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Industrial policy.

 INDUSTRIAL POLICY PRIOR TO 1991

In the initial years, industrial policy in India played a larger role in the industrialization of India. Moreover, on account of shortage of intermediate goods such as cement, coal, steel, etc. and limited industrial output, the government maintained strict price and quantity regulations over the private sector.

Industrial Policy Resolution of 1948 

It divided industries into four categories:

Industries where state had a monopoly

This category had three industries:

  1. Arms and ammunition
  2. Atomic energy
  3. Rail transport

Mixed sector had six industries

  1. Coal
  2. Iron and steel
  3. Aircraft manufacturing
  4. Ship building
  5. Telephone and telegraph
  6. Mineral oil

In this category, new undertaking could only be established by the state, but the existing private undertakings were allowed to continue for 10 years. After this period, the government would review the situation and existing undertakings where necessary would be brought under government control on payment of compensation under industrial policy in India.

Industries involving high government control

Eighteen industries were put under this category. In these industries, the government did not involve directly but provided strong regulation and direction such as sugar, automobiles, fertilizers, paper, cement, etc under industrial policy.

Field of Private Enterprise

All other industries were left for the private sector. However, the state could take over any industry if progress was not satisfactory.

Industries (Development and Regulation) Act, 1951 

The act was passed to attain industrial development in India under strictly regulated environment.

Provisions of the act:

  • Licensing provisions: Business undertakings were required to take license for production. Even increase in manufacturing required approval of the government.
  • Allocation of raw materials based on sanctioned output: The government sanctioned quantity of output that could be produced by an industrial undertaking. Accordingly, raw materials were allocated to the undertaking.
  • Control over prices: The government regulated the price of the output produced by the industrial undertaking under Industrial policy in India.

Rationale Behind Pre-1991 Industrial Policy:

Essential raw materials such as steel, coal, cement, etc. were limited. These raw materials were allocated among various industries. Thus, the output of industrial policy in India was restricted because without restrictions, profitable industries might produce at the cost of less profitable industries, creating a serious shortage of certain type of goods.

Also, there was a possibility that resources would be diverted towards luxury industries benefitting small sections of the society and ignoring essential industries involving large sections of the society.

As the output of the industrial policy in India was limited, the demand for the output was high. Consequently, it was important to regulate the prices of the output.

Moreover, the government was a significant investor in the economy because the private sector lacked funds. The private sector develops financial capability with industrialization of economy. However, under the British rule, India witnessed little industrialization.

Criticism

  • Delay in industrial development: Business approvals were given after a long time period. Moreover, excessive approvals and regulations hampered industrial policy in India development.
  • Concentration of industry in a few hands: People with strong political and administrative links were able to secure licenses.
  • Excessive regulation: Moreover, businesses were required to follow too many regulations. Inspectors \were appointed under these regulations. On account of wide powers enjoyed by the inspectors, the era was called inspector raj.
  • Control over output and prices created black markets for many commodities. Some goods were even sold at a very high premium.

Movement Towards Liberalization

Various liberalization measures were announced under the industrial policy in India licensing policies of 1970, 1973, and 1978. Moreover, many measures were taken in the 1980s to liberalize the industry as follows:

  • Exemption from licensing: The limit for requiring license was enhanced. Most of the industrieal policy in India were exempted from licensing requirements.
  • Regulations on the use of foreign exchange were also reduced.

ECONOMIC REFORMS: LIBERALIZATION, PRIVATIZATION, AND GLOBALIZATION

Liberalization

Liberalization of the economy means reduction in restrictions over business organizations in the economy. It is similar to de-regulation.

What was the need for de-regulation?

  1. Excessive restrictions increase the cost of business and reduce the opportunity for business. For instance, license restrictions to approve capacity expansion reduce the opportunity for business. Similarly, compliance with too many laws raises the cost of operating business.
  2. Higher cost of functioning makes business uncompetitive, and loss of opportunities reduces the growth of business. Growth of the private sector contributes to the overall growth of the economy. Thus, excessive restrictions hamper the growth of the economy.
  3.  India could undertake steps towards liberalization with gradual surplus availability of raw materials such as steel, cement, coal, etc. Moreover, the public-sector units were incurring losses and posing heavy burden on state finances.
  4.  It was expected that with liberalization of economy, many private players would enter each industry and competition among them would lead to availability of good-quality goods at cheap rates.

Liberalization in India

Pre-1991 liberalization attempts:

Attempts were made to liberalize the economy in 1966 and 1985. The first attempt was reversed in 1967. Thereafter, even stronger restrictions were imposed. The second major attempt was in 1985. The process came to a halt in 1987, though 1967-type reversal did not take place. In the 1980s, the government started reforms in the direction of liberalization.

Economic crisis:

Foreign exchange shortages started emerging in 1985, and by the end of 1990, the foreign exchange reserves had reduced to the point that India could barely finance three weeks’ of imports. It had to pledge gold as part of a bailout deal with the International Monetary Fund (IMF). Most of the economic reforms were forced upon India as part of the IMF bailout.

In response, the government initiated the economic liberalization of 1991. The reforms abolished the Licence Raj in most of the industries, ended public-sector monopolies in many industries, and reduced restrictions on foreign direct investment in many sectors.

Privatization

Privatization refers to a greater role of the private sector in the economy either through establishment of new businesses under private ownership or through transfer of existing businesses under the public sector to the private sector.

Liberalization leads to privatization. In other words, fewer regulations facilitate growth of the private sector in the economy.

Public Sector and Private Sector:

Economies are divided into two sections: public sector and private sector. The public sector represents activities in the areas of enterprise or industry that are handled by various government agencies. The private sector represents all other business operations that are not managed directly by a government entity.

Globalization

In economic terms, globalization refers to the process of integration of domestic economy with the outside world. It refers to free movement of goods, services, investment, and technology among nations of the world. Globalization is supported by the theory of comparative cost advantage.

Impact of globalization:

Globalization impacts every aspect of a nation such as economy, society, culture, education, family system, and state sovereignty (state sovereignty refers to the freedom of a state to manage its affairs).

Globalization integrates the economy with outside economics and thus creates dependence of economy and hence reduces the states’ sovereignty. At present, most of the nations of the world are engaged in integration with other countries. Such integration is facilitated either through free-trade agreements or by an international body, namely, World Trade Organization.

Theory of comparative cost advantage:

The theory favours international trade. It states that the source of production which can produce goods at the lowest prices globally should be encouraged. In other words, various local factors favour production of different commodities at different places. Thus, specialization in production should take place on the global level.

This global specialization results in the following benefits:

  • It encourages the most efficient use of capital. For instance, let us suppose that Z2000 crore is required to be invested for oil exploration. The amount of output secured on this investment will vary across the nations of the world. As a result, this amount will be invested at a place where it is expected to yield maximum output.
  • Consumers are also able to obtain the best-quality goods at the lowest prices. Thus, consumers save money, which they can either invest or use for consumption purposes, which further results in higher standards of living. For instance, consumers are required to pay less for imported oil from Saudi Arabia than they would have to pay for the oil produced in India.

Thus, global trade enhances global wealth by facilitating the best possible use of capital and cost savings to consumers.

Advantages of globalization:

Apart from the above mentioned benefits, globalization has the following benefits:

  • Globalization facilitates large-scale production and thus facilitates economies of scale.
  • Globalization leads to competition at the global level, which encourages innovation, adoption of best practices, and exchange of learning.

Economies of Scale

Economies of scale refers to the cost advantage per unit that arises with increased output of a product. Economies of scale arises because with the increase in quantity produced, per-unit fixed costs decrease; i.e. the greater the quantity of a good produced, the lower the per-unit fixed cost because these costs are spread out over a larger number of goods. Economies of scale may also reduce variable costs per unit because of operational efficiencies and higher bargaining power with suppliers.

Example:

Assume you are a factory owner and are considering printing brochure for your customers. The printer quotes a price of ₹5000 for 500 brochures, and ₹10,000 for 2500 copies. While 500 brochures will cost you ₹10 per brochure, 2500 will only cost you ₹4 per brochure. In this case, the printer is passing on a part of the cost advantage of printing a larger number of brochures to you. This cost advantage arises because the printer has the same initial set-up cost regardless of whether the number of brochures printed is 500 or 2500. Once these costs are covered, there is only a marginal extra cost (cost incurred on paper and ink) for printing each additional brochure.

In the above example, the initial set-up cost is the fixed cost. Fixed cost is the cost that remains same irrespective of the level of output (or quantity produced). The cost of paper and ink is the variable cost. Variable cost is the cost that changes with the change in the level of output.

Disadvantages of globalization:

Many disadvantages may arise on account of globalization:

  • Globalization increases the level of competition. Entry of multinational companies in the local market creates high competition for local businesses. Some of these businesses may not be able to survive the competition and collapse.
  • Globalization may create dependence of an economy over other economies for its supplies. Such supplies may not be available in times of dire need.

Open Economy Versus Closed Economy:

A closed economy is one in which the country trades only within its own borders. Usually, countries with closed economies under industrial policy of India are entirely self-sufficient and neither export nor import the goods. In an open economy, the country trades with other nations as well. Closed economies are less common in the modern times.

SOCIALIST VERSUS CAPITALIST ECONOMY:

Socialist Economies

In socialist economies, business is largely controlled and owned by the state. Thus, there is virtual absence or only little presence of private-sector investment. In these economies, the state plays the role of both investor and regulator. In these economies, prices of goods and services are determined by the state.

Advantages of socialist economy

  • In a socialist economy, prices of essential commodities are deliberately kept low to enable access to everyone.
  • The government is the main employer. It attempts to provide employment to a maximum number of people. The pay levels for employees at various levels are similar.
  • The income levels of large population are similar and thus there is equality in the society.

Disadvantages of socialist economy

  • Economic activity is under government control. Government undertakings are usually inefficient. Moreover, there is a lack of economic incentive for private individuals other than fixed salary. Thus, there is overall inefficiency in the industrial policy in India economy leading to higher cost of production of various commodities.
  • These economies trade less with outside economies. Their whole economic output is produced by large government undertakings that are monopoly in their respective field. Thus, there is virtually no competition in these economies. Lack of competition and absence of economic incentive discourage innovation in these economies.
  • Inefficiency in production causes shortage of various commodities. Consequently, black markets develop for various commodities.
  • Excessive regulations followed in these economies make the state very powerful at the cost of individual freedom.

Capitalist Economies

Capitalist economies are the type of economies in which business is largely controlled and owned by the private sector. Thus, there is virtual absence or only little presence of the public sector in economic activity. In these economies, the state plays the role of the regulator only. The private sector plays the role of investor. In these economies, prices of goods as well as services are determined by market forces of demand and supply.

Advantages of capitalist economy:

  • There is sufficient incentive for private individuals to work hard in the form of increase in wealth. Thus, there is overall efficiency in the economy leading to lower cost of production of various commodities.
  • These are many private players producing the same output. Thus, there is a very high competition in these economies. High competition and economic incentives encourage innovation in these economies.
  • Prices are determined by markets and not by governments. Thus, prices reflect the actual value at which customers are willing to buy and sellers are willing to sell.
  • There is a high level of freedom to individuals in these economies on account of lower regulations.

Disadvantages of capitalist economy:

  • In a capitalist economy, prices of even essential commodities are determined by market forces. Thus, the prices of essential commodities may escalate to such a level where these commodities are unaffordable for a larger section of population.
  • The private sector is the main employer. The approach of the private sector is to use minimal workforce to produce maximum output. Machines are preferred over human beings to carry out work. Thus, these economies may have large unemployment rate despite high levels of economic growth.
  • The income levels are grossly unequal. A large section of the population owns little wealth, and a tiny section of the population owns large wealth.

Relation between Liberalization, Privatization, and Globalization:

Capitalist economies are also liberalized, privatized, as well as globalized economies. This is because in these economies there are a few restrictions, there is high presence of the private sector, and these economies are more inter-related to other economies of the world.

On the other hand, socialist economies are less liberalized, have no (or less) presence of the private sector, and have no (or less) trade with other economies of the world.

INDUSTRIAL POLICY SINCE 1991

The Industrial Policy 1991 was launched to attain faster economic growth through participation of the private sector. Accordingly, steps were taken towards liberalization, privatization, and globalization

Provisions of Industrial Policy 1991.

Presently, only five industries require license on account of safety and strategic considerations:

  1. Production of alcohol
  2. Tobacco-based products
  3. Defence equipment and electronic aerospace products
  4. Industrial explosives
  5. Specified hazardous chemicals

In 1991, only eight industries were reserved for the public sector. At present, only two industries are reserved for the public sector:

  1. Operation of railways
  2. Atomic energy

Policy for Medium, Small, and Micro-Scale Industry (Small-Scale Industry):

Some items are reserved for the small-scale industry under industrial policy in India stry can produce these items. The list of reserved items is reviewed on a continuous basis. At present, only 20 items are reserved for the small-scale sector. These items can also be manufactured by large-scale units, provided the unit exports 50% of the output.

Items are reserved for the small-scale sector to insulate it from competition by the large-scale industry. However, the industrial policy in India of reserving items was proving to be counterproductive. Earlier, over 600 items were reserved for the small-scale sector. These items have been de-reserved on account of the following reasons:

  • Small-scale units were deliberately avoiding investment in the plant and machinery to maintain their classification under small-scale units.
  • Reservation of some items for a few units was leading to inefficiency in their production and consequently higher production cost for these items.

Policy for Foreign Investment:

The government has taken steps for promoting foreign investment in India. These steps are discussed under the chapter on foreign investment.

Disinvestment by the government:

Disinvestment (by the government) refers to the sale of assets or share in various public-sector undertakings to private enterprises. Disinvestment is the opposite of nationalization. Nationalization refers to the change of ownership of business from the private to the public (government).

On account of disinvestment, assets are transferred from the public sector to the private sector. On the other hand, during nationalization, assets are transferred from the private sector to the public sector.

Disinvestment receipts, being capital in nature, are transferred to a fund called “National Investment Fund (NIF)”. The corpus of NIF is of a permanent nature, and NIF is professionally managed by selected public-sector mutual funds, namely, UTI Asset Management Company Ltd., SBI Funds Management Private Ltd., and LIC Mutual Fund Asset Management Company Ltd.

Around 75% of the annual income of NIF is used for financing selected social sector schemes that promote education, health, and employment. The residual 25% of the annual income of NIF is used to meet the capital investment requirements of profitable and revivable public-sector undertakings. The NIF is under the Department of Investment and Public Asset Management, Ministry of Finance.

MEDIUM, SMALL, AND MICRO INDUSTRY:

Medium, small, and micro enterprises (MSMEs) are identified on the basis of investment in plant and machinery as follows:

 

Manufacturing sector

 

 

 

Enterprises Investment in plant and machinery
Micro enterprises Does not exceed ₹25 lakh
Small enterprises More than ₹25 lakh but does not exceed ₹5 crore
Medium enterprises More than ₹5 crore but does not exceed ₹10 crore

 

 

 

 

Enterprises Service sector
Investment in plant and machinery
Micro enterprises Does not exceed ₹10 lakh
Small enterprises More than ₹10 lakh but does not exceed ₹2 crore
Medium enterprises More than ₹2 crore but does not exceed ₹5 crore

Contribution of MSMEs in India

Production:

MSMEs contribute towards nearly 40% of the industrial output.

Employment: The small-scale sector in India generates the largest employment opportunities, next only to agriculture. It has been estimated that ₹100,000 of investment in fixed assets in the small-scale sector generates employment for four persons. Among MSMEs, food products industry ranks first in generating employment, providing employment to 13.1% of industrial workforce.

Export: The small-scale sector plays a major role in India’s present export performance. Around 45-50% of Indian exports is contributed by the small-scale sector. Direct exports from the small-scale sector account for nearly 35% of total exports. Besides direct exports, it is estimated that small-scale industrial units contribute around 15% to exports indirectly. Exports from the small-scale sector have been mostly fuelled by the performance of garments, leather, and gems and jewellery.

To conclude, because of its less capital-intensive and high labour absorption nature, the small-scale sector has made significant contributions to employment generation and also to rural industrialization. This sector is ideally suited to build on the strengths of our traditional skills and knowledge.

Challenges:

The MSMEs suffer from inadequacies in capital, technology, and marketing. In the era of liberalization and globalization, government support to this sector is going to reduce. For instance, earlier more than 600 items were reserved for this sector. However, at present only 20 items are reserved.

Benefits of an MSME Registration:

To avail of these benefits, the organizations that qualify must get an MSME or SSI registration (regulated by the MSMED Act), which is among the easiest of government registrations to be granted.

  1. Benefits from banks: Banks and other financial institutions recognize MSMEs and have created special schemes for them. This usually includes priority sector lending, which means that the likelihood of business being sanctioned a loan is high and even at lower interest rates.
  2. Tax benefits: Depending on business, one may enjoy an excise exemption scheme as well as exemption from certain direct taxes in the initial years of business.
  3. Benefits from state governments: Most states offer MSMEs subsidies on power, taxes, and land in state-run industrial estates. In particular, there is a purchase preference on goods produced by MSMEs.
  4. Benefits from central government: The central government, from time to time, announces schemes to benefit MSMEs, such as the MUDRA scheme, subsidies, etc.

TREND IN INDIAN ECONOMY:

The Indian economy has always been a mixed economy in which both the private and public sectors have coexisted. However, the relative roles of the public and private sectors have drastically changed in the Indian economy. At the time of independence, the public sector played a major role in the economy on account of the following reasons:

  • To provide a strong base for industrial development, heavy investment was required in core and large-scale industrial units. Only the public sector had the capacity to make large investments.
  • India had a colonial history. During the colonization, industrialization could not be carried out. As a result, the private sector did not have the necessary resources to play a major role in the economy.
  • There was heavy shortage of essential raw materials such as coal, steel, etc., which were utilized by multiple industries. Thus, there was a strong need to regulate the use of these raw materials.

The public sector created conditions for the overall growth of the economy. The private sector witnessed higher growth than the public sector.

In the late 1960s, the government felt that the private sector is catering to the urban rich population and ignoring the poor and rural population. To enhance services to rural and poor people, the government undertook nationalization of important industries such as banks, insurance companies, coal mines, etc.

From the beginning of the 1980s, the government began to reduce regulation. Consequently, the private sector in India grew at a very fast rate.

In 1991, another era of economic reforms began towards liberalization. Over the time period, the private sector was allowed in various industries such as banks, insurance, telecom, shipping, etc. Similarly, restrictions on foreign trade and investment were also reduced. Moreover, the government undertook disinvestment in various public sector undertakings.

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