loans given by foreigners of dividend on foreign investments in the home country are debits for
the home country, while, on the other hand, the interest received on loans given abroad and dividends on
investments abroad are credits. 

Unilateral Transfers Account 

Unilateral transfers is another terms for gifts. These unilateral transfers include private remittances, government
grants ,disaster relief, etc. Unilateral payments received from abroad are credits and those made abroad are
debits. 

Official Settlements Accounts 

Official reserves represent the holdings by the government or official agencies of the means of payment that are
generally accepted for the settlement of international claims 

 BENEFITS OF FDI

Foreign direct investment (FDI) is made into a business or a sector by an individual or a company from another
country. It is different from portfolio investment, which is made more indirectly into another country’s
economy by using financial instruments, such as bonds and stocks.

There are various levels and forms of foreign direct investment, depending on the type of companies involved
and the reasons for investment. A foreign direct investor might purchase a company in the target country by
means of a merger or acquisition, setting up a new venture or expanding the operations of an existing one. Other
forms of FDI include the acquisition of shares in an associated enterprise, the incorporation of a wholly owned
company or subsidiary and participation in an equity joint venture across international boundaries.

53
If you are planning to engage in this kind of venture, you should determine first if it provides you and the
society with maximum benefits. One good way to do this is evaluating its advantages and disadvantages.

List of Advantages of Foreign Direct Investment

1. Economic Development Stimulation. 

Foreign direct investment can stimulate the target country’s economic development, creating a more conducive
environment for you as the investor and benefits for the local industry.

2. Easy International Trade.

Commonly, a country has its own import tariff, and this is one of the reasons why trading with it is quite
difficult. Also, there are industries that usually require their presence in the international markets to ensure their
sales and goals will be completely met. With FDI, all these will be made easier.

3. Employment and Economic Boost. 

Foreign direct investment creates new jobs, as investors build new companies in the target country, create new
opportunities. This leads to an increase in income and more buying power to the people, which in turn leads to
an economic boost.

4. Development of Human Capital Resources. 

One big advantage brought about by FDI is the development of human capital resources, which is also often
understated as it is not immediately apparent. Human capital is the competence and knowledge of those able to
perform labor, more known to us as the workforce. The attributes gained by training and sharing experience
would increase the education and overall human capital of a country. Its resource is not a tangible asset that is
owned by companies, but instead something that is on loan. With this in mind, a country with FDI can benefit
greatly by developing its human resources while maintaining ownership.

5. Tax Incentives. 
Parent enterprises would also provide foreign direct investment to get additional expertise, technology and
products. As the foreign investor, you can receive tax incentives that will be highly useful in your selected field
of business.

6. Resource Transfer. 
Foreign direct investment will allow resource transfer and other exchanges of knowledge, where various
countries are given access to new technologies and skills.

7. Reduced Disparity Between Revenues and Costs. 

Foreign direct investment can reduce the disparity between revenues and costs. With such, countries will be
able to make sure that production costs will be the same and can be sold easily.

54
8. Increased Productivity. 
The facilities and equipment provided by foreign investors can increase a workforce’s productivity in the target
country.

9. Increment in Income. 
Another big advantage of foreign direct investment is the increase of the target country’s income. With more
jobs and higher wages, the national income normally increases. As a result, economic growth is spurred. Take
note that larger corporations would usually offer higher salary levels than what you would normally find in the
target country, which can lead to increment in income.

 BALANCE OF TRADE VS BALANCE OF PAYMENT

BASIS BALANCE OF TRADE BALANCE OF PAYMENT

FORCOMPARISON

Meaning Balance of Trade is a statement that Balance of Payment is a statement that

captures the country's export and keeps track of all economic
import of goods with the remaining transactions done by the country with
world. the remaining world.

Records Transactions related to goods only. Transactions related to both goods and
services are recorded.

Capital Transfers Are not included in the Balance of Are included in Balance of Payment.
Trade.

Which is better? It gives a partial view of the It gives a clear view of the economic
country's economic status. position of the country.

Result It can be Favorable, Unfavorable or Both the receipts and payment sides
balanced. tallies.

Component It is a component of Current Current Account and Capital Account.

Account of Balance of Payment.

 METHODS OF CORRECTING DISEQUILLIBRIUM IN BOP

Persistent disequilibrium in the balance of payments, particularly the deficit balance, is undesirable because it
(a) weakens the country's economic position at the international level, and (b) affects the progress of the
economy adversely.

55
It must be cured by taking appropriate measures. There are many methods to correct disequilibrium in the
balance of payments. Important among them are discussed below:

1. Deflation:

Deflation is the classical medicine for correcting the deficit in the balance of payments. Deflation refers to the
policy of reducing the quantity of money in order to reduce the prices and the money incomeof the people.

The central bank, by raising the bank rate, by selling the securities in the open market and by other methods can
reduce the volume of credit in the economy which will lead to a fall in prices and money income of the people.

Fall in prices will stimulate exports and reduction in income checks imports. Thus, deflationary policy restores
equilibrium to the balance (a) by encouraging exports through reduction in their prices and (b) by discouraging
imports through the reduction in incomes at home.

Moreover, a higher interest rate in the domestic market will attract foreign funds which can be used for
correcting disequilibrium.

However, deflation is not considered a suitable method to correct adverse balance of payments because of the
following reasons: (a) Deflation means reduction in income or wages which is strongly opposed by the trade
unions, (b) Deflation causes unemployment and suffering to the working class, (c) In a developing economy,
expansionary monetary policy rather than contractionary (deflationary) monetary policy is required to meet the
developmental needs.

2. Depreciation:

Another method of correcting disequilibrium in the balance of payments is depreciation. Deprecation means a
fall in the rate of exchange of one currency (home currency) in terms of another (foreign currency).

A currency will depreciate when its supply in the foreign exchange market is large in relation to its demand. In
other words, a currency is said to depreciate if its value falls in terms of foreign currencies, i.e., ifmore domestic
currency is required to buy a unit of foreign currency.

The effect of depreciation of a currency is to make imports dearer and exports cheaper. Thus, depreciation helps
a country to achieve a favourable balance of payments by checking imports and stimulating exports.

Exchange depreciation is automatic:

It works in a flexible exchange rate system and can correct a mild adverse balance of payments if the country's
demand for imports and the foreign demand for its exports are fairly elastic. But the method of exchange
depreciation has the following defects:

(i) It is not suitable for a country which follows a fixed exchange rate system.
(ii) It makes international trade risky and thus reduces the volume of trade.

(iii) The terms of trade go against the country whose currency depreciates because the foreign goods have
become costlier than the local goods and the country has to export more to pay for the same volume of imports.

56
(iv) Experience of certain countries has indicated that exchange depreciation may generate inflationary pressure
by increasing the domestic price level and money income.

(v) The success of the method of exchange depreciation depends upon the cooperation of other countries. If
other countries also start depreciating their exchange rates, then these methods will not benefit any country.

3. Devaluation:

Devaluation refers to the official reduction of the external values of a currency. The difference between
devaluation and depreciation is that while devaluation means the lowering of external value of a currency by the
government, depreciation means an automatic fall in the external value of the currency by the market forces; the
former is arbitrary and the latter is the result of market mechanism.

Thus, devaluation serves only as an alternative method to depreciation. Both the methods imply the same thing,
i.e., decrease in the value of a currency in terms of foreign currencies.

Both the methods can be used to produce the same effects; they discourage imports, encourage exports and thus
lead to a reduction in the balance of payments deficit.

The success of the method of devaluation depends upon the following conditions :

(i) The elasticity of demand for the country's exports should be greater than unity.

(ii) The elasticity of demand for the country's imports should be greater than unity.

(iii) The exports of the country should be non-traditional and the increasingly demanded from other countries.

(iv) The domestic price should not rise and should remain stable after devaluation.

(v) Other countries should not retaliate by resorting to corresponding devaluation. Such a retaliatory measure
will offset each other's gain.

Devaluation also suffers from certain defects:

(i) Devaluation is a clear revelation on the country's economic weakness.
(ii) It reduces the confidence of the people in country's currency and this may lead to speculative outflow of
capital.

(ii) It encourages inflationary tendencies in the home country.

(iv) It increases the burden of foreign debt.

(v) It involves large time lag to produce effects.

(vi) It is a temporary device and does not provide a permanent remedy to correct adverse balance of payments.

4. Exchange Control:

Exchange control is the most widely used method for correcting disequilibrium in the balance of payments.
Exchange control refers to the control over the use of foreign exchange by the central bank.

57
Under this method, all the exporters are directed by the central bank to surrender their foreign exchange
earnings. Foreign exchange is rationed among the licensed importers. Only essential imports are permitted.

Exchange control is the most direct method of restricting a country's imports. The major drawback of this
method is that it deals with the deficit only, and not its causes. Rather it may aggravate these causes and thus
may create a more basic disequilibrium. In short, exchange control does not provide a permanent solution for a
chronic disequilibrium.

58