The important role played by the fiscal policy in a developing economy can be explained through :
- Fiscal policy during inflation,
- Fiscal policy during depression,
- Fiscal policy and unemployment,
- Fiscal policy and income inequalities and
- Fiscal policy and economic growth.
Fiscal Policy during Inflation
Inflation is a period in which the purchasing power with, the people in the economy is high. The first step to curb inflation is to control the purchasing power with the people. This can be done using all the tools of fiscal policy. For instance, during inflation, since the private expenditure is high the government should bring down the public expenditure so that, to that extent the income generation will be controlled. Alternatively, the government can increase the existing tax rates or impose new taxes. This will have the effect of taking away the purchasing power from the rich and well-to-do people thereby curbing the consumption expenditure. The tax revenue will then be used for public expenditure purposes which will also be low during inflation. Hence, there will be effective control of money supply in the economy. Another way in which the fiscal authorities can function is to indulge in public borrowing. The government may start borrowing from the people in large scale so that the disposable income with the people will be reduced bringing down the demand and prices.…
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By fiscal policy we mean, the government’s tax efforts, public expenditure and public borrowing. Through these the government can effectively encourage consumption, investment and savings habits and also restrict them. For example, suppose there is inflation in a country. Inflation implies that the people have high purchasing power and so they demand goods. To curb this, the government may raise the personal tax and also the corporate tax. Similarly, by altering its expenditure on various public projects, the government would be able to influence the prevailing economic condition. Public borrowing involves government issuing bonds and encouraging common public and other institutions to buy them. By this, the government would be able to bring down the level of purchasing power in the economy and control the inflation.
The following are the objectives of fiscal policy:
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- Maximization of the aggregate saving is the first objective. Tins are achieved by encouraging people to reduce the current and future consumption. Specifically the attempt is to bring down and control the conspicuous consumption of the rich people.
- Maximization of capital formation is the second objective. Through this objective the country can try to achieve an accelerated economic growth. This will help the country to overcome the stagnation and achieve a higher rate of economic growth.
Foreign capital or investment has become significant part of sources of funding for various projects in every country. This source of funding has received the attention of both the government as well as the corporate sector that there has been increasing reliance on this source for planning and execution of projects by the government as well as the corporate sector. Foreign capital can come into a country in different forms. Let us first understand these forms of foreign capital before discussing the need for foreign capital.
Forms of Foreign Capital
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- Direct Entrepreneurial Investment: In this form of foreign capital, the foreign investors can start a company abroad mainly for the purpose of establishing its branches and subsidiaries in other countries. For instance an American business group may invest in a new project in India directly and start its own affiliate or branch or even a subsidiary. Sometimes, the investors abroad may participate in the stocks or share capital of Indian companies. Whenever the Indian companies go for public issue of shares or debentures, the foreign investors may respond by participating in such public issue. This is also called foreign capital. In the past external business group used to invest in new companies and that form of foreign capital used to flow much, but now-a-days participation in the equity or debenture of companies by foreign investors and non-resident Indians is becoming more predominant.
Inflation has to be controlled, otherwise the extent of damage done to the economy will be something substantial and the economy would take a long time to recover from the effects of inflation. In this direction of control of inflation, the following are the theoretical measures available. These measures could be classified into three groups viz. Monetary measures, Fiscal measures and Other measures.
1. Monetary Measures
Monetary measures are steps taken by the Central bank of a country as the head of the monetary system. These measures are usually refereed to as the, quantitative credit controls and qualitative credit controls. The former include bank rate, open market operations and the variable reserve ratio. The, latter include margin requirements, moral suasion, direct action, control through directives, consumer credit regulation or rationing, publicity, etc.
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- Quantitative Credit Controls: Bank rate is the first, measure to curb credit creation activity of the commercial banks, as during inflationary period the volume of money supply has to be reduced. Bank rate is the rate at which the central bank of a country re-discounts the bills already discounted by the commercial banks. When the central bank wants to control credit creation by commercial banks, it would simply increase the bank rate.
The population of an economy is divided into two categories, the economically active and the economically inactive.The economically active population (labor force) or working population refers to the population that is willing and able to work, including those actively engaged in the production of goods and services (employed) and those who are unemployed. Whereas,unemployed refers to people who are willing and a capable of work but are unable to find suitable paid employment. The next category, the economically inactive population refers to people who are neither working nor looking for jobs. Examples include housewives, full time students, invalids,those below the legal age for work, old and retired persons.
Unemployment is of different types. The important types of unemployment are:
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- Structural unemployment: This is a type of unemployment caused mainly by the change in the development strategy adopted by an economy. For example, suppose a country basically agricultural in nature, plans to adopt industrialization as a strategy. This will result in displacement of labor in agriculture and not all of them can be accommodated in the industries. This type of unemployment caused is called Structural unemployment. This type of unemployment is also known as the chronic unemployment or the Marxian or long-term unemployment. It is mostly to be found in the underdeveloped countries. This type of unemployment is due to the deficiency of capital resource sin relation to their demand.
According to the First report of the National Income Committee, “National income estimate measures the volume of commodities and services turned out during a given period, counted without duplication.” This means the total volume of goods and services produced in a year in a country is valued in monetary terms to obtain the National income of the country concerned.
Regarding the measurement of National income, it could be done in three different ways depending upon the interpretation of concept of national income. If National income is considered as a flow of goods and services, then the method used is called Product method. If National income is treated as a flow of income then the relevant method of measuring it is called Income method. Alternatively, if National income is treated as a flow of expenditure, the method used is called the Expenditure method. Apart from these traditional methods of measuring National income, one more method is evolved and it is called the Value added method. Let us now look into the contents of each of these methods.
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- Product method: In this method, the value of goods and services produced in an economy during a year is found at the market prices, to obtain the GNP at market prices.