Changing Global Scenario
Several major economic and political changes occurred during the 1970s and 1980s, which affected the developing countries and paved the way for the implementation of IMF-sponsored Structural Adjustment Policies (New Economic Policy) in India in 1991. This was due to a combination of factors such as stagnant agriculture, low levels of industrial growth and diversification, inadequate capital formation, adverse terms of trade in international markets, limits to domestic resource mobilization due to a fairly narrow tax-base, loss making public sector enterprises, over regulated and controlled economy, poor industrial productivity, huge amount of fiscal deficit, huge amount of public debt, poor rating of Indian economy by international agencies, foreign exchange crisis etc.
New Economic Policy of 1991 includes globalization, liberalization and privatization (Disinvestment)
1) Globalization means flow capital (finance in the form of foreign direct investment (FDI) and foreign portfolio investment (FPI), technology, human resource, goods and service among countries. FDI is investment in real assets like automobile, consumer goods production, service sectors like insurance, telecommunication, air transport etc.
2) Liberalisation means freeing the economic activities and business from unnecessary bureaucratic and other controls imposed by the governments.
3) Privatisation or Disinvestment: Selling the government owned public sector enterprises to private industrialists and opening the government operating sectors for private investment.
The New Economic Policy includes reduction in government expenditure, opening of the economy to trade and foreign investment, adjustment of the exchange rate from fixed exchange rate system to flexible exchange rate system, deregulation in most markets and the removal of restrictions on entry, on exit, on capacity and on pricing.
Immediate consequences of economic liberalization that are to focus on are (a) an increase in internal and external competition and (b) structural change induced by changes in relative prices in the economy.
The Major areas of New Economic Policy 1991 are 1) Fiscal policy reforms
2) Monetary policy reform 3) Pricing policy reform 4) External policy reform 5) Industrial policy reform
6) Foreign investment policy reform 7) Trade policy reform
8) Public sector policy reform
The principal reforms initiated in the year 1991 included;
reduction in import tariffs on most goods other than consumer goods, removal of quantitative restrictions and liberal terms of entry for foreign investors. India’s simple average tariff rate was reduced from 128% in 1991 to about 32.3% in 2001-02. Quotas and non-tariff barriers were also reduced.. To restore Macro economic stability, the reforms package of structural adjustment policies are aimed at freeing markets by dismantling controls on production, prices and trade and reducing intervention in the economy. The need to control the fiscal deficit led to policies to
curb public expenditure and these cuts were mainly on social sector expenditure and on production and consumption subsidies, which directly affected the living standards of the economically vulnerable sections of the population. Privatisation, Liberalisation and export-promotion were the main features of the economic reforms recommended by the international institutions for the problems facing by the developing countries .At the same time, the role of the state in advanced industrial economies was not shrinking as expected, but growing despite the ideological bias in favour of a “rolled back” state. The share of national income spends by government, which averaged 30% in the rich industrial countries in 1960 increased to 42.5% by 1980 and 45% by 1990.The experiences of countries, which have undergone these reforms, have in most cases not led to the expected outcome but have infact worsened the state of their economies. In India, the New Economic Policy (NEP) is a set of policy (ies) and administrative procedures introduced in July 1991 to bring about changes in the economic direction of the country.
Industrial Policy Resolution 1991 (IPR-1991) Industrial Policy
The regulatory policy framework which acted as a barrier to entry and growth by the entrepreneur was sought to be basically changed by the Industrial Policy announced in July 1991.The measures introduced in this area along with other economic
reforms were as under: Industrial licensing has been abolished for all projects except for a list of 15 industries related to security, strategic or environmental concerns and certain items of luxury consumption that have a high proportion of imported inputs. The exemption from licensing also applies to the expansion of existing units.
Industrial licensing was abolished for all projects except for a list of 15 industries related to security, strategic or environmental concerns and certain items of luxury consumption that had a high proportion of imported inputs.
The Monopolies and Restrictive Trade Practices (MRTP) Act applied in a manner which eliminated the need to seek prior government approval for expansion of present undertakings and establishment of new undertakings by large companies.
The set of activities henceforth reserved for the public sector was much narrower than before, and there would be no ban on the remaining reserved areas being opened up to the private sector.
Foreign Investment Policy
The Industrial Policy 1991 also provided increased opportunities for foreign investment with a view to take
advantage of technology transfer, marketing expertise and introduction of modern managerial techniques. It was also intended to promote a much – needed shift in the composition of external private capital flows. The following measures were announced in this regard:
Automatic approval would be given for direct foreign investment upto 51 per cent foreign equity ownership in a wide range of industries. Earlier, all foreign investment was generally limited to 40 per cent.
To provide access to international markets, major foreign equity holdings upto 51 per cent equity would be allowed for trading companies primarily engaged in export activities.
Automatic permission would be given for foreign technology agreements for royalty payments upto 5 per cent of domestic sales or 8 per cent of export sales or for lumpsum payments of Rs.10 million. Automatic approval for all other royalty payments will also be given if the projects can generate internally the foreign exchange required.
Abolished MRTP Act and FERA and instead of FERA, FEMA Act was passed in the Parliament.
The threshold (Minimum) asset limit for companies under MRTP Act was raised from Rs.20 crores to Rs.100 Crores.
Public Sector Policy
The Government was of the view that public sector had not generated internal surpluses on a large scale. On account of its inadequate exposure to competition; the public sector was subject to a high cost structure. To provide a solution to the problems of the public sector, Government decided to adopt a new approach, the key elements of which were:
The existing portfolio of public sector investment would be reviewed with a greater sense of realism to avoid areas where social considerations were not paramount or where the private sector would be more efficient.
Enterprises in areas where continued public sector involvement was judged appropriate would be provided a much greater degree of managerial autonomy.
Budgetary support to public enterprises would be progressively reduced
To provide further market discipline for public enterprises, competition from the private sector would be encouraged and part of the equity in selected enterprises would be disinvested; and
Chronically sick public enterprises would not be allowed to incur heavy losses.
As a follow up of this policy, several measures were taken:
The number of industries reserved for the public sector was reduced from 17 to 8. Even in these areas, private sector participation was allowed selectively. Joint ventures with foreign companies would be encouraged.
Public enterprises that were chronically sick and unlikely to be turned around would be referred to the Board for Industrial and Financial Reconstruction (BIFR) for rehabilitation or restructuring.
The existing system of monitoring public enterprises through Memorandum of Understanding (MOU) was strengthened with primary emphasis on profitability and rate of return.
Initiated the disinvestment of public sector enterprises.
Global Financial meltdown in 2008
In the western capitalists economies and the economies closely linked to the United States economies were negatively affected by this financial crisis of 2008. That is all the economies having economic relationship with each other were affected by this financial crisis of 2008 so it is called a global financial crisis.
Capitalism is a system of economic organization featured by the private ownership and the use for private profit of man-made and nature-made capital. It is clear that under capitalism all means of production such as farms, factories, mines, transport, communication, education etc are owned and controlled by private individuals and firms. Private initiatives and ideas are
promoted and respected highly and there is personal freedom and liberty.
The global financial crisis of 2008 is an extreme manifestation of the crisis in the capitalism due to wrong practice and misuse of freedom enjoyed by the financial institutions in the United States of America. Indian economy was more integrated to the global economy after the introduction of the New Economic Policy (NEP) of 1991. This encouraged more integration of the Indian economy with the global economy.But in the Indian banking system, nearly 90 per cent of the banking institutions are in the public sector and our financial sectors are well regulated by the Reserve bank of India (RBI). So this financial management system, to a greater extent insulated Indian economy from the global financial crisis.
The Major Reasons for the Global Financial Crisis are
1) Consumption was seen as the driver of economic growth and prosperity and debt to facilitate such consumption was consequently seen as a good thing. This had led to the rather extreme situation in which vendor financing (i.e., lending of money by producers to consumers for purchasing products they produce) of the US by the developing nations was seen as a necessary business practice.
2) The sub-Prime Crisis – Sub-Prime Lending is the latest chapter in the story of the economics of greed wrapped as modern economics, a process in which the US’s entire
financial architecture — the government and the Federal Reserve System (the Central Bank of the US like India’s RBI) is involved. The sub-prime crisis is now presented as the villain of US economy as also the global economic scene.
Sub-prime lending refers to loans given to persons who, in simple terms, are unfit to borrow. That is, no lender will part with his own money to such a borrower. Two reasons are there. First, such lending was popularised from the White House to ordinary American homes as achieving a noble purpose to induce Americans to borrow and shop for their country. That is, it was part of the patriotic duty the Americans as a whole to borrow and shop.
The Major Features of the Present Global Financial Crisis are
1) The Current US recession is much deeper than in 1991 or 2001.
2) Yet Asia’s growth will slow by less than in the previous US recessions. It is now less dependent on US demand.
3) Asia is led by India and China increasingly becoming important as the engines of global growth.
4) This global financial crisis is the beginning of the end for the dollar as the main reserve currency
5) The USA has been borrowing $ 3 billion every day to fund its spending
6) The USA’S national debt is more than $10 trillion, which is more than 80 per cent of its national income.
7) The budget deficit is skyrocketing; it is expected to reach mote than 10 per cent soon.
8) The federal deficit as percentage of GDP is now expected to reach more than 10 per cent.
9) Unlike the Great Depression of the 1930s, the current crisis of the West is not just an economic crisis. It has a dimension of demography and conflict.o it. Demographic, because Europe is slowly fading away from the global map. It used to have more than 20 per cent of the global population during the First World War, and now has less than 11 per cent. It is expected to shrink to three per cent in as many decades. The reproductive rate in many European countries is less than 1.5 whereas the stable one is 2.1.
In the case of US, the crisis is more severe due to its declining savings rate.
10) The personal saving as a percentage of disposable income has now become negative.
The debt ridden financial institutions like Lehman Brothers’ assets were $ 690 billion and capital was $ 22 billion. Lehman filed for the biggest bankruptcy in American history. Merrill Lynch assets were $ 1020 billion and capital was $ 32 billion, Freddie Mac’s assets were $ 794 and capital was $ 27 billion, Fannie Mae’ assets were $880 billion and capital was $ 44 billion, Bear Stearns’s was
$ 400 billion and capital was $ 11 billion. The allegations that ratings are not forward looking has been proved right in more than one occasion in the current financial crisis. Many repackaged
sub-prime loans were rated high by global credit rating agencies, down graded only after accelerated defaults and stoppage in trading. Ratings are not sancrosanct and lenders need to form own view about the credit worthiness of borrowers, independent of any external ratings.
Conclusions
Asia is more important than the US as a driver of global economic growth. Thanks to the vigour of Asia and other emerging economies, a US recession need not drag the whole world into recession. A prolonged downturn in the US, while emerging economies continue to grow rapidly will reinforce the shift in global power from the old industrial world to the new emerging markets. In future the world economy will be steered not by the US and Europe, but increasingly by India and China. As Maharishi Aurobindo says: “India shall arise upon the ruins of the West”. He says by the year 2011 the Western countries will fall and India will rise. The question is, are we getting ready to create a new world order?
Keynesian Theory
Keynes’s Theory and Underdeveloped Countries.
Lord John Maynard Keynes wrote the General Theory of Employment, Interest and Money as a solution to the problem of periodic unemployment faced by developed industrial nations of the West during the great depression of the thirties. Keynesian theory singles out deficiency of effective demand as the major
cause of unemployment and low level of income in industrial economy operations under a laissez faire system. Deficiency of effective demand is a prominent feature of economies undergoing depression and in order to improve the level of effective demand in an economy. Keynes suggested policy measures like cheap money policy, government’s compensatory investment spending, deficit financing and other fiscal methods. In essence, therefore, Keynesian economics turn out to be economics of depression applicable to developed countries. Its applicability in underdeveloped countries is very limited. To quote Joan Robinson:
“ Keynes’s theory has little to say directly, to the underdeveloped countries, for it was framed entirely in the context of an advanced industrial economy, with highly developed financial institutions and a sophisticated business class.
Though Keynesian Economics has revolutionized modern economic thinking, it has inherent weaknesses:
1) It is fundamentally a capitalistic theory. It basically examines the determinants of employment in a free enterprise economy. Though Keynes suggests government intervention and controlled capitalism his theory fails to deal with the socialist economic system. In communism, Keynes is as Ricardo.
2) Keynesian economics is, by and large, characterized as depressionary economics. It was the outcome of the Great Depression of the Thirties. It suggested policy measures like deficit financing to solve the problem of unemployment in a
depressionary phase of the capitalist economy. In the era of inflationary situation, the theory has not much validity.
3) Keynes’s theory deals with short-run phenomena only. It pays little attention to the long-run problems of a dynamic economy.
4) Keynesian theory is not strictly applicable to underdeveloped countries. Keynes deals with the problem of cyclical unemployment. Underdeveloped countries have the problem of chronic unemployment and disguised unemployment.
Keynes encouraged spending and condemned savings.But;
poor countries need curbs on spending and increase in savings for capital formation and wide-scale investment to break the vicious circle of poverty. In short, Keynes’s theory is not really “general” in application as Keynes claimed.
5) One dangerous practice is that the solution to global economic crisis and depression in advanced capitalism was sought to be applied for solving the economic crisis of less developed countries. In fact in the west there are arguments against Keynes’s economics that it is not Keynesian economics but the Second World war revived the world economy. Keynesian revolution succeeded the industrial revolution as an adhoc theory of countering the industrial depression in Britain during the thirties, just before the Second World War, became the all-encompassing theory of development. Dennis Robertson at the out set of his Cambridge lecturers, delivered between 1945-46 to 1956-57,
warned the under graduate students about the controversial nature of Keynes’s General Theory and to supplement its readings by critical writings on the same.
6) Laws of economics are relative and valid for particular situations in the economic history of a nation. To the British economists, the economic forces generated by the industrial revolution in that country was universal and economic laws were accordingly formulated. What was good for Britain was good for the entire world, irrespective of differences in socio-economic conditions. But great personalities like Arnold Toynbee argued against this dominant view and the need for region specific models of development. His dream of this way of study never materialized because of his premature death and lack of followers. Adam Smith advocated free trade at a time when British manufacturing industries, particularly the textile mills had increased their capacity through various practical innovations. Trying to universalize economic laws has been one of the greatest disservices to the science of economics. The attempt by the third world countries to formulate their development plans on the basis of these economic laws has created serious imbalances in their economy and has kept them perpetually indebted, leading to erosion of their economic independence.
7) Lord John Maynard Keynes (J.M. Keynes) was a great advocate of easy money policy and abundance of credit for economic prosperity. Keynesian prescriptions failed in
developing countries due to inelastic nature of agriculture sector and high inflation. Keynes found D.Robertson’s ideas inconvenient and chose to ignore it. An academically and theoretically sound thesis will not shy away from an academic debate. The relation between agriculture and industry does not form a part of the theoretical frame work of the General Theory of Keynes. Keynes was highly intolerant of his critics and he had high hope in capitalism and he could avoid economists jumped into Marxist band wagon. Indian planning was over influenced by Keynesian school because of the economic experts trained in British Universities or Anglo-Saxon schools. In India Dr.B.S.Minhas resigned from Planning Commission protesting against high inflationary practice (Keynesian model of deficit financing).But no one from the academic world or Planning Commission came to his support. It is of importance to note that deficit financing started with the recommendation of the IMF in its report in 1953.N.Kaldor says that the deficit financing imply a corresponding increase in privately owned
developing countries due to inelastic nature of agriculture sector and high inflation. Keynes found D.Robertson’s ideas inconvenient and chose to ignore it. An academically and theoretically sound thesis will not shy away from an academic debate. The relation between agriculture and industry does not form a part of the theoretical frame work of the General Theory of Keynes. Keynes was highly intolerant of his critics and he had high hope in capitalism and he could avoid economists jumped into Marxist band wagon. Indian planning was over influenced by Keynesian school because of the economic experts trained in British Universities or Anglo-Saxon schools. In India Dr.B.S.Minhas resigned from Planning Commission protesting against high inflationary practice (Keynesian model of deficit financing).But no one from the academic world or Planning Commission came to his support. It is of importance to note that deficit financing started with the recommendation of the IMF in its report in 1953.N.Kaldor says that the deficit financing imply a corresponding increase in privately owned