To control the forces of demand and supply state intervention is essential in developing countries like India. For the proper development of the country this becomes an important function with the government. Now the question is, how and in what ways should government intervene? There are generally three main ways in which government can intervene.
They are Monetary policy, Fiscal policy, and Physical control over production and distribution.
Monetary policy refers to those measures which help control the supply of money and credit in the economy. The main objectives of monetary policy in India have been economic growth, price stability and deployment of credit among different sectors of the economy.
The monetary policy is formulated and operated by the central bank of the country. In our country this work of monetary and credit control is performed by the Reserve Bank of India. For this the Reserve Bank generally adopts following five measures
Measures of Monetary and Credit Control
- Issue of Currency Notes. In our country RBI has the monopoly to issue currency notes. Government’s deficit in budget is financed by the credit from the Reserve Bank. Consequently it increases the money supply in the country. The increase in money supply increases purchasing power of the people and the demand in the market. If this increase in demand is not matched by an increase in supply of goods, it results in price-rise. That is why the RBI has to keep control on the circulation of currency notes. Besides the control on currency, the RBI also keeps control on the bank credit.
- Bank Rate Policy. The rate at which the RBI gives loans to the commercial banks is known as bank rate. On the other, the rate at which commercial banks gives credit to their customers is interest rate. Bank rate and interest rate have a very close relation. If the RBI wants to expand credit creation, it decreases the bank rate and if it wants to contract credit creation, it increases the bank rate.
- Open Market Operations. Activities related with the sale and purchase of securities by the central bank in an open market are known as open market operations. If the Reserve Bank wants to expand credit, it starts to purchase the securities in the open market and if it wants to contract credit, it starts to sell securities.
- Changes in the Cash-reserve Ratio. We know that every bank has to keep a certain minimum proportion of its total deposits in the form of cash. This minimum cash reserve is determined by the Reserve Bank. The Reserve Bank can increase credit creation by reducing this cash-reserve ratio and it can decrease credit creation by enhancing the rate of cash reserve ratio.
- Selective Credit Control. In developing countries like India it is not sufficient to have control merely on the total volume of credit in the country. Here it is also essential to see that credit should be available in sufficient quantity and at concessional rates to the socially desirable activities and on the other, the flow of credit should be checked to the undesirable or unessential activities. For this the Reserve Bank adopts many measures such as credit rationing, direct action or preventing credit for certain purposes, consumer credit control, changes in margin requirements etc. These are the measures which are known as selective credit control. In the Indian situation selective credit control measures are more important.
Fiscal policy means the policy related with public expenditure, taxation and public debt. In short, it is the budgetary policy of the government.
The main objectives of fiscal policy for underdeveloped countries like India are as follows
(i) Economic growth, (ii) Increase in rate of investment and capital formation, (iii) Diversion of investments into socially desirable channels (iv) Social justice or equity in the distribution of income and wealth, and (v) Price stability.
There are two main constituents of the budget: public revenue and public expenditure. Public revenue can further be divided into two parts; non-tax revenue and tax-revenue.
Taxation. Taxation is a very important instrument with the government with which it can intervene in the economy to control the forces of demand and supply. Taxes are of two types; direct taxes and indirect taxes.
A tax which is paid by a person on whom it is imposed and the burden of which cannot be shifted on others is called a direct tax. Examples of direct tax are : income tax, wealth tax, estate duty, gift tax, expenditure tax etc. The central aim of direct tax is to reduce inequalities between the rich and the poor. That is why we should extract more from a richer man’s income.
The tax which is ultimately paid by some other person than the person on whom it is imposed, is called indirect tax. The burden of this tax can be shifted to some other person. For example, sales tax is imposed on the sellers by the government but sellers realise it from the buyers. Sales tax, excise duty, stamp duty, custom duty etc. are all examples of indirect taxes.
There are two main differences between direct tax and indirect tax (i) The burden of direct tax cannot be shifted to others while the burden of indirect tax can be shifted to others. (ii) Direct tax is imposed on persons while indirect tax is imposed on transactions.
The aim of indirect taxes is two-fold: (a) Indirect taxes can be used, to a certain extent, in reducing inequalities. (b) Through them we can either encourage production and the use of certain goods or discourage the production and the use of some other goods.
Thus, taxation can be used to achieve following objectives
(i) To earn revenue;
(ii) To reduce inequalities;
(iii) To influence the allocation of resources;
(iv) To influence saving and investment.
To influence economy, public expenditure is also an important instrument with the government. As we know that the purchasing power of the poor people is low. Hence, private entrepreneurs do not want to produce goods for them. Therefore, government should prepare its public expenditure programme in such a way so that it can provide more facilities to the general public. For example, schools, hospitals, public parks, buses, railways, supply of drinking water etc. are examples of such. Besides this, the total volume of public expenditure also influences the economy. When there is inflation in the country, government should curtail its non-essential and non-developmental expenditure.
Thus, government can make changes in the economy through taxation and public expenditure policy. Here in the Indian context w must bear in mind one more important point. We know that ours is a federal country. Here we have central government as well as state governments. It is, therefore, essential to have complete harmony in the policies of central and state governments with regard to taxation and public expenditure.
III. Physical Control Over Production and Distribution
Government exercises physical control mainly in two ways (i) Industrial licensing, and (ii) Rationing and Public Distribution System.
In the field of production government exercises its physical control through the policy of industrial licensing. The main objectives of industrial licensing policy in India have been as follows
(i) To check the concentration of economic power and monopoly in the industrial sector;
(ii) To reduce regional economic disparities;
(iii) To encourage Cottage and Small Scale Industries;
(iv) To give direction to the industrial investment,
Industrial licensing is governed by the Industries (Development an Regulation) Act, 1951. Over the years, keeping in view the changing industrial scene in the country, the industrial licensing policy has undergone modifications. Accordingly a new industrial policy was announced in July 1991. In this policy industrial licensing has been abolished for all industries except for 7 specified groups. Compulsory licensing has been considered necessary for security and strategic considerations, safety reasons and over riding environmental concerns and the need to regulate production of articles of elitist consumption. The theme of the policy is continuity with change.