Types of Economy

Types of Economy: It is said that every economy in the world is

unique in some way or another. No two economies are identical.

However, these economies do share many of the same features and

characteristics. So economists have been able to identify four different

types of economy – traditional economy, command economy, market

economy and mixed economy. Let us learn about these in some detail. 

Types of Economy

I. Traditional Economy

A traditional economy, as the name suggests, is based on a traditional

approach. These economies are based on ancient rules and are the

most basic type of economy. The focus in a traditional economy is

only on the goods and services that match their customs, beliefs, and

history.

Such traditional economies tend to focus primarily on agriculture,

cattle herding, fishing etc. A traditional economy will use the barter

system and has no concept of currency or money. Their economies

center around their tribes or families. Such economies believe in only

producing what and how much they require. They find no need to

produce any market surplus. There is no concept of trading.

If such traditional economy does not adapt it becomes very vulnerable

to change in their environment. Once such economies evolve they

begin to adopt farming. They even trade their surplus crop and start

evolving from this traditional economy. And when a traditional

economy interacts with a market or a command economy it becomes a

traditional mixed economy.

Then money (currency) starts to take importance in their lives as well.

This type of traditional economy is suited to underdevelop and

developing economies. Even today such economies can be found in

some pockets of Africa and the Middle East.

II. Command Economy

A command economy is the opposite of a free market economy. In a

command economy system, there is one centralized power, which in

most cases is the government. So the government makes all decisions

regarding the economy. It will decide which goods and services will

be produced, in what quantities. The price will also be determined by

such centralized power and not by market forces.

A command economy is a characteristic trait of a communist country.

Countries like Cuba, China, and the previous USSR are practical

examples of this command economy system. Such economies are also

known as Planned Economies because the government plans all the

forces of the economy, nothing is decided by the free market.

In such a planned economy there cannot be any competition. The

government has a monopoly in almost all the businesses and sectors.

All businesses follow the regulations and instructions of the

government and are not influenced by the forces of the economy.

One of the biggest disadvantages of such a command economy is that

the government cannot plan or provide for all its citizen’s individual

needs. And so this often leads to rationing. In an ideal world under

such a command economy the government should be able to provide a

living to all its citizens. However, the reality is different.

III. Market Economy

This is the complete opposite of a command economy. A free market

economy relies entirely on the free market and free market trends.

There is no involvement or interference from the government or any

such controlling power. This means there are no rules or regulations

imposed on either buyers or sellers. The entire economy is determined

by the participants of the economy and the laws of demand and

supply.

Theoretically, a free market economy can show very high levels of

growth. It makes private organizations (only these exist) very

powerful and influential in the country. So it may create an imbalance

of wealth and a scenario where the rich get richer and poor get poorer.

Realistically there are no perfect free market economies in the world.

Every economy has some level of government regulation as it is

necessary. Like for example laws that prevent monopolies, or restrict

production of harmful substances. Even anti-pollution laws that affect

production are a hindrance for a market economy. So in the modern

world free market is a subjective definition.

Currently, the United States is considered the epitome of capitalism.

Hong Kong is also a good example of a free market economy.

IV. Mixed Economy

A mixed economy is a perfect marriage between a command economy

and a free market economy. So, by and large, the economy is free of

government intervention. But the government will regulate and

oversee specific sensitive areas of the economy like transportation,

public services, defence etc. Such an economy is known as a dual

economy. The best examples of such a mixed economy are India and

France.

Such a mixed economy allows private businesses the freedom to

operate in the economy with minimum oversight. At the same time,

the government can regulate the economy so it does not adversely

affect the public interests. Both public sector and private sector can

co-exist peacefully in one economy. It is the perfect blend of socialism

and capitalism. In fact, most economies of the world are currently

considered as mixed economies.

Solved Example for You on Types of Economy

Q: One of the biggest limitations of a free market economy is which of

the following?

a. High taxes

b. Government Interference

c. Economic restrictions

d. Uneven distribution of resources

Ans: The correct answer is option D. In a market economy the

government cannot interfere to stop monopoly or concentration of

wealth in the hand of a few. So this often leads to uneven distribution

of resources as people with money hold all the cards.

This concludes our discussion on the topic of the types of economy.

Five Year Plan

After India gained independence in 1947 it basically had to rebuild its

economy from scratch. The leaders of those times had to pick the type

of economy India would be and also outline the economic planning as

well. This is where the five year plan was born. Let us study a bit

more about them. 

Indian Economy after Independence

In the post-independence era, the leaders of the country had some

precarious decisions to take. One of them was which type of economic

model would India follow? In those times there were two models

followed by most countries in the world – capitalist economy and

socialist economy.

Our first Prime Minister Jawaharlal Nehru preferred the socialist

model. But in a democracy like India, a pure socialist economy can

not flourish. Capitalism was also not suited since the government had

to build up an economy and look after the common man and his needs.

So as a solution our economy combined aspects of both socialism and

capitalism.

It was decided India would develop a strong socialist society, where

the public sector would take care of its citizens. But the government

would also promote and encourage a strong private sector for the

future. There would be no prohibition on private property or wealth

keeping our democracy in mind.

Five Year Plan

An economic plan allocates the resources of a nation to fulfil the

general and specific goals as planned by the government for a

specified period. In India, these plans are made for five years and

hence are known as five year plans. These five year plans are

ultimately a short-term plan for a perspective plan. A perspective plan

outlines the long-term goals of a nation, spanning twenty years.

In India, after the independence, the government set up a Planning

Commision in 1950. This commission would be responsible for

framing and implementing the five year plans of the country. They

began their efforts with the first five year plan in 1950.

The Goals of the Five Year Plans

Every five year plan is developed with a specific goal in mind. But

there is never one solitary objective of the plan. The plan is supposed

to work towards the perspective plan and must cover a few important

objectives. However, it is not possible or practical to give equal

importance to all aspects of a plan.

There are basically five generalized goals of a five year plan, wherein

a particular plan one or two are given the most importance. In fact,

some of the goals are actually conflicting. So let us now look at these

five types of goals we cover in the five year plans.

Growth

This is the first and the most basic goal of an economic plan. Growth

in terms of an economy focuses on the increase of the Gross Domestic

Product (GDP) of the country. GDP is a way to measure the growth of

an economy. Higher the GDP more the common public can benefit

from the economic policies of the country.

This economic growth actually happens due to an increase in the

production capacity of a nation for either its goods or its services. This

can be due to an influx of capital into the economy as well. The sector

in which the growth is happening is also important. There are three

basic sectors – agricultural, industrial and service. Their respective

contributions make up the structural composition of the GDP.

For very many years India’s primary focus was the agricultural sector.

It was the main contributor to our GDP. And it also saw the highest

growth rate in the few initial five year plans.

Modernisation

Modernisation refers to the integration of technology in the economy.

Innovation, inventions, and advancement in technology play a huge

part in upgrading our economy and increasing its output. One example

would be the introduction of modern agricultural techniques which

increased output. Over the years, the Indian economy also saw a major

boom in the IT industry due to modernization.

Another aspect of modernization would be our advancement as a

society. Leaving behind discriminatory practices and pushing towards

an equal, fair and modern society.

Self Reliance

A new economy like India’s post-independence can become too

reliant on imports. So for seven editions of the five year plan, the

government promoted self-reliance. This basically meant that anything

we were capable of producing domestically we did not import.

Especially food and agricultural products were never imported as long

as possible. This was to ensure we not only became self-reliant but

also to protect our sovereignty. Because importing basic essentials

from other nations would make us dependent on them. Then after

1991, the government finally opened up our economy to the global

markets once we had already established a domestic base.

Equity

Now the previous three goals mainly relate to the economy. But the

development of the economy only is not sufficient. The five year plans

must also focus on the development of our society. It is essential to

ensure that these benefits from the economy are enjoyed by all

members of the society. This is where equity comes in.

Equity focuses on ensuring that all citizens of our country have their

basic needs for food, housing, clothing etc fulfilled. It also looks to

reduce the wealth gap and the inequality in our society.

Solved Question for You

Q: In which year was the first five year plan passed?

a. 1947

b. 1948

c. 1950

d. 1951

Ans: The correct option is D. India became independent in 1947 but

our first economic plan came out in 1951 under the guidance of the

PM and chairman of the Planning Commision Jawarhalal Nehru.

Land Reforms

After the British left, India had to undo a lot of damage they had done

to our economy and society. One such system of the British Raj that

independent India had to correct was the zamindari system. To

promote equity the government introduced land reforms. Let us see

how this was implemented. 

Land Reforms

During the British times, the tillers of the lands were not its owners.

So a farmer did not have actual ownership of the land. The ownership

was with the intermediaries, i.e. the zamindars, jagidars etc. The

farmer would farm the land and pay rent to these zamindars.

This did not motivate the zamindars to invest in the farm or invest in

the agricultural practices. They were only focussed on collecting their

rent. And as you can imagine the farm and the farmer both suffered.

But after independence, the government realized that the agricultural

output was not sufficient for the whole country. One way to boost the

produce was to make the tillers of the land its owner. And so efforts

were made to abolish the intermediaries and this was known as the

land reforms.

Objectives of the Land Reforms

The government of a newly independent India had a few objectives in

mind to implement these land reforms. Let us take a look at the few

important ones

● The main objective was to bring systematic and complete

changes to the agrarian structure of the country.

● Its other main aim was to abolish the intermediaries of the

semi-feudal landlordism system of India, i.e. get rid of the

zamindars

● Bring about equity in the economy and society and ensure

social justice for past atrocities towards farmers

● The land reforms would also prevent any exploitation of the

tenant farmers by the hands of the landlords

● And finally to motivate these farmers and implement practices

to increase agricultural output.

Steps Implemented under the Land Reforms

Immediately after independence, many states in India passed the

Zamindari Abolition Act. In the states of Uttar Pradesh, Andhra

Pradesh, Bihar etc the surplus land of the landlords were seized by the

states. Although the Supreme Court found the act unconstitutional, the

legislature amended the article and corrected their actions.

By the abolition of intermediaries of all types, nearly 2 crore tenants

became owners of their own lands. The tenure laws were updated and

the land reforms were finally showing some positive results.

The other important step taken was the imposition of the land ceiling.

This law fixes the total amount of land an individual or family can

hold. Not only does the law implement the fixation of the ceiling, it

also allows the government to take over the surplus land. Such land

was then distributed among landless farmers or small farmers. The

imposition of such a ceiling was to deter the concentration of land in

the hands of a few.

The reforms also promoted consolidation of holdings. If a farmer had

a few plots of land in the village, under this scheme these lands would

be consolidated into one big piece of land. This can be done by the

purchase or exchange of land. Actually, one problem of agriculture in

India is that the land parcels are too small for commercial farming.

This method can solve the problem of land fragmentation.

To solve the problems of land subdivision and lack of financing the

government also began promoting co-operative farming. Here farmers

can pool their lands and resources and gain the advantages of

economies of scale and capital investment. But co-operative farming

in India has only seen limited success.

Importance of Land Reforms

The main incentive of these land reforms is to act as an incentive for

the farmers and the cultivators of the land. If the government can

assure their protection (from exploitation) and provide them financial

help, these farmers are willing to do the hard work. Once he is actually

granted ownership he can raise credit and cultivate his land to the full

potential.

Another major advantage of such land reforms is that they can

increase the agricultural output of the country. This is done without

any major influx of capital by the state. India was anyways struggling

with food self-sufficiency. These land reforms were a cost-free

method to increase grain and agricultural output from farms. And once

the farmer is self-sufficient he will sell the market surplus and help the

economy.

These land reforms also helped in establishing a relationship between

the farmers and the government. During the British rule these farmers

were heavily exploited and hence they became disenfranchised. These

reforms opened a dialogue between the government and the farmers.

They both cooperated to boost the agricultural sector of our economy.

And land reforms fulfilled one of the major goals of the five-year plan

– Equity. It provided social justice to the crores of farmers across the

country. It made sure the farmers benefitted from their own labour and

promoted equality of wealth.

Solved Question for You

Q: Bhoodan movement was started in India by _______.

a. Vinoba Bhave

b. Sardar Patel

c. M K Swami

d. None of the above

Ans: The correct option is A. Vinoba Bhave initiated this movement

in 1951. It was also known as the Land Gift Movement. This was a

voluntary form of land reform where they collected surrendered land

from landowners and gifted them to the poor landless farmers.

Green Revolution

At the time of its independence, India was an agricultural dependent

economy. And yet the state of Indian agricultural sector was dismal.

From the lack of investment, a dearth of technology, low yield per

acre and many such problems plagued the industry. And so the Indian

government took steps to bring about the Green Revolution using

HYV seeds. Let us see how. 

Green Revolution

The Green Revolution started in 1965 with the first introduction of

High Yielding Variety (HYV) seeds in Indian agriculture. This was

coupled with better and efficient irrigation and the correct use of

fertilizers to boost the crop. The end result of the Green Revolution

was to make India self-sufficient when it came to food grains.

After 1947 India had to rebuild its economy. Over three-quarters of

the population depended on agriculture in some way. But agriculture

in India was faced with several problems. Firstly, the productivity of

grains was very low. And India was still monsoon dependent because

of lack of irrigation and other infrastructure.

There was also an absence of modern technology. And India had

previously faced severe famines during the British Raj, who had only

promoted cash crops instead of food crops. The idea was to never

depend on any other country for food sufficiency.

So in 1965, the government with the help of Indian geneticists M.S.

Swaminathan, known as the father of Green Revolution, launched the

Green Revolution. The movement lasted from 1967 to 1978 and was a

great success.

Features of the Green Revolution

● The introduction of the HYV seeds for the first time in Indian

agriculture. These seeds had more success with the wheat crop

and were highly effective in regions that had proper irrigation.

So the first stage of the Green Revolution was focused on states

with better infra – like Punjab and Tamil Nadu.

● During the second phase, the HYV seeds were given to several

other states. And other crops than wheat were also included

into the plan

● One basic requirement for the HYV seeds is proper irrigation.

Crops from HYV seeds need alternating amounts of water

supply during its growth. So the farms cannot depend on

monsoons. The Green Revolution vastly improved the inland

irrigation systems around farms in India.

● The emphasis of the plan was mostly on food grains such as

wheat and rice. Cash crops and commercial crops like cotton,

jute, oilseeds etc were not a part of the plan

● Increased availability and use of fertilizers to enhance the

productivity of the farms

● Use of pesticides and weedicides to reduce any loss or damage

to the crops

● And finally the introduction of technology and machinery like

tractors, harvesters, drills etc. This helped immensely to

promote commercial farming in the country.

Market Surplus

The Green Revolution by and far was a success. But now there was

another aspect to it. The government had to ensure that the benefit of

the higher productivity was passed on to the general public. If the

farmers kept the grains for themselves then the benefit of the higher

productivity would be lost.

But thankfully this did not happen. Due to the high yield and

productivity of the farms, the farmers started selling their produce in

the markets. The portion of the produce which is sold by them is

known as market surplus.

And so the higher output caused due to the Green Revolution started

benefiting the economy. There was a decline in the prices of grains

and such food products. The common man was able to easily afford to

buy them. The government was even able to stock grains and build a

food bank in case of future food shortages.

Impact of the Green Revolution

● Increase in Agricultural Production: Foodgrains in India saw a

great rise in output. It was a remarkable increase. The biggest

beneficiary of the plan was the Wheat Grain. The production of

wheat increased to 55 million tonnes in 1990 from just 11

million tonnes in 1960.

● Increase in per Acre Yield: Not only did the Green Revolution

increase the total agricultural output, it also increased the per

hectare yield. In case of wheat, the per hectare yield increased

from 850 kg/hectare to an incredible 2281 kg/hectare by 1990.

● Less Dependence on Imports: After the green revolution, India

was finally on its way to self-sufficiency. There was now

enough production for the population and to build a stock in

case of emergencies. We did not need to import grains or

depend on other countries for our food supply. In fact, India

was able to start exporting its agricultural produce.

● Employment: It was feared that commercial farming would

leave a lot of the labour force jobless. But on the other hand,

we saw a rise in rural employment. This is because the

supporting industries created employment opportunities.

Irrigation, transportation, food processing, marketing all

created new jobs for the workforce.

● A Benefit to the Farmers: The Green Revolution majorly

benefited the farmers. Their income saw a significant raise. Not

only were they surviving, they were prospering. It enabled

them to shift to commercial farming from only sustenance

farming.

Solved Question for You

Q: Which of the following grains were produced the most during the

Indian green revolution?

a. Wheat and Jute

b. Rice and Oilseeds

c. Wheat and Rice

d. Jute and Cotton

Ans: The correct option is C. The two grains that benefitted the most

in the Green Revolution were Wheat and Rice. In fact many believe

rather than Green Revolution, Grain Revolution is the more suited

name.

Industrial Policy

During many decades after independence, India was largely an

agrarian economy. But for any economy to be globally successful it

must have a robust industrial sector. And so for the first seven

five-year plans India actively focussed on industrial development

through industrial policy formation. Let us take a look. 

Industrial Policy

Industrial development is a very important aspect of any economy. It

creates employment, promotes research and development, leads to

modernization and ultimately makes the economy self-sufficient. In

fact, industrial development even boosts other sectors of the economy

like the agricultural sector (new farming technology) and the service

sector. It is also closely related to the development of trade.

But just after independence India’s industrial sector was in very poor

condition. It only contributed about 11.8% to the national GDP. The

output and productivity were very low. We were also technologically

backward. There were only two established industries – cotton and

jute. So it became clear that there needed to be an emphasis on

industrial development and increasing the variety of industries in our

industrial sector. And so the government formed our industrial

policies accordingly.

Control of the State

One of the biggest hurdles in industrial development was the lack of

capital. Private industrialists did not have enough capital to build a

new industry. And even if they did, the risk involved was too high. So

in 1948, it was decided that state would play the primary role in

promoting the industrial sector. So the state would have absolute and

complete control over all industries that were vital to the economy and

the needs of the public.

Coal, petroleum, aviation, steel etc were all reserved exclusively for

the state. The private sector could provide services complementary to

those by the state. The public enterprises thus had a monopoly over

the markets for many years to come.

Industrial Policy Resolution 1956

During the second five-year plan the industrial policy resolution came

into action. The aim was to introduce more private capital int the

industry but in a systematic manner. So this resolution classified

industries into three categories as seen below,

i. First Category: Industries exclusively owned only by the State

ii. Second Category: Industries for which private sectors could

provide supplementary services. These industries would still be

mainly the responsibility of the State. And also only the State

could start new industries.

iii.Third Category: The remaining industries which fell to the

Private Sector.

While any private company or individual could start an industry

falling in the third category it was not that simple. The state still

maintained control over these industries via licenses and permits.

Every new industry needed a license and many permits from the

appropriate ministry. They even needed permissions and permits to

expand the present industry.

The aim behind such an industrial policy was to keep a check on the

quality of the products. It was also an important tool to promote

regional equality, i.e. make sure industries were developed in

economically backward areas.

Small Scale Industries

In 1955 a special committee known as the Karve Committee advised

the promotion of small-scale industries for the purpose of rural

development. It was believed that since small-scale industries are

more labour intensive they would create more employment. Also, the

manpower requirement of small-scale industries is semi-skilled or

unskilled which was suitable for those times.

However, these small-scale industries cannot match up to large scale

industries. So there were special goods and products reserved by the

government. These could only be manufactured by small and medium

scale industries. Such industries also got financial aid in form of loans

and tax and duty breaks.

Strengthening of Infrastructure for Industrial Development

One of the first requirements for the development of the economy is to

improve the infrastructure of the country. The various other sectors of

the economy cannot develop without the support of infrastructure

facilities like transport, rail, banking communication etc.

So to develop these industries the government formed appropriate

industrial policies. The development of most of these industries fell to

the public sector. Like for example, the rail industry to this day

remains firmly in the public sector.

Promotion of Capital Goods Industry

Capital goods are goods used in the production of other goods. Capital

goods are not for direct sale to the consumer. But they are a hallmark

of a good industrials sector. So the government decided to focus on

the capital goods industry for the development of our industrial sector.

So the Mahalanobis model came into effect in the second five-year

plan. The focus here was on heavy industries, especially those that

produce capital goods. This was to create a robust capital base for the

economy. So industries of heavy metals, chemicals, machine building,

tools, electrical etc all saw growth in this period.

Such industries have massive capital requirements. But the

government ensured they had enough capital to function smoothly.

Soon there was a development of high-tech goods in the market as

well.

Solved Questions for You

Q: What was the contribution of the industrial sector in 1950?

a. 11.8%

b. 12.3%

c. 24.6%

d. None of the above

Ans: The correct option is A. During the post-independence era the

contribution of the industrial sector was only 11.8% of the GDP. We

saw some development of this in the coming years and by 1991 it had

become around 25%.

Subsidies

A subsidy, often viewed as the discussion of a tax, is an instrument of

fiscal policy. Derived from the Latin word ‘subsidium’, a subsidy

factually implies coming to support from behind. Subsidies are useful

for both economy and citizens as well. These have a long-term impact

on a financial system like green revolution etc. These are only for the

reason that farmers receive good quality of grain on subsidized prices. 

Subsidies

Subsidies, by means of creating a block between consumer prices and

producer costs, lead to changes in demand or supply decisions. These

are often aimed at:

1. Suggesting higher consumption/ production

2. Balancing market deficiency including internalization of

externalities;

3. The success of social policy objectives including redistribution

of income, population control, etc.

Transfers and Subsidy

Transfers which are directly income supplements need to be

distinguished from a subsidy. An unconditional transfer to an

individual will add to his income and will distribute it over the entire

range of his expenditures.

A subsidy, however, refers to a particular good, the relative price of

which has been lesser because of the subsidy with a view to changing

the consumption/ distribution decisions in favor of the subsidized

goods. Even when the subsidy is hundred percent, i.e. the good is

supplied free of cost, it should be distinguished from an

income-transfer (of an equivalent amount) which need not be spent

completely on the subsidized good.

Mode of Administering a Subsidy

The range of alternative means of administering a subsidy are:

1. Subsidy to producers

2. Subsidy to consumers

3. Providing Incentives Instead of Subsidizing

4. Production/sales through public enterprises

5. Cross-subsidization

Subsidy Targeting

A subsidy can be spread among individuals according to a set of

selected criteria, e.g. merit, income-level, social group etc. Two types

of errors arise if we do not do the proper targeting, i.e. exclusion

errors and inclusion errors. In the previous case, some of those who

deserve to receive a subsidy are disqualified. While, in the second

case, some of those who do not deserve to receive subsidy get

integrated with the subsidy programme.

Source: stock.adobe

Effects of a Subsidy

We can generally group the economic effects of a subsidy into:

1. Allocative effects: these relate to the sectoral distribution of

resources.

2. Redistributive effects: these generally depend upon the

flexibility of demands of the relevant groups for the subsidized

good as well as the flexibility of supply of the same good and

the mode of administering the subsidy.

3. Fiscal effects: subsidies have obvious fiscal effects since a

large part of subsidies originate from the budget. They in a

straight line increase fiscal deficits.

4. Trade effects: a regulated price, which is to a large extent lower

than the market clearing price, may reduce domestic supply and

lead to an increase in imports.

5. The subsidies may also lead to unmanageable or unplanned

economic effects. They would result in inefficient resource

allocation if forced on a competitive market or where market

imperfections do not give a good reason for a subsidy, by

diverting economic resources missing from areas where their

marginal productivity would be superior. For instance, a price

control may lead to lower production and shortages and thus

generate black markets resulting in profits to operators in such

markets and economic rents to private people who have right to

use to the distribution of the good concerned at the controlled

price.

Subsidy Issues in India

Subsidies have greater issues than before in India for several reasons.

In particular, we can trace this rise to the following:

i. The vastness of governmental activities

ii. Somewhat weak determination of governments to recover costs

from the respective users of the subsidies, even when this may

be desirable on economic grounds, and

iii.Usually low-efficiency levels of governmental activities.

Methodology for Estimation of Subsidies in India

Different approaches and conventions have changed regarding

measurement of the magnitude of subsidies. Two major conventions

relate to measurement through (i) budgets and (ii) National Accounts.

The comparative distribution of the benefits of a subsidy may be

studied with respect to different classes or groups of beneficiaries such

as consumers and producers. Thus, the various examples of subsidies

are:

● food subsidy

● electricity

● public irrigation

● Subsidies to elementary

● Subsidies for health

Solved Example for Tou

The government gives subsidies in various sectors. Which of the

following are the special effects of subsidies?

1. increases inflation

2. increases fiscal deficit

3. decreases export competitiveness

Pick the correct answer using the codes given below.

1. a) 1 and 2 only

2. b) 2 only

3. c) 2 and 3 only

4. d) 1, 2 and 3

Ans. b) 2 only. There is no straight relation between subsidies given

and inflation. It may increase inflation (eg. subsidies on LPG helping

people save more, as a result, increasing their capacity which can

cause demand-pull inflation.) or decrease inflation by making easy to

get to low cost subsidized goods. Subsidies certainly increase the

fiscal deficit. Subsidies increases do not decrease the export

competitiveness of goods, as a result, it decreases their cost of

production.

Trade Policy

Industry and Trade are both closely related in an economy. After

independence, the leaders had to focus on the industrial growth of our

country. So they framed the trade policy to achieve this objective. Let

us take a look at some of the important features of the trade policy of

India after independence. 

Trade Policy

India’s trade policy has been through many stages over the last few

decades. There were transitory phases and some short-term policies to

deal with the changing economy. But overall the trade policy followed

some basic themes spread over three specific periods.

From independence until the 1980’s there was the general policy of

planned regulation and import substitution. After the 1980’s the

government started to focus on some partial form of liberalization.

And then came the phase after 1991 which focused on liberalization,

privatization, and globalization.

We will be focusing on the trade policy formation of a few years just

after independence and how they shaped our economy and promoted

industrial growth as well.

Inward Looking Strategy

Just after independence, the government was looking to boost trade

and industry in the country. We were an economy heavily dependent

on the agricultural sector, and to change that the development of trade

and industry was of the essence.

So for many years, the first seven Five-year plans precisely, India

adopted the trade policy of inward-looking, or better known as Import

Substitution. The policy was simple, we were going to substitute the

imports of our economy with domestic production. This trade policy

was applied to almost all sectors of the economy.

The aim of this policy was to boost domestic production and also

protect domestic goods from international competition. In a way, this

policy closed off our economy from the world. But during the initial

stages of development, this was secondary to our main aim of

boosting domestic production.

Such a protection of imports was done through two steps.

● Tariffs: Firstly tariffs were imposed on imports. Such tariffs

make imports costlier. This, in turn, will help the production as

well as the sale of domestic products.

● Quotas: Another measure was to impose quotas on imports.

This means only a specific quantity of goods can be imported.

And hence the domestic market will have to make up to meet

the demand.

Trade Policies and Industrial Development

We already saw that one of the aims of any trade policy is to influence

industrial development in the country. The trade policies of the first

seven plans had a profound effect on the GDP of the country and the

industrial growth as well.

The contribution of the industrial sector was only 11.8% in 1950. By

1991 it had more than doubled and was now at 24.6% of the GDP.

And it was not just growth, but the industrial sector also saw great

diversification. Initially, the main contributors of the sector were the

cotton and the jute industries. But the trade policy of the plans

promoted many other small-scale industries.

Protecting the domestic market from foreign imports really helped the

small and medium scale industries boom in the economy. It even

assisted indigenous industries, especially in the automobile and

electronics sector.

Public Sector Enterprises

We saw earlier, that India adopted a mixed economic system. It had

ideologies of both socialism and capitalism. One feature of the earlier

five year plans was the massive development of the public sector.

Most of the major industries like telecom, air travel, railways, defence

etc were entrusted to the public sector. And for many years they were

successful in ensuring that all members of the public got access to

these products.

However, some economists and academics have been critical of this

over-dependence on the public sector. Some were even critical of the

performance of such public companies. During the initial few years

after independence, these companies were essential. But some

economists were of the opinion that after a few years they were

actually blocking the entry of private players into the market.

We have now come to the realization that state and national

enterprises may have overstayed their welcome. They continued with

the production and the monopolization of certain goods and services

even though their services were no longer of any requirement. The

best example here is the telecom industry. The government had a

monopoly over this industry until the 1990’s. The private sector was

capable of providing this service, but the government never granted

any licenses. This lead to slow and poor service by the public

company.

There are many such examples where public companies continued to

function despite being loss-making operations. Closing a public

company is a huge task and usually leaves a hole in the market. And

so the government just allowed these companies to run inefficiently,

sometimes for decades. There were no checks to ensure the quality of

products or services and the public companies became insensitive to

the consumer demands.

Solved Question for You

Q: What was the Permit License Raj? How did it affect our economy?

Ans: During 1960-1980, to open any company or business in India the

industrialist had to obtain many permits from the associated

authorities. So industrialist spends more time lobbying the ministry

and trying to obtain the licenses and permits that they spend on

developing their products. This system was also misused by certain

industrialists to keep away the competition. It even leads to an

increase in corruption. And so the government needed to change their

trade policy to promote ease of doing business in the country.