The Role of the Government in the Economy

  • India embraced an economic model which has the features of both free market capitalism and socialism. The policy makers called this a model of ‘Mixed Economy’.
  • The reason for adopting such a hybrid model was to raise people’s standard of living and reduce income inequality.
  • India embraced an economic model that uniquely combined free market capitalism with that of State intervention in essential sectors of the economy.
  • The record of India’s successive governments in providing social welfare is at best mediocre.
  • The Government must build a comprehensive welfare state with a strong emphasis on redistribution of resources to poor along with provisions of social services (Public Health, Education, Equitable Institutions, Un-Employment Benefits, Old Age Pensions etc.) financed through taxation.
  • In today’s changing World of high technology, the Government must do a lot of public spending on investment in human capital and research and development.
  • On Jobs creation front, the government must adopt a judicious mix of labour market institution that includes a fairly flexible labour market allowing easy hiring and firing of employees along with strong labour associations to safeguard the interest of employees.
  • On the External front, the government must embrace globalisation, openness to trade and investment but with risk sharing approach. The government should share the risk arising out of globalisation, by training and skilling those who have suffered from the negative impact of globalisation. The process of risk sharing will make globalisation acceptable to all.
  • Adopting the above features will allow India to achieve high growth along with high social ambitions/indicators.
  • Therefore, in a nutshell, the future of India’s rapid and sustainable development lies in the following:

 

Functions of Government

Allocation Function

  • The government provides certain public goods and services which the private sector fails to provide because there exists no market for them.
  • Example: National Defence, Public Parks and National Highways etc.
  • The reason of government providing such goods is the nature of public goods. The public goods are by nature non-rival and non-excludable.
  • Non-Rivalry means, the consumption of the good by one individual does not stop another individual from consuming the same good. The goods remain available to all the citizens.
  • Non-Excludability means the government cannot exclude any person from enjoying the benefit of the good whether they pay or not. The goods are non-excludable in nature.
Private Goods Public Goods
They are Rival in nature. Rivalry means if one person consumes a good, then it will not be available for the consumption of another individual. Example- Any private good like a car, a pen, a mobile handset etc. if I own a car, then that particular car is not available to any other person. They are non-rival in nature. Consumption by one individual does not affect consumption of another individual. Example: National Defence or Public Highway- if I am driving a car on the highway that does not stop any other individual from driving his/her car on the same highway.
They are excludable in nature. Excludability means that exclusion is possible. If someone does not buy a metro ticket, then he/she can be excluded from riding on the metro train. They are non-excludable in nature. It means exclusion is not possible. If a public park is constructed, then no person can be excluded from using it, whether he pay tax/price or not.
The market for private goods exist. The existence of market helps in their price discovery, and hence prices for private goods exist which makes exclusion possible. The market for public goods does not exist. Hence price discovery is not possible. With no price available private sector will never supply such goods. Thus, Government must provide such goods.
Property Rights of private goods are well determined. If I own a house, then I have exclusive property rights over its usage. The house is in my name; it belongs to me. Property Rights are not determined. No person owns the Highway or a public park. They are common goods to be shared by all. No single person can claim that it belongs to them.
Free Ridership is not possible. Free ridership is a situation when someone who has not paid for it started using it. Free ridership is possible. Example- Government comes up with a provision that all houses must contribute Re 100 towards spreading of medicine for Dengue prevention. Despite this, some houses refuse to pay. The government simply does not let its prevention program fail because some houses are not paying. Since the issue involves public health threat, the government decides to provide it anyway. Thus, the houses that had not paid Re 100 will also enjoy the benefit of dengue prevention program.

Distribution Function

  • The government through its tax and expenditure policies attempts to bring out income redistribution in the society that is fair to all.
  • The government transfer payments from one citizen to other through taxation policy.
  • Example: Old age pensions, Social sector initiatives for the poor. Through these programs, the government provides income support to those individuals who do not have any source of earnings. The funds for running these programs comes from progressive taxation. Those with higher income paying higher taxes.
  • The idea of distribution is not to rob the rich by forcing them to pay high taxes or to discourage people from earning more but to make just redistribution which will be equitable for all.
  • Think like this, the per capita consumption of common resources will be higher for rich individuals as compared to the poorer individual (who survives on bare necessities). Thus they must pay a higher price for its provision. Space taken by an SUV or Sedan on the road is much higher than the space taken by Bicycle. Thus, the SUV owner must pay a higher price/ tax for the construction of the road as compared to bicycle owner. The above example explained the concept Progressive taxation.
  • Similarly, the old age pensions are not grants by the government but are right of those individuals who have worked endlessly during their productive years. Thus, the government must take care of them by providing them old age benefits.

Stabilisation Function

  • The economy tends to undergo periods of instability and fluctuations. The periods of fluctuations require the government to play an active role in removing it.
  • The year of 2008-09 witnessed the Global Financial Crisis. The GFC led to a decline in GDP growth rate along with employment. To help recover economy from the GFC, the government provided Fiscal Stimulus package for the industry.
  • Let’s understand the channel

  • Similarly, the economy may at times overshoot when expenditure becomes greater than output. In such a situation when consumers are spending more than what producer are willing to supply. Inflation happens. To remove inflationary pressure from the economy, the government intervenes through tight fiscal policy.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University
CategoriesUncategorized
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